Guide to Becoming a LandlordUpdated: April 27, 2022
Veterans and service members frequently purchase investment properties to build wealth. Or, they move with the military and convert a primary residence into a rental. Regardless of route, owning rental properties can be a great choice financially. But, owning these investment properties comes with challenges, too. As such, we’ll use this article as a guide to becoming a landlord.
Specifically, we’ll discuss the following:
- Financial Benefits of Being a Landlord
- Military-specific Landlord Advantages
- Determining Your Level of Involvement as a Landlord
- Finding the Right Property
- Landlord Responsibilities – Finding Tenants
- Landlord Responsibilities – Operating the Property
- Additional Landlord Considerations
- Final Thoughts
Financial Benefits of Being a Landlord
Owning a rental property can provide tremendous financial benefits. In particular, landlords can potentially collect profits from a property four different ways:
This is the simplest – and most immediate – form of profit. If a rental property’s monthly income exceeds its monthly expenses, you can pocket the difference as extra cash flow.
With an amortizing loan (like a home mortgage), a portion of every payment goes to paying down the principal – or balance – of the loan, with the rest going to loan interest. Every month, when your tenant’s rent pays your mortgage for you, your loan balance gets a little smaller. And, when your loan balance decreases, your ownership – or equity – in the property increases.
Over the long term, homes tend to appreciate, that is, increase in value. This increase certainly isn’t guaranteed. For instance, a major economic change in a region (e.g. a major employer leaving the area) could freeze or decrease local property values. But, on average, home prices go up over time, meaning that, the longer you hold your property, the more valuable it will become.
Cash-out Refinance Proceeds
As you pay down your mortgage balance, you open up another profit vehicle: cash-out refinance proceeds. With one of these loans, you can borrow against your rental property, taking cash out in the process. Many real estate investors use this as a means of purchasing additional rental properties. And, unlike selling the property, this won’t trigger capital gains taxes, and you’ll still own the income-producing property.
Military-specific Landlord Advantages
In addition to the above general financial benefit to owning a rental property, military and veteran landlords have another unique advantage: access to the VA loan.
The VA loan exists to promote homeownership. Consequently, you cannot use these loans to purchase pure investment properties. But, a variety of strategies exist to invest with the VA loan. For example:
- “House hacking” with single-family homes
- Purchasing up to a four-plex and occupying one unit as a primary residence
- Primary residence to rental property conversion
With all of these strategies, eligible borrowers can use the VA loan to purchase a rental property with no money down – an incredible investment opportunity.
Determining Your Level of Involvement as a Landlord
Before diving into life as a landlord, individuals need to determine their level of involvement. On one end of the spectrum, you can completely manage the property yourself. This means you’ll be responsible for finding, screening, and placing tenants, managing the day-to-day operations of the property, and dealing with maintenance issues as they arise. While this saves you property management fees, it can also add tremendous amounts of stress and work to your life.
On the other end of the spectrum, you can hire a property management company to do everything. Think of this as the “set-it-and-forget-it” approach. You purchase the home, sign a property management agreement, and the company handles the rest. This level of property management makes owning a rental property as close to passive as possible, but it will also come at a price. Property management companies frequently charge anywhere from 8% to 12% of monthly rent and, often, a one- or half-month commission for placing new tenants.
A middle ground between the above options also exists. For example, you can manage a property but also pay a local maintenance specialist to handle all repairs. This saves you the full property management fees while also ensuring that someone else receives those Sunday morning broken toilet calls.
Ultimately, landlords need to balance their desired level of involvement and general life situation with the additional costs of a property management company.
Finding the Right Property
Once you commit to becoming a landlord, you need to actually find a rental property. And, unfortunately, not all properties will make sense. Here are a few factors to consider in finding the right rental property for your situation:
Your Post-Military Plans
If you’re in flight school in Pensacola, buying a rental property there may make sense at the time. But, what about in the future? Where will you be stationed after flight school? Where do you plan on living after you separate from the military?
This ties back into your desired level of involvement. For instance, if you plan on leaving the military and settling in Maine, buying a rental property in Florida to personally manage doesn’t make sense. But, if you view it from the onset as a hands-off, company-managed property, your post-military plans may not matter as much, as you’ll have a property management company handling the day-to-day operations.
Cash Flow Analysis
A lot of military landlords make this mistake when they convert a primary residence into a rental property. They think about how much they loved living there, so it’ll naturally be a great rental property, right? Not always.
Before buying or converting a rental property, you need to run the numbers with a cash flow analysis. Simply put, this means taking your future monthly rent, subtracting all of your monthly property expenses, and seeing if you get a positive or negative number. If negative, it means rents won’t cover expenses – not a good situation for a rental property. And, with the advent of Zillow and other online platforms, you can fairly easily find market rent in an area.
For example, say you have a 2-bedroom, 2-bathroom townhouse with a garage that you’re considering converting to a rental. If you search Zillow for other 2-bedroom, 2-bathroom townhouses with garages for rent in your neighborhood, you can get a good sense of market rent. However, a word of caution: take a conservative approach and subtract 10% from these average rents. Listed rents on Zillow and other rental platforms tend to be slightly inflated, so taking a conservative approach will provide you more realistic numbers.
It’s an inevitable fact of landlord life: tenants put wear and tear on properties. Between move-ins, move-outs, and just general treatment, rental properties take a beating. As a result, landlords should “tenant-proof” properties as much as possible. That is, use durable, long-lasting materials where able. For example, instead of hardwood floors, maybe use a more inexpensive and scratch-resistant synthetic flooring. Or, use commercial-grade carpets instead of normal residential ones. These typically cost more up-front but last far longer and require less upkeep.
