It’s one thing to rent out a home, or self-manage a multi-family rental property, but it’s another thing entirely to do it profitably. Whether you’re still at the stage where you’re deciding whether a rental property is an advisable investment for your money and time, or you’re looking to up your game as a rental operator, our goal is that this guide will provide you with insight on how to rent a property out while maximizing your profits, and minimizing your risk exposure.
Table of contents:
- How do you identify a good rental market?
- How much should you charge for rent?
- What do you do when a renter withholds rent because of disrepair, but you can’t afford repairs?
- For apartment owners, what improvements will allow you to raise your rent rates?
- What is the current state of rental demand?
- What are the tax benefits of investing in rental properties?
- What are the pros and cons of investing in Airbnb rentals?
- If you’re a flipper who wants to scale up your rental holdings, how do you build a team to renovate new rentals?
- How do natural disasters like wildfires impact rental markets?
All real estate is, essentially, speculation. This is especially true when it comes to buying a property for a long-term investment as a rental. You have to anticipate what the market will be like a few years down the road.
When looking at a rental market, there are a lot of underlying factors that make an area grow. Even in cities with established rental markets, there are areas and neighborhoods that are primed for growth, where a rehab professional with a hard money loan can get in for cheap, fix up a place, and have it ready to rent when the market shifts. Knowing these underlying economic factors is the best way to anticipate the future.
Major cities are vast and complex. It doesn’t mean much to say, “the city is doing well,” or “the city is doing poorly,” because even if one of those extremes is true on a large scale, there are still enough exceptions to make the actual lived-in experience of the city vary wildly. Rich cities have very poor quarters, and vice versa.
This complexity means that when evaluating areas to purchase property, with an eye on the rental market, you can’t just say “Los Angeles is doing well, so any property should be ok.” You need to understand what makes certain areas promising for rentals, and that means understanding the underlying economic fundamentals. Here are some variables that anyone scoping out rental markets should keep in mind.
The right kind of job market.
There is no such thing as the wrong kind of job, as any work is valuable, but when you are hoping to rent a place and turn a profit, you’ll want tenants with well-paying, stable jobs. Perhaps the most important sector in this economy is the tech sector, which attracts young people who have money, don’t yet have families, and are transient and not looking to buy. Obviously, there are exceptions to this, but speaking broadly it is an accurate demographically representation. Cities with tech sectors tend to be very good rental markets, and the areas near where these jobs are located are especially valuable. Older areas with buildings that can be rehabbed as incubators or for single start-ups are a great place to start looking, as people will want to rent homes around these workspaces.
Access to transportation.
Public transportation is becoming increasingly important again, as the car-centric mode of commuting feels wasteful, stressful, and time-consuming to many people. Cities are investing in trains, light rail, and even cable cars. This is extremely important to the younger generations, who are making up an increasingly high percentage of the workforce, particularly in the tech sector. So areas with the “right” jobs that also have access to public transit, or areas that are connected by public transportation to the jobs, are ideal.
Proximity to hubs.
Of course, the best of all worlds are areas that have jobs, residential space, and public transportation (because not everyone can live or work there). Neighborhoods that are really beginning to boom are “hub-oriented”: areas that are full of mixed-use multi-family residences, where people can live, work, or play. San Diego, especially, is using aggressive urban planning to make more-or-less self-contained hubs, striving to become a “city of villages.” Urban planning isn’t a secret, though: look to city council records and other sources to find out where the next wave will be, and how to get in on it.
New restaurants and stores.
Sometimes, jobs and urban planning aren’t what make an area boom. For some reason, restaurants and stores either know when an area is going to grow, or make it grow. Keep your ear to the ground. If you hear about a cheap area that is suddenly the hot spot to eat or dance, look into it. That is often the start of a transforming neighborhood, and at a time when property can be had cheaply.
Setting a competitive rental rate is one of the first steps in generating positive ROIs from property investments. If rents are set too high, landlords run the risk of a property standing vacant. On the flip side, if rents are set too low, landlords may surrender income and potentially lose money on the investment. The challenge lies in finding the right balance. Here are seven factors landlords should consider when pricing rental properties.
