I’ve often stated that one of the most important factors in your success as a real estate investor is your ability to select, screen, and retain quality tenants. This is something that I think I’m pretty good at, which has helped me as an investor.

I was going to write an article about this not to long ago when, bam, I ran into a problem: tenants who stopped paying.

The tenants were a flaky young couple that I knew I might be taking a chance back when they signed the lease in May. But I decided to rent to them and mitigated my risk by signing a short lease (six months, with renewal contingent on timely payment), charged them first and last month’s rent upfront, plus one month’s rent as deposit. I won’t go through the boring details, but they ended up breaking the lease and abandoning the property while they owed me money. If you find yourself in a situation like this one here are some points to keep in mind.

• Property codes, generally speaking, exist to protect the tenant. However, most tenants who end up in situations like this have not followed the law. On the other hand, you have – assuming you’re a responsible landlord. The party who is on the right side of the law (you) negotiates from a position of considerable strength.
• Ensure that you use a current, legally compliant lease contract that includes specific references to the property codes. For example, all of my leases state that tenants are prohibited from withholding payment for any portion of any month’s rent on grounds that the security deposit is security for unpaid rent, and that bad faith violations may subject the tenant to liability up to three times the rent wrongfully withheld plus Landlord’s reasonable attorney fees.
• We all have our own style, but in tenant/landlord disputes you want to be more like Agent Friday (“just the facts, ma’am”) than, say, John Madden. Communicate clearly, calmly, and factually. Quote relevant state property codes, chapter and verse. Read the relevant clauses from the lease that the tenant signed. Use the facts, the contract, and the law as a blunt instrument.  Don't call or email when you're angry. 
• Back up phone calls with written communication – email or a leter. Tell ‘em on the phone, the follow up in writing to tell ‘em what you told ‘em. Keep copies of everything.
• Once you feel a problem brewing, keep a written log of everything. Capture dates and times of phone calls and what each party said.
• Follow the law with regards to notices. You can’t just put deadbeats out on the street; you need to serve them with a Pay or Quit notice with the proper lead times. Consult your local property codes and know what your obligations are.

The idea of all of this is that you’ll be following a rational, well planned strategy. If you end up in front of a judge, either in an effort to evict the tenant or suing for damages, your ducks will be in a row.

This reminds me of my brother. Greg isn’t always right about everything, but if he offers to bet me about something then there’s a 99.9% chance he is. Greg hates to lose, so when he puts his money where his mouth is and offers to shake on a bet then I tend to back down. If you end up in court you want to be like Greg; you should know you’re going to win. Smart, ethical landlords don’t lose these cases.

And if you follow these guidelines then, in the end, the tenant (if he has a rational bone in his body) will often back down. That’s what happened in my case; they paid and got out, and I didn’t have to drag them to court. They saw the handwriting in on the wall.  Sure I wasted some time hammering out threatening letters and trying to chase them on the phone, but all in all it wasn’t a bad outcome.

There’s a conventional wisdom out there that higher-end properties bring good tenants and lower end properties bring problem tenants. In my experience, this isn’t necessarily true. Ask most buy-and-hold investors about what makes a good tenant and many will respond by recalling a specific tenant that they wish was the model for all their properties.

In my case, my example was in one of my most inexpensive properties; the tenants were a young family with no credit and not a lot of resources, but their references checked out and I rented to them, more or less, based on gut feel. And they were the best tenants I ever had: took great care of the place (flowers in the front yard), made minor repairs on their own and never were late paying the rent. Plus, they were a pleasure to deal with.

Your goal as an investor is to create a portfolio of properties filled with this kind of tenant. Identifying, attracting and retaining them is one of the most important factors to ensuring your success as a real estate investor. Getting the wrong tenant in your property is expensive in two ways: not only does it cost you money in repair, vacancies, and lost revenue – it can also cost you dearly in terms of investor burnout. Get a bad tenant or two and you’ll be ready to throw in the towel in no time, but if you develop a knack for renting to the right people then on the average month managing a property is as easy as cashing the rent check that shows up in your mailbox (on or before the first of the month!)

So what happens when you get a bad apple? Well don’t sit on your hands; take care of the issue. What follows are some fairly broad generalizations, but that’s how I conceptualize problems. Most of the situations I have dealt with fall, roughly, into these three categories:

In all of these cases the key is action. Good relationships don’t happen automatically; you have to work at them. But if you establish a good relationship with your tenant early in the process then it’s easy to maintain, and will help to make your investing profitable and less stressful.

Related Posts:

• Four tips for sniffing out illicit activity in your Investment Property
• Navigating the Eviction Maze
• Avoiding Investor Burnout

In January I announced a resolution for the New Year to sell a high-end property that had accumulated some equity and reinvest in a multi-family that generates better income. 

Well the first part of that mission has been accomplished; I sold the property, a three-story townhouse loft.  And what does that have to do with the headline on this post?  Well it highlights a couple of things that investors often overlook when screening for tenants.

1 :: Your tenant is a potential buyer.  I ended up making this sale to the tenant who was in the property.  This has some major advantages. 

Easier and cheaper for you :: No vacancy period.  No showings.  And no real estate agent – which means no commission. 

Easier and cheaper for the buyer :: No relocation costs, no inconvenience of moving

When the stars line up like this it tends to make it easier for the two parties to negotiate mutually beneficial terms.  So when you’re screening your tenants give extra points to applicants who might be potential buyers.  Note: (I’m not a rent to own fan – I’ll talk about this an another post soon.)