Ideally, landlords can find the perfect balance of durability, cost, and tenant appeal when outfitting a rental property. Simply put, you want a property that looks good and functions well but doesn’t require frequent, expensive maintenance.
Primary Landlord Responsibilities – Finding Tenants
Next, landlords need to understand their primary responsibilities. Broadly speaking, we group these responsibilities into two categories: 1) finding tenants, and 2) operating the property. And, while the below isn’t an exhaustive list, it outlines the major tasks landlords can expect to perform.
Advertising a Property
When you have a vacant property, you need to advertise it to potential tenants. A variety of techniques exist, but the internet has made this a far easier process. Websites like Zillow, CraigsList, and MilitaryByOwner all give landlords a quick and efficient way to advertise their properties.
Show a Property
Not every person who looks at an online listing will want to view your property. But, for interested parties, you’ll need to show your property. In the COVID era, many landlords transitioned to virtual showings, walking someone through a property virtually via Zoom. However, before signing a lease, most potential tenants will want to physically walk a property at least once.
Vetting Potential Tenants
After a showing, you have to decide whether someone is a good fit for the property. Do they make enough money? Do they have a criminal history? Have they ever been evicted before? Fortunately, online sites offer convenient application platforms to run credit and background checks. And, you can – and should – require that potential tenants include prior landlords as references. This lets you call and ask what sort of tenant he or she was in the past.
NOTE: In order to avoid discrimination, equal housing, and other legal issues, landlords must apply the same rental criteria to all potential tenants. If you have questions or concerns, you should speak with a real estate attorney in your area.
Signing the Lease
After you find a tenant and confirm his or her application, you need to sign a lease agreement. This provides both the landlord and tenant legal protection in case of disagreements. You can download a boilerplate lease agreement for your state or ask a real estate attorney to draft one for you. But, if downloading one, we recommend at least paying for an attorney to review it to ensure it meets your state’s requirements while protecting you as a landlord.
Primary Landlord Responsibilities – Operating the Property
After signing the lease, you’ve successfully placed a tenant in your rental property. Now, you need to actually operate the property. Of note, some of these tasks will vary depending on whether or not you hire a management company.
Collecting Security Deposits and Monthly Rent
It seems obvious, but people can forget about rent collection on the first of the month. By using online rent collection platforms, you can ask tenants to automate payments, which makes this process far smoother for all parties.
And, make sure to collect a security deposit. This protects you in case of tenant damages, and it helps vet potential tenants. That is, if someone can’t pay for a security deposit up front, there’s a good chance he or she can’t afford rent.
Enforcing Lease Rules
Successful landlords tend to A) clearly outline the rules to their tenants, and B) strictly enforce them. This provides both tenant and landlord clear expectations about behavior while helping to avoid future conflicts. Typically, when tenants know that your rules apply to all tenants, they’ll be far more willing to follow them.
Landlords should take key steps to minimize their liability at a rental property. In other words, be proactive about not getting sued. Make sure your home is up to code. Keep the walkways free of ice. Get your smoke detectors inspected annually. If you have a pool, make sure it’s properly gated. Comply with your local landlord-tenant laws. Once again, if you have questions about possible liability, you should seek the advice of a real estate attorney.
Keeping Detailed Records
As a landlord of a single-family home, you don’t need to pay a CPA to generate annual financial statements for you. But, you absolutely do need to maintain detailed records of all income and expenses for a property. You can do this with a basic Excel tracker.
For tax purposes, you’ll want to keep track of all rent payments, deductible expenses, and capital improvements (as these final items will affect your annual depreciation expense). If you have questions about common landlord tax deductions, a wealth of resources exists online. And, as a rule of thumb, if you plan on deducting something, make sure you have a receipt to support the deduction in case of an IRS audit. Using something like Google Drive provides a convenient way to digitally save and organize property-related receipts.
For general investment analysis, you’ll want to keep track of all cash inflow and outflows, regardless of tax status. This provides you the long-term ability to analyze the investment performance of a rental property.
Satisfied tenants are good tenants. If (when) a maintenance issue arises, address the repair immediately. This is A) the right thing to do as a landlord, B) a solid business decision, as responsiveness to tenant needs generally increases tenant retention.
Additional Landlord Considerations
Landlords should also plan for some rare – but important – contingencies.
Prepare for the Worst
Unfortunately, even with a solid vetting and application process, you may need to evict a tenant. No landlord wants to go through this process, but if you own rental properties for long enough, you’ll likely need to at least once. Accordingly, you should understand how to evict a tenant before you need to evict one.
Evictions require strict legal compliance, otherwise you can find yourself in significant legal trouble. This is another scenario where you can work with a real estate attorney to confirm the necessary steps in the eviction process for your area. Bottom line, you should prepare for a worst-case scenario and hope you never have to deal with it. That way, if an eviction scenario arises, you have step-by-step procedures for how to legally handle the process.
Some rental property repairs don’t occur regularly, but they cost a lot of money. For example, you won’t replace an HVAC system or roof annually, but you’ll need to pay a lot when you do.
To prepare for these infrequent but expensive repairs, landlords should establish a monthly reserve transfer. Basically, this takes a certain amount of money every month and moves it from your operating account into a separate, reserve bank account. That way, when a major expense comes up, you don’t need to put it on a credit card or draw on your personal savings – you simply transfer the necessary funds out of your reserve account.
Without a doubt, owning rental properties can be an outstanding strategy for building long-term wealth. But, becoming a landlord also comes with a unique set of challenges and considerations. Before diving head first into the world of rental real estate, potential landlords must determine whether the advantages of a rental property outweigh these items.
Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.