Renting seems like the perfect way to mitigate the costs of an extra home that won't sell; the intended course of action when a property was purchased for an unbelievable price, or many of the other reasons that people become landlords. Although it seems like a fail-proof plan on the surface, becoming a landlord can be a financially and mentally rewarding experience, or it could be the source of a large-scale loss of time and money.
TUTORIAL: Exploring Real Estate
Like all investments, renting comes with risk, and that risk is only worth your time if the rewards are greater. Experienced landlords know that the way to mitigate the risks involved in renting, is to protect themselves against loss. This is called hedging in the investment world. Here are five ways to hedge the investment risks involved with renting your property.
You hedge the financial risks associated with crashing your car, or injuring others, by purchasing car insurance, and as a landlord, you should do the same thing. If you are renting a single-family home, traditional homeowners insurance doesn't fully protect you against the potential losses that come with renting your home to someone else.
You need an insurance policy that not only protects the property from a large scale event, but if a tenant were to injure themselves, as a result of a problem with your property, you could face civil litigation and possibly a large payout. An insurance policy tailored for rental property has provisions insuring a landlord against these types of events. (Use these simple ideas to save money and get better coverage for your house, see Insurance Tips For Homeowners, and 7 Homeowner Costs Renters Don't Pay.)
Most states allow contracts to be oral or written, but in the case of renting a written contract is essentially required. With friends or family, a written contract might seem awkward, but it is very important. States have differing laws pertaining to the rights of a tenant and a landlord. Florida, for example, requires that any notice to and from a landlord be in written form.
The written agreement should contain the rental rate, the length of the agreement, how the utility payments are split up and the many other complexities that come with renting. The more detailed you are in the agreement, the more protected you are in the event that eviction proceedings take place.
Most states allow for collection of certain deposits as long as they are contained in the agreement and each party agrees. One of those deposits should be the security deposit. This money is collected to give you leverage in case the tenant decides to abruptly leave, or doesn't want to repair damage, beyond normal wear and tear, at the end of their lease. (Besides creating ongoing income and capital appreciation, real estate provides deductions that can reduce the income tax on your profits, check out Tax Deductions For Rental Property Owners.)
At the end of the leasing term, state law gives you, the landlord, only a certain amount of time to examine the property before you have to return the deposit. As soon as the tenants vacate the property, inspect for any damage and immediately notify the ex-tenant in writing via certified mail. Then, follow the appropriate laws in your state regarding any disputes that may arise.
Before a tenant moves in, document in detail the condition of the property. Using a video camera, high quality still pictures and a witness, document every part of the property including the walls, windows, appliances, floors, doors and everything else. Also, make sure that these files are in a format that allows for a time and date stamp.
For added protection, send the files to a friend or relative so you have an electronic trail proving that these files were created prior to the move-in date. If you have to go to court, there is no such thing as too much documentation.
You, as the landlord, have the right to do a walk through of your property; providing you give the tenant at least 24 hours notice. If you request a walk through twice throughout the rental term, tenants will usually make sure to keep the home in good repair. Most tenants want their security deposit returned to them, so it is in their best interest to keep your property well maintained. A walk through not only lets the tenant know that you're watching, and if there is a problem, you can address it before they move out and possibly become hard to find. (Find out what factors you should weigh when searching for income-producing real estate, read Top 10 Features Of A Profitable Rental Property.)
The Bottom Line
Renting is often rewarding, but it does come with risk. As any investor knows, risk is never removed. Instead, it can only be managed, and the best investors learn how to manage risk in a cost effective way.