In the Ring of Investment Protection | Think Realty | A Real Estate of Mind
Investing Strategies

In the Ring of Investment Protection

RealtyMatters-BoxingGloves

An anecdote on rent pricing, property management, and asking the tough questions

How hard can it be?” a prospective client for my former property management business asked.

“Well, it really depends on…” I started. Before I completed my sentence, he couldn’t help himself from throwing another jab, trying to get me on the ropes.

“Depends on what?” he interjected. He was setting me up for a knockout blow to show he knew more than I did. At least he thought he was. But I was ready to counter.

It depends on how well the property is positioned against the others in the market, how clean it is, how well it’s maintained. That impacts pricing, and how well it compares to competitive properties, which of course assumes knowledge of the market and competitive offerings. It depends on the financial strength and position of the owner, to ensure the lease terms account for those considerations.

Rent pricing is a combination of art and science. Have you researched nearby vacancies to make sure you’re getting top dollar? How easy is it for a prospective renter to inquire, prequalify, and apply? If good systems are in place, the lead-to-lease ratio will indicate if something is amiss. 

At this stage, the renter application and evaluation of that renter as a candidate is critical to getting a signed lease. This, of course, depends on how well the screening is done. Experience teaches how to check references, what questions to ask, and what documentation is required to send to those who are not accepted.

Before he can get a word in, I continue.

By the way, it’s important to know which questions are legal to ask and which are in violation of Fair Housing laws. It’s possible your “prospective renter” is auditing you for discriminatory practices. Assuming you get the selection process unscathed, it’s time for lease signing and collection of security deposit. Do they have pets? A service animal? Is a reasonable accommodation necessary? Are you aware of the differences, and the subsequent documentation requirements? Saying the wrong thing could be in violation of the Americans with Disabilities Act (ADA), which may invite a lawsuit, a steep fine, or both.

Once that lease is signed and the renter takes possession, the owner effectively relinquishes legal rights to the property to the tenant. Do you understand the legal significance of that? How strongly written is your lease? 

He thought he had me on the ropes, set up for his knockout punch, schooling me on why the fees I charged were too high. But instead, he found himself in the corner of the ring, sitting on a three-legged stool, with a proverbial black eye.

Being creative with investing in real estate isn’t just about creative deal making. It’s about creative thinking, analysis, and operations: understanding what could go wrong, managing the property to prevent that, and knowing how to protect your investment. It’s like the three-legged stool: each leg of the stool is necessary for your business to remain upright. Remove one of the legs and the stool tumbles, sometimes with you on it. 

RealtyMatters-BoxingRingRisk reduction hinges around three key areas with property investment whether it’s a buy-and-hold, fix-and-flip, or another type of investment. The categories are fairly universal and can be tailored to your investment strategy:

Financial: Elements such as rent payments, rent delinquency, turnover costs, rent escrow, lease terms, finance costs, financial liability and cross collateralization all matter. Are proper reserves available if the project goes over budget? Having reserves is essential. It’s important to not be over-leveraged. Historically, it’s inevitable to have up and down markets. Financial management and operating philosophies should account for up and down cycles.

Legal: Laws between housing providers and renters has astonishing variation from state to state, and even vary greatly across jurisdictions within the same state. Doing something improperly can cause a litany of problems that often cascade. Potential exposures can be managed with appropriate administrative oversight and compliance with local and state laws. Legal documentation is critical. New investors may spend tens of thousands of dollars of their own money for down-payments or repairs, and leverage the balance of an investment purchase with tens of thousands in debt financing; yet, be unwilling to spend a few hundred dollars on a well-written lease document.

Asset Protection: Whether renting or flipping, protecting the asset and thinking creatively can mitigate damage from unanticipated costs. A proper and thorough inspection of physical infrastructure may provide for a value-add and negotiating opportunity. On the other hand, a less thorough inspection based on previous use and condition of the property may result in unforeseen costs. For instance, one of my previous clients had found a niche with buying foreclosures with hard money, fixing them up, getting them rented and then doing a cash-out refinance. Many foreclosures sit for long periods of time, unused, creating hidden problems. As a result of a sewer backup in one of his properties, which occurred after his renter had moved in, his inspections always include running a camera down the sewer line to verify there is no hardened accumulation. 

The Platform of Interdependencies

Each of those legs provides support for the platform. They all are interdependent, requiring support from the other two to function properly. As technology and availability of off-the-shelf systems to assist in each of those areas becomes ubiquitous, it will become easier to manage those major risk components. The key is to be creative with identifying possible risk components, beyond the obvious, to anticipate and protect your asset(s) from toppling over from being on an unstable three-legged stool.