Ask anyone who has been a landlord, and they’ll tell you one of two things: they either loved it or they hated it. The difference between the two usually depends on how well the property owner was able to prepare for and respond to unforeseen challenges.
Here are the top three common challenges that can make or break it for an inexperienced property owner, and what steps to take to avoid those pitfalls:
1. Renovations end up being more expensive and more complicated than initially anticipated. Many first-time investment property owners have little experience in the construction industry. They might buy a home and expect renovations to take a few weeks, but then contractors get in and find unanticipated problems once they start getting into ceilings and walls. There could be mold behind a wall, pipes covered in asbestos, and more. What may seem like a straight-forward project can turn into a much larger one, much more costly, and more time-intensive. Prepare by setting aside at least 20% of the original project costs as a contingency in the event of overruns, and prepare to have a few additional months’ rent in reserves in case it takes longer to get tenants in the building.
2. Taking on problematic residents through current lease agreements. Sellers sometimes unload their properties because of headaches with their tenants, only to find those headaches passed on to you as the new owner. That’s why some investment home buyers require the property to be delivered vacant at closing – allowing them to find and screen their residents. Others, though, are eager to get cash flow and will allow the tenants to stay (unaware that residents might be problematic).
If this is the route you want to go, be sure to do your due diligence in advance. Who are the current residents? How long have they lived there? What do they pay in rent? What are the terms of their lease agreements? Be sure to ask the seller to provide copies of bank deposits, so you know the existing tenants are paying on time and following their existing lease agreements. In the event, that you purchase the home occupied but do not plan on renewing the terms of the lease agreements, draft a letter to the tenants as soon as possible to let them know so they can either prepare for the new lease terms or begin looking for a rental elsewhere.
3. Landing in hot water with the IRS due to sloppy bookkeeping. Newly minted landlords often find themselves in a bind when it comes time to tax season. They haven’t been setting aside enough money to pay the taxes owed on rental income, or they failed to keep records of capital costs and ordinary maintenance. While owning a rental property can have tremendous tax advantages, it can just as easily lead to unanticipated taxes for owners with sloppy accounting. Property managers need to create a system for bookkeeping from the outset, often via SaaS. Buy a scanner and file copies of all receipts. Don’t feel comfortable with basic accounting, finance, or tax regulations? Consider hiring an accountant to help file your taxes come year-end. REITs with more extensive holdings might consider using more robust software like Quicken Property Management, Buildium, or Yardi.
Owning and operating rental property is a great way to earn passive income. Even though it’s “passive” and doesn’t usually require intensive, day-to-day management does not mean that property owners should have any less of a business mindset. Solid planning, preparation, and control of finances are just as important for property manager as they are for entrepreneurs in other industries.