2 :: If you’re using a real estate agent to find a tenant make sure there’s not a clause in the contract which stipulates that she can come back and demand a commission in the tenant decides to buy the place from you in a year or two.  This is a flat non-starter for me.  If your agent demands that this is included then find someone else.  Going rate for placing a tenant here in Houston is one month’s rent – fair enough – but I don’t expect to pay the agent a big windfall in a year or two if I manage to build a relationship with the tenant and later negotiate a sale. 

Note:  as an investor you want to work with an agent who values your repeat business, not one who is trying to squeeze every cent out of each deal that you do.  Got a good agent (like I do)? Well share and let other investors know. 

Illicit activity is something that every landlord needs to be on the lookout for, and the methamphetamine (“meth”) epidemic that hitting some regions is adding new twists to this concern.  
The Sandusky Register in Ohio recently reported a story on the woes of a landlord there who is facing the economic blow of discovering that a tenant in one of his investment properties was running a meth lab .  

Aside from the obvious social and economic costs to the landlord, a meth lab has a particularly destructive impact on the building where it is housed.  Toxic chemicals can permeate any porous surface: drywall, wood floors, carpet, ceilings – practically all of the materials that go into building a house.  

The best case is that this will turn into a nasty cleaning bill.  Worst case – depending on how long the activity was going on – is that your rental property becomes a teardown candidate.  

A meth lab isn't the only type of illicit mischief that your tenants might be getting into; I'm sure you could come up with a list of shady activities that that would make you life difficult if you were to make the mistake of signing a lease with a bad apple.  But in many ways criminals aren't too creative, so there are some patterns that may tip you off that something bad is going on in there.  Here are four things to look out for:

• 1:: Tenant pre-pays rent: six months or even a year.  This is a tough one.  Investors know that cash is king, and it’s tough to turn down a big pre-payment.  But be aware that there may be a darker motive.  By paying several months in advance the tenant may be sending you a signal that you don’t need to come around for a while.  Not all pre-payments are sinister in nature (I’ve accepted prepayments before) but when an applicants offers it should cause your antenna to go up.
• 2:: Tenant pays exclusively in cash: Again, cash is king – but resist the temptation to look the other way.  Nuff said.
• 3:: Lots of traffic at odd hours:  You’ll notice this if you live nearby, but you might not if you don’t.  That is, unless you make an effort to – which you should.  
• 4:: Tenant never contacts you:  I don’t get a lot of calls from my tenants, so it’s not like my phone is ringing off the hook in the middle of the nights or I’m schlepping around unclogging toilets.  Far from it; well maintained investment properties inhabited by responsible, well screened tenants are very easy to manage and require very little of my time.  But that said – every blue moon I’ll get an inquiry from even the lowest-maintenance tenant I have.  Be suspicious of a tenant who never ever calls you, not even once.  That guy might be sending you a message that he doesn’t want you coming around.  So go check him out.

There are some other things to look for specifically when it comes to sniffing out meth labs.  If that’s a particular concern in your area then check out the KCI Anti-Meth site.  

I find it interesting that one finds so many references in the popular press about the horrors of being a landlord. 

Consider this blurb that appeared recently on Money.com:  

• “…if you can't imagine yourself answering late-night calls about clogged toilets, your choices come down to holding your property vacant or selling.”

Or this gem from the MSN finance page: 

• “…Just when you thought being a property magnate was going to be glamorous, that late night phone call from your tenant saying they have left the bath running and flooded the place is just what you didn't need.”

Note that these comments were written by journalists, not by real estate investors.  Experienced investors will know that if you’re judicious about selecting your tenants and if you maintain your properties responsibly then your landlord duties won’t overwhelm you.  I’ve yet to receive a call in the middle of the night. 

Sure there are challenges to landlording, and yes things will break – but establishing a good relationship with your tenants and finding a handyman that you trust go a long way towards helping you maintain your work life balance. 

Principle 2: Select the right tenantLast month I started a series of posts on Avoiding Burnout in Real Estate Investments.

Before I bought my first investment property my wife ran out and rented Pacific Heights on video and forced me to watch it. Perhaps you remember this movie: Michael Keaton plays a evil con-man who rents half of a San Francisco duplex from a naïve yuppie couple then turns their lives into a living hell.  Bloodshed and drama ensue.
 
Well it’s not a great movie so I won’t recommend that you sit through it, but I will share with you the film’s primary insight: if you’re renting a high-end property do a credit check the applicant before signing the lease.  Housing laws vary from state to state, but one trait that they have in common is that they’re designed to protect the tenant, not the landlord. If you end up renting to a family who destroys your house or refuses to pay the rent then you’ll surely spend a fortune and a lot of time and effort getting them out.
 
If you’re renting a lower-end property then doing a credit check on the applicant is less likely to yield any useful insights since applicants for inexpensive properties may not have established credit histories. You’ll have to rely on other methods of evaluating applicants, such as references from previous landlords and from employers. Call the references. Follow up.
 
And lastly, learn something about the applicants when you meet them (and yes, you should meet them – don’t leave this to your realtor). Do they arrive on time? Do they strike you as someone who will treat your property respectfully?
 
In the end you’ll have to trust your instincts. Having a vacancy is stressful, but it’s not nearly as stressful as having a unit occupied by a tenant who makes your life difficult. It’s not a good idea to indiscriminately accept the first applicant who waves some cash in your face, tempting though it may be.  Remember – housing laws are first and foremost designed to protect the tenant; they’re not designed to protect your rights as a landlord.  Renting your property to the wrong person is an expensive mistake.
 
But it’s not just about finding the right tenant.  It’s also about taking care of your tenant once he or she has signed the lease. Being mindful of the obligation that you have to the family who is living in your property is a moral/ethical issue, but just as importantly it’s a key business issue as well. Doing the right thing goes hand-in-hand with economic success. I’ll talk about that in my next post.