When I started investing, my main concern was cash flow. So, my first property was a four-story Class C (Class D?) property in Houston with good cash flow on the books.
After a year of skipping, evicting, vandalizing and over-maintaining, I realized it was not a cash cow but a money pit. When I sold that property, I was excited.
My next investment was two buildings with four apartments in the suburbs of Atlanta. These are Class A properties and I have had no issues with late payments, evictions, or vandalism. The tenants have been here for a few years and the cash flow is very good.
I learned two important lessons from this:
- Paper returns have nothing to do with actual returns.
- The tenants occupying the property are the key factor in success; it is not the property itself.
These two lessons changed my entire approach to rental properties.
Buy a property for the tenants you want, not for yourself
If you want to minimize tenant problems (and have reliable rental income), you need a reliable tenant. A reliable tenant will stay for many years, take care of the property, and always pay the rent.
If the property you purchase meets the housing requirements for a reliable tenant pool, you maximize the likelihood that you will always have reliable tenants. We did this when we started our investor services business 16 years ago, targeting market segments with a high concentration of reliable people.
Here are our results:
- We have delivered over 500 single-family rental properties.
- During the 2008 financial crisis, there was zero decrease in rents and zero vacancies.
- The COVID-19 pandemic has had almost no impact.
- The eviction moratorium has had almost no impact.
- The average stay of our tenants is over five years.
- We have had 6 evictions (over 1,000 tenants) in the past 16 years.
- Our average tenant turnover cost to landlords is $500 (due to minimal damage).
How to target specific groups of tenants?
Each tenant group has specific housing requirements and people are unlikely to rent a property that does not meet all of their requirements. If the property you select is similar to properties currently rented in your target segment, most applicants will be from that segment because their housing requirements match your property’s characteristics.
How do you know what your target segment is renting today? Through interviews with multiple local property managers. Once you identify the right niche through interviews, you can purchase a property similar to the one they are currently renting.
Screen your tenants smartly
Even if you choose a property that attracts the right group of tenants, not everyone in your target group will be reliable. A property manager who is good at selecting reliable tenants can save you thousands of dollars.
For example, I know a property manager who believes that the FICO score is the most important selection criterion. This is not true. For example, assume a tenant has a high FICO score and:
- They smoke inside the house, so the odor needs to be removed at an expensive cost when they move out.
- They continually submit requests for minor repairs, eroding your profitability.
- They have a history of moving every year, which results in high vacancy and renovation costs for you.
I could elaborate further, but FICO scores are only one factor in tenant selection and not necessarily the most important.
For example, one of my best tenants has a FICO score of 530. This was a family that had a child who was seriously ill and they had no health insurance. They ultimately received $480,000 in medical compensation.
Before the medical event, they had a high FICO score and owned a home. Because of the medical collection, they had to sell their house and rent. They will be long-term tenants because they can’t use their FICO scores and medical collections to buy a house, a car, or anything else. The last time I checked, they had been in the house for over six years and had always paid their rent on time.
The key is, you need to work with a property manager who is good at selecting reliable tenants—a skill that few possess. I believe there are only two property managers in Las Vegas who can select reliable tenants.
final thoughts
The best way to prevent tenant problems is to not place problematic tenants in the property in the first place. The first is to buy a property that meets the housing requirements of an ethnic group with a high proportion of reliable population.
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Notes on BiggerPockets: These are the opinions written by the author and do not necessarily represent the views of BiggerPockets.
