What are the most common ways that rental properties lose money and can hiring a property manager help me avoid them?
Let’s clarify something right out of the gate: It’s not the property managers’ responsibility to prevent a rental property from losing money. It’s the landlord’s. If the landlord has not made a prudent investment in the first place, no property manager is going to be able to undo the mistake.
Your property manager cannot bail you out of bad investments. Instead, think of property managers as assistants and consultants that help you efficiently unlock the value of your good investments!
Let’s examine the most common ways rental properties become money-losers, and you will see that the property manager is usually irrelevant or tangential to the reasons underlying the loss.
1. The landlord paid too much. The best investors will tell you: Make your money when you buy – not when you sell. You want to acquire the property at a discount to the present value of the expected future stream of rental payments. Period. If you fail to do this, no property manager will be able to turn things around for you – at least, not without a massive cash infusion to upgrade and renovate the property to something that will generate enough rental income to compensate you and the management company.
This is the number one cause of rental property losses. But you will recognize some of the variants, below.
2. Underestimating repair and maintenance costs. This is of a piece with overpaying for the property. I see figures that advise landlords to plan on committing between 1 and 4 percent of the value of the property for year on maintenance costs. Even this seems low to me, in many cases, and you can easily double these figures and still run out of reasonable home maintenance projects you can do with the budgeted sum of cash.
A good landlord can help you budget for this eventuality, because with enough experience and a handy contractor on their speed dial, they will be able to come up with a more accurate projection of expected maintenance and repair costs than most individual landlords.
A property manager can help you avoid being blindsided. But the ideal time to make this calculation is at the time of purchase, so you can discount the purchase price appropriately. Not afterwards.
This is important because for a time in the mid-to-late 2000s, landlords were acquiring properties without seeming regard for price nor value, hoping price appreciation would bail them out of sloppy purchasing.
These investors were savagely mauled by the market, and there’s no property manager who ever lived who could have saved them – other than by convincing them to sell in time.
3. Skimping on insurance. Sure, some people win the bet. But few people can afford to lose that bet – and pay a heavy price. Here are some examples of how landlords skimp on insurance:
- Failure to buy flood insurance. Some people still think homeowners insurance covers floods. It doesn’t.
- Failure to insure for replacement cost of the home. This could be a lot more than what it cost to build a similarly-sized home on the same location. Building codes change, for example.
- Failure to get windstorm coverage. Coastal landlords, take note: It wasn’t raining when Noah built the ark. If there’s already a tropical storm or hurricane watch, you cannot get coverage.
- Failure to obtain landlord insurance. As a landlord, you aren’t just responsible for your own actions and negligence but potentially for the negligent or damaging actions or inactions of your tenants. Landlords’ insurance is designed to protect you against the potential additional liabilities. But too many landlords fail to obtain this coverage, relying on their inadequate individual homeowners policies designed for the owner-resident.
- Other specialized coverage. An earthquake or sinkhole can utterly destroy your property. But these are very localized risks that are not covered in standard home insurance policies and even landlord insurance policies. You must obtain these policies separately from your standard home or landlords insurance policy, or get them specifically included as riders.
4. Undercharging for rent. Naturally, your vacancy rate will be low. But if you undercharge too much you leave money on the table and sell yourself short. As a landlord who has put capital at risk, you deserve a fair return on your investment, and a big part of that is efficient rental pricing.
This is one area where a property manager can indeed help you, because the good ones stay on top of the going market value for similar properties in the market. As leases expire, they can be valuable sources of intelligence on what rent you can reasonably expect.
5. Overcharging for rent. Greed can hurt you, too. Overcharge for the rent and the actual income you receive from the property will be zero. Again, your property manager can help provide you with market intelligence so that you can get a tenant in a reasonable amount of time.
6. Systemic market risk. Sometimes real estate asset prices fall, and there’s nothing anybody can do about it. We saw this happen in 2007-2010 or so, when real estate prices were falling across the country, and turned into a wholesale collapse in some markets. No property manager in the world could undo it, though in some cases the risk could be mitigated by good maintenance and marketing. But property managers don’t control the whole economy, and can’t make bankers lend!
It’s up to landlords to soberly assess the market risk of the asset class and the neighborhood, and make their purchase offers accordingly.
7. Bad tenants. These are tenants who can’t or won’t pay their rent on time, or who don’t take care of the property, or who are criminals themselves or let criminals stay with them, and therefore degrade the value of the property.
The antidote is good tenant screening. This isn’t impossible for a do-it-yourself landlord, though experience helps a lot. Tenant screening is actually one of the areas where property management firms can and do add value for a lot of landlords. A property manager can also do the tenant screening in such a way as to keep you out of hot water with regulators enforcing unlawful discrimination rules – and thereby help you avoid some big fines and penalties.
Writing about personal finance and investments since 1999, Jason Van Steenwyk started as a reporter with Mutual Funds Magazine and served as editor of Investors’ Digest. He now publishes feature articles in many publications including Annuity Selling Guide, Bankrate.com, and more.