Know the neighborhood.
Landlords should familiarize themselves with the neighborhood. That means knowing the distances to local shopping centers, entertainment and schools, how schools rank compared to nearby districts, and neighborhood crime statistics. Watching trends in occupancies and rents is useful in identifying up-and-coming markets where rents are more likely to rise. The location of the property helps determine rents as well. A property that sits within walking distance of schools and shopping will typically command higher rent than one that is located on the neighborhood’s periphery. Landlords can find information on median rents and rent trends by checking local market reports on Zillow.
Evaluate the property.
Once basic information about the neighborhood is known, a landlord’s next step should be assessing how this specific property compares to others nearby that offer similar amenities. Median area rents set a baseline that can be adjusted up or down depending on amenities such as enclosed parking or a fenced yard. Zillow offers a practical tool called Rent Estimate that takes into consideration a home’s size, amenities, last sales price, and comparable neighborhood rents to estimate a monthly rental rate.
Landlords must also factor in the condition of the property. A freshly painted and carpeted home that has a neatly trimmed yard will attract more tenants and support a higher monthly rent.
A rule of thumb some landlords use to calculate rents is to charge 1.0% to 1.25% of the property’s value. Applying this formula, a property valued at $250,000 should rent for between $2,500 and $3,125 a month.
When in doubt, it’s better to err on the side of charging too little rent rather than too much. After all, a smaller profit is superior to no rent at all from a property standing empty for months. In addition, vacant houses are magnets for crime, and can drive down properties values in a neighborhood.
Know out-of-pocket expenses.
Rental rates must also take into account the ongoing property expenses, which may include mortgage payments, taxes, maintenance costs and homeowner’s insurance. These inputs are needed to calculate return on investment (ROI). Most investors target an ROI of 10% or more from real estate assets.
Calculate debt service coverage.
Landlords should know the property’s debt service coverage ratio when setting rental rates. The debt service coverage ratio is defined as annual income generated by the property divided by its mortgage principal and interest payments. Be conservative by factoring in a vacancy rate when calculating this ratio; it’s unrealistic to assume a property will be fully occupied 100% of the time. In general, solid properties in strong neighborhoods can support debt service coverage ratios of 1.25 times or higher.
Consult with tax and insurance experts.
Mortgage payments are usually the largest property expense, but property taxes and insurance can also take a big bite out of profits. Landlords can mitigate some of the cost by seeking advice from a tax expert who can help reduce your tax bill and an insurance broker who can help you shop around for the best deal. In addition, insurance brokers can help find ways to make improvements that reduce the costs of a policy. These include installing a home security system or upgrading exterior lighting to help deter break-ins.
Don’t neglect marketing and other costs.
When calculating property expenses, landlords should also remember to add in costs for advertising the property, as well as legal and accounting fees. Be sure to include upkeep, utilities (if not paid by the tenant) and a reserve for unanticipated repairs in expenses. Without factoring in all these costs, landlords cannot calculate an accurate debt coverage ratio or ROI.
The landlord-tenant relationship is one of the few situations where both sides have leverage, and both sides have power. The tenant owes rent, of course, but they are also owed service, responsiveness, and decent living conditions. California law allows tenants to withhold rent if the property is not up to code. This can spell deep trouble for some landlords, particularly if you depend on a single property for your income. It then becomes a catch-22.
It’s hard to make needed repairs in case of an accident or disaster without the rental income, but you can’t get the income without first making the repairs. One way to avoid losing your rental income is to secure cash out refinancing to finance much-needed improvements to your rental property. This keeps your tenants paying their rent and your investment income flowing.
