Seven Ways to Prevent Unpaid Rent
Real estate investors spend years or even decades building up a portfolio of rental properties but just a few consecutive months of unpaid rent could put all that hard work in danger. Any economic downturn can make it harder for renters to make their payments. In addition, during the COVID-19 recession some community groups called for “rent holidays” and encouraged renters to not pay their rent. As the economy works in cycles, this lost rent prevents property owners from paying mortgages which in turn can deepen the recession leading to wider job loss combined with an increase in foreclosures. If foreclosures rise, more renters will lose their housing and if they failed to pay rent, their credit will be damaged which will make it harder to find future housing. Fortunately, there are ways to mitigate the risk of unpaid rent; below are seven options to consider.
1. Respect: The people renting your properties will treat the property better if they feel like it is their own home. They are residents in your property and giving them the proper respect, the same respect you would appreciate if you were renting, goes a long way. All communication with your renters should be clear and courteous. Any interruptions in their lives such as inspecting the property or performing regular maintenance should be well coordinated in advance. And when it comes to collecting any overdue rent, always be professional. Do not make threats or use obscenities, as this will only escalate the situation and make it more stressful for all parties involved.
2. Enforce: Every real estate investor must use a well drafted lease that is reviewed by a local attorney to ensure it conforms with local laws. Do not try to save a few dollars by creating a lease on your own. In addition, you must consistently enforce all the terms of your lease. For example, if your lease requires issuing a late notice after five days, you must issue it every time. If your lease has a late fee of $50 for past due rent, enforce it. Your lease only protects you if you consistently enforce it. If you fail to enforce these terms, your renters can make an argument that you have waived them.
3. Automation: If you want to get paid, automate the process for your renters. No one wants to chase down a rental check especially when economic times are hard. When you bring on a new renter, set up automated rent payments as part of the on-boarding process. There is a great list of automatic payment options here from BiggerPockets.
4. Reserves: For each rental property, set aside 5% of annual rents as vacancy reserves. Diligently saving these reserves each year will enable you to cover any vacancy periods including rental losses caused by unpaid rent. Failing to set aside adequate vacancy reserves is a common mistake made by new investors. They don’t realize their mistake until they face a cash crunch. If you are buying rentals is also good practice to set aside another 5% of annual rents for capital expenses and 5% for common repairs. These reserves will provide the resources to weather multiple months of unpaid rent.
5. Quality: As an investor I purchase properties that I would personally want to live in. These are well maintained properties close to good schools, and walking distance to grocery stores and nice parks. They are also near public transportation so renters can travel to work without a car. These types of properties tend to have stronger demand, so even if you need to slightly lower your rents, you will find qualified renters. Also, renters in these areas tend to stay longer which reduces vacancy and property turnover costs. Having renters that stay for five or ten years is a great way to increases long-term returns. It also helps to purchase in neighborhoods where it is unlikely or prohibited to build large apartment buildings. Hundreds of new rental units can flood the market with competition bringing down rents and making it harder to find qualified renters.
6. Screening: To be a successful real estate investor you must properly screen every potential renter; this includes both credit and criminal background checks (as permitted in your location) and verifying all employment information. In addition, you need to apply your screening requirements in a consistent manner to every applicant. Do not violate your minimum requirements such as accepting a renter with a credit score that is below your minimum. Also set standards such as requiring all renters to have monthly income equal to 3 times the rent and no prior criminal convictions involving violence or physical harm. Breaking these minimum requirements often leads to more difficult renters.
7. Insurance: Investors can purchase rent guarantee insurance for commercial or residential properties to provide monthly payments if a renter stops paying. This insurance usually covers a limited period such as six months or less. Rent guarantee insurance is not widely used by smaller scale real estate investors because many landlords are looking to reduce expenses and prefer to self-insure with the vacancy reserves described above. Keep in mind that if you fail to comply with the terms of your lease or your property becomes uninhabitable, you will become ineligible to collect on this insurance policy.
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