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Question: Several years ago my wife and I decided to buy a rental property. Since real estate is my profession, we thought it would make sense to have some real estate as part of our long term investment program. We got a good buy on a little single family home (with great owner financing) in a nice area of town.. We had a very small “after tax” positive cash flow for the first few years and now that rents have gone up we have a pretty decent “before and after tax” cash flow. The increased value of the property makes my “net worth” look a lot better on paper than it really is. It went down in value somewhat recently, but it was just a “paper loss” for us. Here’s my problem: tenants drive me crazy. We had one fellow who kept paying with bad checks. A young couple (who looked great on paper) had so many late night parties that the neighbors kept contacting me to do something about it. Here’s my question: is it all worth the effort?
Answer: Don’t loose heart. You’ve solved the toughest part of the problem - acquiring an income producing piece of real property that is providing you with a positive cash flow every month, an income tax shelter, and a hedge against inflation. Yes, real property values can go down, but the best predictor of future trends is the past. Over the years, wise investments in real property has been a winner.
The fact that you have yet to completely master the human factor in the equation shouldn’t deter you from persevering. Here are some specific sanity saving suggestions.
Your Secret to Success - Tenant Selection. I can speak from experience on this one. My wife and I have had a few single family rentals over the years. Initially I managed them. I was not a great landlord. I tended to see too much virtue in potential tenants. I was not consistent in doing credit checks and calling previous landlords. I once rented to a young woman who looked and acted as though she could have been the leader of the local Girl Scout troop. According to police reports I read later, that was a rather severe error in judgement.
We now have two small residential rentals and my wife has taken over all the landlording duties. She’s all business. She personally checks references and has a formal credit check done. Since they are both nice little units in quiet and well kept neighborhoods, we typically have several applicants when a vacancy occurs. The mortgage is now completely paid off, and rents keep edging up. The only thing that causes some unease now is contemplating the income tax hit if we sold. While on that point, I would strongly advise you to locate a tax professional who has expertise in real estate. Rules keep changing and what may be a great opportunity this year could vanish in a heartbeat. The best example of that is how the capital gains tax rates tend to fluctuate.
Here’s my main point: assuming you have an economically viable property (it appears that you do) the difference between being a calm, contented landlord, and a harried, frazzled one is tenant selection.
Fair Housing - Get Up to Date, and Stay There! There are federal Fair Housing Laws and there are state and local laws. It is absolutely critical that you become thoroughly familiar with all of them. What may appear to be an innocent and reasonable method of selecting your tenants to you, could turn out to be a violation of the law. Trust me, you don’t want to go there.
Hiring Help. If you like the idea of having a rental property, but you decide you’re just not cut out for the every day business of managing it, you could always hire a property manager. While it’s true you would have to pay a percentage of your rental income each month to the property manager, the peace of mind may be well worth it. Since your rental income exceeds your expenses, you do have some cushion. Remember all the things you’ve learned about “agency” as a real estate professional. The same agency relationship would exist in this instance, except here you would be the principal and the property manager the agent, and would owe you all those great fiduciary duties. It’s nice to have the shoe on the other foot for a change. If you do hire someone, do some thorough checking, including calling individuals whose property the manager now handles. Get someone who has experience in managing single family homes.
Do Your Homework and Be a Joiner. While the long term payoff in being a rental property owner can be substantial, there are some other potential pitfalls, in addition to the possible strain on your mental health. Each community of any size will have an organization composed of rental property owners whose goal it is to keep everyone up-to-date on everything from fair housing requirements to state landlord-tenant laws. Find it and join it. The best national level reference book I’ve ever seen on the subject is titled Landlording, by Leigh Robinson. It’s big, user friendly, and updated frequently. You can check it out as www.Landlording.com. Amazon.com has a “search inside” feature you can use to preview the book. If there is a state specific book on the subject, that would also be a wise investment.
Looking Down the Road. If you satisfactorily resolve your human relations challenge you may even conclude that it would be good to expand your real estate holdings. As an active agent, you’re going to be in an excellent position to do that. You’ll become a good judge of property values, and will be well informed on financing options. Remember that each state has specific rules regarding real estate professionals who purchase real property. As a minimum, in most instances it involves disclosing your licensing status.
If you think your net worth and cash flow looks good now, think what it could be in ten or fifteen years, assuming rents and property values do what they’ve historically done - creep ever upward. Happy landlording!
Best Regards, Ken Edwards