When a Renter Can Withhold Rent
There are numerous instances where California allows renters to withhold paying rent to their landlords legally. If you’re a landlord, you probably know a tenant can withhold rent when there are serious defects to the property that endanger the inhabitants or breach the “implied warranty of habitability.” Breaches include:
- Collapse and/or non-repair of ceilings or foundational walls
- Vermin and/or insect infestation
- No heat
- Blocked plumbing
- Illegally installed and dangerous appliances
- Illegally installed electrical wiring
- Serious code violations
Naturally, the damages cannot have been caused by the tenant. If they are, the tenant cannot withhold the rent. If they aren’t, the tenant can withhold rent until the repairs are made, making it very hard on the landlord who relies upon rental income to keep the building maintained. It’s a vicious cycle than can continue perpetually unless something is done.
But It’s Not My Fault!
These laws were put into place to protect tenants from absentee slumlords, not typical landlords. Damages can occur, however, and still require repair. Imagine a scenario where you have already hired a contractor to perform some needed repairs to your rental property. You paid the contractor, but the work he performed was shoddy and failed inspection. To make matters worse, the contractor is nowhere to be found. He took off with your money and you’re left with an uninhabitable residence and some very angry tenants.
In a case like this, your only recourse to recover the lost funds might be to file a series of claims against surety bonds and insurance companies. This will take a long time, particularly if the matter has to go to court. You’ve already paid for the repairs, you don’t have the additional funds to have the work done again…and now your tenants are refusing to pay rent, so you’ve lost your source of income on this property. What can you do?
How the Cash Out Refi Can Help
In cases such as this one, you must get your income property back to earning you income—that’s the priority. One solution is to borrow against the home or apartment unit. Cash out refinance loans enable people to borrow against the equity of their existing property; they refinance existing mortgages at a higher rate, so the owner can collect the difference between the two loans in cash.
There are many benefits associated with cash out refi loans, and in our example, the primary benefit is you will receive the cash you need to make the necessary repairs to the rental property and get your tenants paying their rent again. This restores your source of income, which you can then use to pay off the refinance loan.
It’s also good to think about how a cash out refi can increase the overall value of the property’s mortgage. If the property is assessed as more valuable, you can get more money for it down the road when you are ready to sell. In fact, if there’s enough money left over after needed repairs are made, why not improve upon the property? This increases the property’s value and ultimately the amount you can charge monthly for rent.
When the Property Value is Too Low
If your property needs repairs and you are still “upside-down” in the mortgage, however, there is a possibility that a traditional lender will not assess it high enough to offer a refinance loan. Don’t lose hope! Look for specialized lenders (like Socotra Capital) that are willing work with you and get you the money you need.
Some lenders may also offer you the option of leveraging all your commercial property against the loan on a specific building, not just the building in question. This means you can secure the additional income you need even if the equity in the building requiring repair doesn’t cover all of the necessary construction costs.
For landlords and owners looking to attract tenants that’ll pay more rent, making sure you make the right upgrades is the best investment you can make. When we say, “the right upgrades,” we mean upgrades that will maximize your return on investment. This means spending as little as possible while making the improvements that can allow you to attract the right kind of tenant and charge the right kind of rent. These may not be as cheap as a coat of paint, but don’t have to break the bank either. Here are some of the best ROI tenant improvements:
Improving Initial Impressions
We’ll start with the least expensive. Every building has a door, and when prospective tenants first see your property that’s the first impression they get. An amazing property can overcome a junky door, but unless you can blow viewers away, a bad door can temper the rest of the experience. A solid door will cost you a few hundred dollars, although interior hollow-core doors should only set you back around $50.
Another important area to consider is the common entry areas which people first walk in to. These are crucial when it comes to managing expectations. If people walk into a marbled foyer, they’ll often expect to pay more for an apartment. It might seem odd to spend money on the place where the least amount of time will be spent, but it can do wonders for the reputation of your building. The same goes for the landscape.
New Floors, New Appliances, New Countertops
Now we start spending more money. Inside the apartment, there are a lot of things you can do to improve tenant experience. The first is to look at the floor. Some people still like carpet, but for most, it is hardwood or nothing. Depending on what kind of floor you have, you may be able just to tear up the carpet. Of course, you’ll have to buff and sand the wood underneath. If you have to do a full replacement, expect to spend $9 to $12 per square foot.
