The Mortgage Guru

Q: As you probably know, the rental market is very hard for landlords right now. We have only one rental property, but we are having a difficult time filling our current vacancy. After your reading your column for years, we know that renting to a bad tenant can be a costly mistake. We want to know why kinds of questions you ask prospective tenants, and I believe you have also suggested contacting their employer. What questions do you ask the employer?

A: Yes, I am well aware that we are currently in very difficult market for landlords trying to rent single family homes. I currently have a vacancy in a rental house that I have owned for 15 years that has never had a significant vacancy period. I am now in my second month of vacancy, and although I have had a few phone calls, I have yet to take single rental application for that house. The problem is that many new investors have been buying up houses to cash in on the booming housing market, and that has created a tremendous glut of rental houses in many areas of the Puget Sound region. I have heard one landlord who owns several rental houses say that his average vacancy time is four months!

In a market like this, it is very tempting to rent to the first person who shows interest in your property, because you worry that there may not be another interested applicant coming along any time soon. But you must resist that temptation and stick to sound business practices.

Whether you own one rental house or dozens of rental units it is crucial to treat your investment as a business. As I said last week, real estate is not a “passive” investment like investing in the stock market. When you buy a rental house you’re starting a business and creating a part-time job for yourself. If you take your job seriously, you will prosper. If you treat it as an after-thought, you may be setting yourself up for failure.

As I have stated many times, the key to success in the landlording business to take the time to select good quality tenants. Most tenant horror stories can be traced back to a hasty decision by an amateur landlord who rented to the first person who showed up because they didn’t want to “waste time” showing the house to other prospective tenants. In today’s market, it’s more often a case of desperation rather than taking the time to sort through multiple applications. Either way, it’s a serious mistake.

Now, before the renters reading this column get the wrong impression, let me emphasize that I am not advocating discrimination in any way, shape or form. My only criteria for selecting a tenant are: 1) Does the applicant have sufficient income to pay the rent? Most landlords want to see a monthly gross income of at least three times the monthly rent. 2) Will the applicant pay the rent on time? This is determined by analyzing the applicant’s credit report. 3) Will the applicant take good care of the property? This is determined by talking to the applicant’s previous landlords. Those are the only factors that really matter. The applicant’s race, sex, age, marital status, etc. are practically irrelevant.

You should use your rental application form to gather pertinent information about the applicants, but beware of discriminatory questions. For example, there is no law against asking for the ages of prospective tenants but it is illegal to discriminate against children. In other words, you better not even give the appearance that you’re using the information to screen out families with kids.

You MUST run a credit check on all rental applicants. This is critical. It is permissible to charge the applicant a fee to cover your out-of-pocket expense, but you cannot make a profit on this fee. For example, if the tenant screening service charges $35 per applicant you could not charge a $50 rental application fee.

After last week’s column, I received a couple letters from property management companies asking why I didn’t recommend that amateur landlords use them to handle vacancies and managing rental houses. Frankly, I prefer to handle that job myself because my rental properties are valuable investments and nobody cares as much about them as I do. But if you are the type of rental property owner who refuses to put in the time to do a proper tenant screening job, you are much better off using a property management company or tenant screening service rather than renting to somebody without bothering to check credit or references.

I want to know as much as possible about the tenants before I let them move into my property. You may find this hard to believe, but some people lie. One common trick is to write down the names of friends as previous “landlords.” To combat this, I never call the reference and say, “Hi, this is Steve Tytler. Jim Jones said he rented a house from you last year. Was he a good tenant?” Such an introduction only tips off the fake “landlord,” who then proceeds to tell you what a great tenant Jim was. Instead, I try to catch them off guard by saying something like, “Jim Jones gave me your name as a reference. How do you know him?” A phony “landlord” might reply, “Oh, Jim’s an old frat brother of mine …,” while a legitimate landlord would say, “He rented a house from me last year.” I know this sounds sneaky, but it’s better to be safe than sorry.

As for employer references, the purpose is simply to verify that the rental applicant really works where he or she claims to work. Few people will admit to being unemployed. When calling the place of employment, don’t identify yourself as a landlord, just ask to speak to the owner or manager of the company. It’s not uncommon for applicants to list their co-workers or friends as their “supervisor.” You can’t be too careful.

Believe me, I know how painful it is to make the mortgage payment on a vacant rental property, but don’t panic. If you find it difficult to attract a good quality tenant, you are better off lowering your rent rather than settling for a questionable renter. A bad tenant will cost you more money in the long run than a relatively small decrease in rental income.