It’s not uncommon for us to receive calls from our DuPage and Chicago clients saying they are considering purchasing an investment property, and wondering what they should think about before doing so. Here are some tips that might be helpful. These are focused primarily on residential leases, but apply as well to commercial buildings. And be sure to give us a call to discuss your particular situation—every client, tenant, and property is different.
- Be very careful who you rent to. Evicting a tenant is a pain. The more you can learn about your potential tenant ahead of time, the better. Before you decide to purchase a residential property, investigate how much it costs to do a background check, how long that takes, and how accurate those reports are. Then build the cost of doing a background check into your financial model, including how much you ask for as rent and security deposit. Or, if you’re looking at a commercial property, understand how to read a balance sheet and financial statements. Then require that your tenants provide those to you as part of the application process. You want to know not only that they will be able to pay the rent each month, but also whether you will likely be able to collect a judgment if they skip out on the rent, or whether to approve an assignment or sublease to a new tenant of similar or better financial background.
- Know the rules of your jurisdiction–every municipality is different. For instance, the Chicago Residential Landlord Tenant Ordinance is VERY tenant friendly, and as a result, very easy for landlords to trip over. And some home owner and condo associations have declarations and bylaws that prohibit leasing the space to a non-owner or someone who is not a close family member of the owner. If you don’t know the answer to the following questions, you’re probably not prepared to purchase the property you’re looking at: (a) whether you’re required to hold security deposits in particular kinds of bank accounts; (b) whether you’re supposed to give a written account of how the security deposit was spent (if you spend it) at the end of the lease; (c) whether you need to provide copies of the receipts with that security-deposit accounting; (d) whether you’re required to disclose to tenants that the building has had any recent code violations; (e) whether you need to be registered with the municipality as a landlord. Each jurisdiction has its own rules, and these are just a sample of the ones you might see. We can help you figure out if there are others and what they are.
- Don’t purchase rental properties unless you know you can make the mortgage payments regardless of whether you collect the rent. We’ve seen many a landlord fighting to evict a tenant, only to turn around find themselves in a foreclosure because they couldn’t make their payments during the eviction. One way to avoid this is by paying cash for the building. That way, even if your tenant flakes out on you, you’ll still be able to keep the building while you work getting someone new to lease it.
- Along those lines, if you can afford to, stash away the first few months of rent as an eviction reserve. (If you can’t afford to, you probably can’t afford to purchase the building.) The quickest and easiest eviction we’ve worked on cost close to $2,500 in attorney fees and costs. That included various calls with the client about how to address the situation, preparing and serving a 5-day notice to quit, filing and serving the eviction complaint, and going to court once only to have the tenant show up and tell the judge that she moved out the day before. The longest took over a year involved multiple appeals and related motions to stay enforcement of the eviction. Then, after finally getting the people evicted, the case still wasn’t over, as the tenants continued to file motions asking the Court to reconsider and put them back in possession of the building. And during all that time, the client still had to make mortgage payments, on top of paying our legal bills, all without receiving a penny in rent for the property. Evictions are just another form of litigation. As such, they’re not cheap, and you need to have a good reserve build up in anticipation of them.
- Be prepared to pay your tenants to leave when (not if) they default. Because an eviction can be so difficult, expensive, and time consuming, we frequently tell landlords that–as unpalatable as it may seem–paying a tenant to get out may be the quickest, cheapest, and easiest way to get it resolved. Sometimes it only takes a few hundred dollars. Other times, you need to offer enough for them to have the security deposit for their next apartment.
- It’s also best to get a release of claims before you hand over any money. What you don’t want is to pay someone to leave, and then find out they’ve sued you claiming that you damaged their property because of mold, bed bugs, or other problems that you may not have even known about because the tenant didn’t tell you about them.
- Don’t let your tenants get more than 5 days behind on rent. Because it takes a long time to get an eviction done, you need to start the process sooner as opposed to later. Don’t let things linger. An apartment occupied by a non-paying tenant is a sinkhole for money. If they can’t pay on time, they are gone.
- Get a good-sized payment up front. I’ve seen as much as first and last month’s rent, plus another month’s rent for a security deposit in case there is damage to the location. Although you want to have a reserve to pay for any repairs, you may have to use some of that money to cover back-due rent. The more you can get ahead of time, the better. Then stash it away in case of problems. (See #4, above)
- Take pictures before and after the tenants move in and move out. Anyone who has rented a car knows the drill before you drive off with it–you have to walk around the car so the rental agent and you can both mark on a drawing of the car any scratches or dents you both see. Then you both initial the drawing. That way, there’s no dispute about what the car was supposed to look like when you drop it off at the end of your trip. Doing the same with your rental property is also a good habit to get into. Make sure you know which rooms did (and more importantly, didn’t) have dings in the paint and drywall, that the fridge and oven were spic-and-span at the beginning of the lease, and that the carpet didn’t have any cigarette burns in it. That way, you know what you can charge for after your tenants move out.
- Similarly, do periodic walk-throughs during the term of the lease. I would suggest at least once per year at renewal time, but depending on the reliability of the tenant, you may want to do it more often. If you notice that the place is a pigsty, or if you see damage that hasn’t been disclosed to you, you will know how much of a stickler you need to be regarding other non-rent lease requirements. A poorly kept home or super messy storage room can be a harbinger of other problems to come.
- Have a good landlord-friendly lease. Anticipate some of the problems described above and require that your tenants stick to them. If you require renter’s insurance, make sure you see the certificate of insurance and that you are named as an additional insured. Then require proof of insurance during the term of the lease. Where allowed by statute, modify the rules regarding service of notice for evictions, and limit the damages that a tenant can claim related to problems at the location. If you know there will be multiple tenants, get them all to sign the lease. Or if you are renting a commercial property, get a personal guaranty from all of the business owners (and if you’re really a stickler, from their spouses). And be sure that you have a good attorney’s fees provision that allows you (but not your tenant) to recover your fees if you have enforcement problems. We can help you draft a good lease.
If you have your heart set on purchasing a rental property–and they can be very good investments–at least be smart about how you do it. Talking to a lawyer ahead of time can help you get your ducks in a row. A good advisor will not only draft a lease for you, but will also help you think through the practical problems you may face being a landlord. At the Entrepreneur’s Legal Resource, we have that experience–both from years of representing landlords, as well as serving as landlords ourselves. Contact us today to discuss how we can help you navigate the sometimes choppy waters of investment-property ownership.
Charles is an attorney in Glen Ellyn, Illinois.After graduating from the University of Utah, he clerked for Chief Justice John T. Broderick of the New Hampshire Supreme Court. He then became a litigation associate at Kirkland & Ellis LLP before opening his own office and partnering with Rick Lofgren. He lives just outside of Chicago, where he participates in community activities, including Boy Scouts and little-league baseball.
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