Next, move on to the appliances. A washer/dryer combo can cost a few hundred dollars, but you can easily earn that back in a matter of years. People value convenience, and not having to go downstairs to the laundry room is huge. Forcing people to go to a laundromat can make it very hard to get the kind of tenants you desire. Lack of a dishwasher may not force people out of the apartment, but it also can make them do work they don’t want to do and is another attractive amenity.
Finally, look at countertops. Marble or stainless steel are both pretty timeless. Granite can begin to get very expensive, but if you are trying to attract the cream of the crop, especially new tech money, it is an investment that can quickly be gotten back.
Finally, you have to decide what kind of apartment you want to be. It may be acceptable just to have a bunch of nice apartments, but many people decide based on the other things. For instance, a gym, or at least a workout room. Excellent wi-fi. Common areas for people to congregate. Specialized bike rooms. Common land in the yard where people can plant, like a community garden. Anything to separate you from other places where people can live. Anything, in short, that makes a rental unit a home.
Crunching the Numbers
So, you’re spending, but what are you getting back. Estimates can vary depending on the region and other market conditions. One estimate is that spending $6500 per unit allows for an increase in rent of $150 per month. A quick back-of-the-envelope calculation estimates that this investment pays for itself in a little over 3 ½ years. Another estimate we’ve seen cited is an $80 increase resulting from $4000 worth of work, which amortizes in four years. So, we can conclude that reasonable upgrades pay for themselves in 3 to 4 years, depending on the variables.
The alternative may be just sitting on your hands and letting the competitive rental market do its work. It’s true that you can succeed right now even without much effort, but these conditions don’t last forever. Getting the right tenants in now helps ensure they’ll stay in the future, and to draw those tenants, you need to improve your properties. Your real estate assets are your best investments for the future.
Surveys in recent years have consistently shown a growing preference among millennials and boomers for renting a home over buying one. For instance, in a detailed survey of nearly 4,500 people conducted by Freddie Mac a couple years ago, 76% of millennials saw renting as a more affordable option than buying, up roughly 66% a year previous. 82% of baby boomers believed renting was the best option, up from 71%. The majority of people surveyed cited ‘affordability,’ ‘convenience,’ and ‘flexibility’ as the main reasons renting was preferred. While it wasn’t so long ago that virtually every American aspired to home ownership, attitudes have shifted considerably.
Freddie Mac found a notable decline in the percentage of renters actively working toward home ownership: 14%, down from 21% at the beginning of the year. Given this, it’s unsurprising that home ownership rates are 1 to 5 percentage points below historical averages, despite a recovered economy.
A years-long increase in home prices in many markets alongside slowing rent rates has likely fueled the preference for renting.
The average home price is up roughly 6% from last year, according to the S&P CoreLogic Case-Shiller National Home Price Index; Seattle led the nation in home-value growth, with prices up 13% year-over-year, while California home prices averaged 7% higher, according to the California Association of Realtors. Most economists expect home prices to rise 4 to 5% per year over the next few years due to housing inventory that continues to lag demand.
And while home prices continue to increase, rent mark-ups have decelerated in many cities. For example, rents grew roughly 2% during 2017, according to Axiometrics, which was in line with historic averages. At the time, prime markets such as New York and San Francisco were expected to go flat, or experience even negative rent growth in 2018. The pessimists proved to be right.
In Los Angeles County, the median rental price fell 0.5% year-over-year in August 2018, after having grown by 4.3% in 2017, and 6.5% in 2016. Nationally, rental prices declined slightly, breaking a growth trend dating back to 2012.
This moderation in growth is due to a burst in apartment construction that has caused supply to greatly exceed demand. Roughly 400,000 new apartments were built in 2017, and roughly 283,000 more were built in 2018. While the pace of apartment construction is expected to slow, more than 900,000 apartments were built between 2016 and 2018, the greatest three-year period of construction since the 1980s.
But rentals are still a great investment strategy. Demand continues to be high due to a widespread cultural preference for anxiety-free renting.
While affordability was found to be a main driving force for renting in Freddie Mac’s survey—it was not the only one. Some cited the ‘anxiety of high maintenance costs’, the ‘relief associated with home ownership’, and the ‘greater convenience and flexibility of renting’ as motivating factors as well. More boomers than millennials considered maintenance costs in their decision. And boomers, 28% listed maintenance costs as a reason for not owning a home versus just 7% of millennials.
Among all the survey’s respondents, 23% cited ‘convenience’ and ‘flexibility’ as some of the strongest reasons they prefer renting. Other reasons were ‘insufficient savings for a down payment’ and renting as an ‘optimal means for exploring new neighborhoods’.
Furthermore, the results also illustrated that a return to the higher home ownership rates of the past few decades is unlikely to return anytime soon. However, with more millennials and boomers interested in renting, landlords will likely continue to experience increased demand for their product, potentially pushing rates higher again as new construction slows.
The tax benefits associated with owning real estate are excellent. In fact, they’re far better than any benefits you receive owning your own business.
Rental Income Fares Better with the IRS
Investing in real estate is much like being self-employed, with one big difference. A few years ago, real estate entrepreneur Brandon Turner raised an insightful question in an article for Entrepreneur magazine: “If you earn $100,000 at your own business and I earn $100,000 through rental properties, who gets to keep more?” The answer is the real estate investor. Rental income is taxed differently than self-employment income, and, in some cases, extraneous taxes, such as Medicare tax, are not due on real estate property income.
For example, assume you own one rental property with two units. You charge a monthly rent of $1,000 for each unit. Because both units are leased, your total rental income for the year is $24,000. You will not owe Medicare taxes on your rental income because you did not meet the income threshold, which ranged from $125,000 to $250,000 depending on your filing status for the tax year. However, you would owe Medicare tax on your business income, regardless of your overall earnings.
Another advantage of rental income over self-employment income is that you get to deduct the expenses of maintaining your rental property, and these expenses tend to total a greater amount than general business operating expenses. The list of allowable deductions is extensive, and includes:
- Casualty losses
- Local property taxes
- Management fees
- Mortgage interest
- Pest control
- Real estate taxes
- Trash removal
- Yard upkeep
Let’s continue with our scenario above. Assume one of your tenants has just moved out and you need to advertise to rent the unit. You work full-time, so you’ve hired a property management company to sort through the applications and find the perfect tenant. They do so and bill you. Your advertising fees and commissions paid to the property management company will be deductible expenses for that tax year. When you add those to all of the expenses you incur maintaining your duplex, you have a nice chunk of change to reduce your taxable rental income.
Deductions from Tax Cuts and Jobs Act of 2017
The tax bill passed by the government in 2017 provides for a tax credit on pass-through businesses, which enables property owners to deduct up to 20% of taxable rental income by creating a pass-through entity such as a LLC, S Corporation or partnership. The pass-through deduction is restricted, however, to individuals earning less than $157,500 annually or couples filing jointly and earning less than $315,000.
Deductions for Depreciation
Depreciation is a fancy word for aging, and as your rental property ages, you can recover what the IRS calls the property’s “cost basis” via depreciation. Unlike with a car, a rental property allows you to deduct the normal wear and tear of doing business. Remember, this isn’t just something you own, it is your means of income, so it is treated differently by the IRS.
Once you’ve rented out your property, your allowable time for depreciation begins. You are in this depreciation period until you stop renting or until you sell the property, after you have recovered the cost basis of the property via the deduction. This deduction provides an even greater reduction of your taxable rental income throughout the depreciation period.
You Can Use Your Savings for Additional Investment
What does all of this mean? Your tax savings can be put back into your rental property, increasing its overall value and your ability to assess higher rents. You can also use your tax savings to purchase additional property to rent out as long-term housing – or you can:
- Upgrade your properties
- Purchase other types of rentals, such as vacation rentals
- Pay off your mortgages more quickly, and once paid…
- Sell the original rental property for a profit
It’s never a good idea to try to time a market perfectly. However, having a rental property as part of your portfolio allows you flexibility, income, and tax benefits, so that you can see a market evolve over the long term. You earn additional income from your tenants, you are taxed at lower rates, and you are afforded deductions to reduce your overall taxable gain.
Airbnb, which launched just over a decade ago, has become a major force in the hospitality industry. The company generated more than $2.6 billion in revenue in 2017, and today more than 660,000 homes in the United States are listed on the company’s website.
The popularity of Airbnb and other vacation rental websites has had a seismic impact on rental markets across the United States, with buyers snapping up investment properties and converting them into short-term rentals. But let’s take a step back and examine the merits and consequences of buying and owning vacation rental homes.
The Pros of Renting Airbnb Rentals
The success of Airbnb has many real estate investors considering the purchase of properties that can be listed as short-term rentals. A major appeal of Airbnb models is commissions much lower than traditional rentals. Airbnb typically charges property owners 3% commissions and guests 6-12% fees.
Another factor that makes the Airbnb concept appealing is reduced risk for property owners. Guests are rated on the Airbnb site and properties typically suffer less wear and tear due to shorter-term stays. The principal attraction of the Airbnb model, however, is opportunities for outsized returns. Cash returns often exceed 40%. According to Los Angeles Alliance for a New Economy (LAANE), a LA real estate investor earns more renting a property as an Airbnb for 83 nights per year than could be earned on a traditional rental for an entire year.
Where Should You Purchase an Airbnb Rental?
If you are contemplating the purchase of an Airbnb, location is a prime consideration. Demand is strongest in highly populated cities that attract plenty of tourists and are homes for major companies and universities. Rentals in these cities benefit from their ability to attract both business and recreational travelers and demand is especially high near convention centers, sports stadiums and major shopping districts.
At present, the top US Airbnb markets are Los Angeles, New York City, San Francisco, San Diego, Miami and Austin, but there are also plenty of secondary cities supporting robust Airbnb returns. The Mashvisor website provides Airbnb occupancy rates and rental rates for many cities.
With Airbnb occupancy rates estimated at 55%, Los Angeles is the country’s top Airbnb market. The strength of the LA market reflects the city’s status as a top tourist destination. LA set a tourism record for its 6th consecutive year in 2016 with more than 47 million visitors. Tourists come to shop on Rodeo Drive, tour Beverly Hills and the Hollywood Walk of Fame, and visit Universal Studios and Disneyland.
Another consideration for Airbnb owners is pricing short-term rentals. Airbnb rentals compete directly with hotels, especially in larger cities, and almost always charge less while still making a respectable profit. In markets where hotel occupancy rates are high such as Los Angeles, San Francisco and New York City, Airbnbs also have high occupancy rates and can price competitively. In high demand markets, price is less important than reviews in determining occupancy rates.
Guest reviews are the single most important factor affecting Airbnb occupancy rates. In San Francisco, where occupancy rates average 44%, the number of guest reviews has a 27% impact on occupancy rates, according to Mashvisor. Each additional review resulted in a 0.3% increase in occupancy rates. In San Jose, the number of reviews had a 34% impact on occupancy rates, with each additional review boosting occupancy rates by 0.5%.
Given the importance of ratings, how can Airbnb owners encourage guests to leave reviews? One approach is to post reviews of your guests as soon as the option becomes available. This increases the odds that guests will return the favor by writing reviews. Another strategy involves being pro-active in soliciting reviews. This begins with sending guests a thank-you note after checkout along with a request for a review, sending an additional reminder two weeks later, and following up with a final request before the review option expires (i.e. 30 days after checkout).
Setting up an Airbnb property requires time and attention to detail. Plan on allocating several hours per week for managing reservations, responding to inquiries and making sure the property is ready for guest arrivals. Services such as Pillow can help you manage the property and Rented.com can help you find a property manager. Owners can further reduce workload and expenses by selling weeks to a property management company. On-line businesses such as Guesty and Handy can be hired to provide cleaning services. Owners who work full-time or travel frequently may also want to invest in Lockitron, which can lock and unlock doors via a smart phone app. Lockitron also allows owners to add or delete guests or give guests access for a limited time.
The Cons of Owning an Airbnb Rental
A major challenge to successful Airbnbs is unhappy neighbors so plan to communicate regularly with your neighbors and make sure their privacy is respected. Choose guests carefully, designate parking areas and make sure guests understand HOA rules regarding pools, gyms and other shared amenities.
Unanticipated costs are another challenge. For example, many cities tax short-term rentals. This tax, known as the transient occupancy tax (TOT), varies by city. Los Angeles imposes a 14% transient occupancy tax based on the listing price for stays less than 30 nights.
The biggest obstacle for Airbnb owners is regulations. Some cities impose minimum rental periods or set limits on the number of days per month or per year that the property can be rented. There are also city zoning ordinances that limit short-term rentals to specific neighborhoods, prohibit short-term rental homes near other short-term rentals, or limit the number of occupants. A list of regulations for several major cities can be found on the Airbnb site. Because rules are determined city-by-city, property owners frequently encounter outdated regulations neither prohibiting nor allowing listings, making it difficult to plan for the long-term. If the property is a townhome or condo, HOA rules and regulations must also be followed. Some HOAs prohibit rentals that are less than 30 days while others require the owner to furnish tenant information to the management company.
For property owners located near major tourist areas, Airbnbs can provide an attractive return on investment with the added benefit of less risk and expense than a full-time rental. However, like any other real estate investment, success depends on careful planning, due diligence and effective execution.
If you’re a flipper who wants to scale up your rental holdings, how do you build a team to renovate new rentals?
Let’s say that you’re a fix-and-flip professional. You know how to look at a piece of property, evaluate its worth, judge what to fix, and then actually do it. There are a lot of people, even capable people, who can’t do what you do, from tiling to duct work. However, no man is an island.
There are some jobs that are too big to do alone, or even with a partner. If you are buying a multifamily building with the intention of renting it out, it will take a long time to renovate. That’s time where the building is not earning money, and you are just sitting on it. The “rent” part of “fix-and-rent” is sorely lacking.
So, what to do? A lot of professionals are reluctant to hire contractors, thinking that they are going to lose profit to the overhead of hiring, or simply because they don’t trust other people to do the work. Neither of these issues have to come to fruition, however. Fix-and-flip professionals can hire people to get the work done, while letting everyone earn.
The Money Issue: Cost vs. Lost Income
Imagine that you are going to be renting out a 6-unit place with an average price of $1,000 a month, per unit (clearly, this apartment isn’t in the Bay Area). But you need to renovate it first. Every month that the work goes unfinished, that’s six grand you are losing out on by not having the building ready. If it takes you a year, on your own, to get all the units ready to rent, you’ve cost yourself $72,000 in lost income, not to mention the cost of materials and your time.
Spending money on a team to help you might not add up to a 1:1 cost-saving analysis. After all, that money is spent up front. (But that’s where a hard-money loan comes in. Based on your equity, you can get a loan to hire a team.) The benefit of hiring a team is that you start earning faster. The sooner you start renting out, the sooner you start earning, and the sooner you can take advantage of the tax benefits that come with owning a rental property (as opposed to owning a property you will theoretically rent one day). There is no benefit to taking a long time to get your properties in a rentable state.
How a Fix-And-Rent Pro Hires and Runs a Team
So, now that you are on board with the financial side, you might be wondering both how you can hire a team you can trust, and how you can lead them. There are a few things to keep in mind.
Even if you don’t feel like a leader, you can still lead. Working on a home often means working in solitude. It tends to draw in people who are comfortable on their own. But that doesn’t mean you can’t lead. Introverts often make the best leaders, because they allow for others working with them (or under them) to feel comfortable sharing ideas.
Open the lines of communication. Sharing ideas is the best way to get a job done. When you are working with people you aren’t familiar with, or who don’t know you, they might feel unsure about saying they have a better way to do things. Contractors sometimes just put their heads down and do the work. But maybe the guy you hired knows more about HVAC than you. Ask him questions. Let him feel free to talk. It can make the work environment a lot more efficient.
Look at reviews. Yelp, Emily’s List, and a bunch of other sites have reviews for contractors. Take advantage of those to do a quick look at who you are hiring. Remember that these reviews aren’t infallible, and that one unfair review can taint the whole rating. However, it is another data point, and worth considering.
Ask around. You know people in the business, and sometimes it seems like everyone has worked for everyone else at some point or another. Call for references. These tend to be less biased—for good and ill—than the general public’s opinion. You’ll get the real scoop from professionals.
Provide incentives. Remember, you want them to do the best possible job, and take pride in the work, even though they don’t technically have any ownership of the property. Incentives include bonuses, training, or even just bringing a case in after work on Friday. You want your contractors to feel like this isn’t just a gig, but a place to shine.
Sometimes, you have to spend money to make money. While you might feel like you are saving on expenses by not hiring a team to help with your buy-and-hold property, every day that goes by without renting is money you are missing out on.
On November 8, 2018, the town of Paradise was devastated by the most destructive wildfire in California state history. 83 people were killed, and nearly 14,000 homes were destroyed. While the emotional cost of this disaster can never begin to be comprehended, we are beginning to understand that such disasters have a measurable impact on local housing markets, and especially on rental markets. This is because of a very basic, and very tragic fact: When families lose their homes, they have to go somewhere.
While it will be years before housing experts will be able to assess the consequences of the fire that destroyed Paradise, we are able to look back at past fires to get a sense of how rental markets are affected when homes are lost. The Wine Country fires of October 2017, which damaged or destroyed more than 18,000 homes in Napa and Sonoma Counties, are an effective example of how rental markets respond when areas with high demand for rentals experience a sudden loss of housing due to disaster.
In the summer prior to the fires, property prices had already been soaring in Napa and Sonoma. In particular, investors were seeing a huge shortage of rental properties on the market.
While large amounts of rural area in Sonoma had been developed and built out, many communities have pushed back hard against the rising popularity of short-term vacation rentals through sites such as Airbnb and VRBO. In 2016, the Sonoma City Council temporarily imposed a moratorium on granting vacation rental permits, though it later allowed that moratorium to expire. Sonoma’s current vacation rental ordinances allow the short-term rental of homes in certain zoning districts—AR, RR, and R1, as well as existing homes in the LC district, and certain agricultural areas—but prohibits vacation rentals in higher density districts, such as R2 and R3.
This constraint has been pushing rental property prices ever higher in the region as the popularity of vacation rentals has soared.
The Wine Country fires seriously exacerbated rental demand in Sonoma County, and rent rates responded accordingly.
Two weeks after the fires started, a sharp-eyed journalist at the Santa Rosa Press Democrat noticed that long-term rental rates had soared on Zillow in Sonoma and adjacent Napa County.
While already expensive Napa County’s median rental rates jumped 23 percent to $3,094, Sonoma saw an increase of 36 percent, climbing to $3,224 per month. In comparison, during the same period, rent prices rose by only 1 percent in Solano County, and actually fell by 4 percent in Marin County.
A representative from Zillow noted that they had not seen a majority of the listings on the site before, and thus it was likely that most of the properties had previously been vacation rentals. The article in the Press Democrat noted that the sudden price increases were so significant that there is some question as to whether they come into conflict with California’s prohibition on increasing rents by more than 10 percent during declared emergencies.
It should also be noted that insurers with customers whose homes were damaged or destroyed by fire in many cases have to cover the customers’ rent costs while their homes are being repaired. Some policies even require insurers to provide housing that is similar in quality to the homes covered by the policy. As a result, insurance companies relocating customers out of multimillion dollar properties are unlikely (or unable) to aggressively negotiate with landlords charging above market rents. This could inflate rates for an unknown amount of time.
Rental prices receded from their peaks in areas affected by the Wine Country fires as victims found new homes, but housing prices remained extremely high. The month of the fire, listings in Sonoma County on Zillow had a median price of $597,000. In December 2018, the median was $638,000.