Real estate investors instinctively pass on deals presented to them simply because the numbers don’t work. This is quite understandable; however, more digging can sometimes uncover a simple reason for the property’s lack of cash flow. This issue often comes down to incompetent ownership, which results in mismanaged properties.
Mismanaged properties or “underperforming” can be a virtual goldmine if you know how to identify and capitalize on the true potential another investor is not realizing. Owner incompetence typically comes down to six major issues. In most cases, these issues can be remedied simply with good management practices, understanding fair market value pricing and rents in your neighborhood, and injecting a little cash. The following examples generally pertain to smaller multi-families (2 -20 units); however, the principles can be applied to larger multi-families.
Below-market value rents
This common faux pas stems from a lack of knowledge of fair market value in the area, resulting in a cash flow issue. If a property is at +/- breakeven cash flow at 100% occupancy, any vacancy results in the owner having to cover any shortfall. The solution is clear. Raising the rents by even $100.00 per unit (depending on the number of units) can turn an apparent cash flow issue around. However, this can be a more difficult process based on which province the property is in and the Landlord/Tenant board guidelines of the particular area.
As the new buyer of a property, you have the option of requesting vacant possession. This allows you to reset the rental amounts at whatever the market will bear. It is not until you set the rental amount that most provincial Landlord & Tenant guidelines bind you to how much of an annual rental increase you are allowed. It does need to be said that by requesting vacant possession, you must abide by provincial laws, which clearly state that you must be moving into the property yourself (or a family member) or intend to do significant renovations.
Absence of good property management
Lack of this skill is one of the biggest downfalls of any would-be investor. Lack of initial tenant qualification, absence of urgency in collecting rents, and lack of proper eviction procedures are common characteristics of a mismanaged property. This encompasses everything from improper screening during the tenant interview process to the daily aspects of running the property. Neglecting any of these areas will result in an underperforming property. Without a rigid system to screen the tenants, owners subject themselves to delinquent rents, frequent vacancies, and potentially large repair bills.
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Using property management or self-managing is another factor to consider. The novice investor often self-manages to save money. However, lack of efficiency is typically equated with the lack of time the investor has to dedicate to property management, and ultimately the property suffers and becomes an underperformer. Hiring an incapable property management company can also create an underperforming property. Property managers have been known to have poor screening procedures because they only get paid when a unit is tenanted. This is more common than you may expect. The bottom line is low rents and high turnover.
Often property managers also outsource repairs and “pad” the bills as extra income. If the owner were in control of the management, they would know exactly what the repair was, the cost of materials and labor necessary to fix the repair, not to mention the name and number of people in their database to repair. If the property you are looking at is part of a condo corporation or strata, reserve funds could be mismanaged. This is common and results in excessive monthly fees.
Being on the condo/strata board and having a hand in how money is spent can potentially bring down the monthly fees, thus enhancing the bottom line. Ultimately, giving the management to someone else or not managing the manager will often lead to underperformance. Negative results stemming from poor property management are also why many incompetent investors leave property ownership.
Lack of routine maintenance
Lack of response to tenant requests for routine maintenance is the number one reason for turnover and vacancy. This results in negative cash flow, which contributes to underperformance. This issue is straightforward and inexpensive to correct. Hiring a caretaker instead of a property manager with handyman skills allows payment of an hourly wage instead of an overall percentage rate and “padded” repair costs.
A caretaker can show units, perform tenant interviews, enforce leases, collect rents, deal with tenant issues and repairs, and oversee more significant maintenance to ensure they are done satisfactorily in budget, schedule, and quality artistry, especially in terms of quality artistry if you are an absentee owner. I also provide my tenants get a repair request sheet forcing the tenant to document each repair and create a paper trail. This helps avoid hearsay if an issue arises and incentivizes the landlord to get the repairs dcomplete the repairsble amount of time. This goes a long way in creating long-term tenants, making an efficient property.
Letting properties become rundown by neglecting routine maintenance
The properties being referred to are neighborhood eyesores. Common characteristics are unkempt landscaping, clearly visible overdue repairs, to even a makeshift car (or appliance) repair/storage facility on the driveway (or front lawn). Not only does the incompetent investor have an undesirable-looking property but probably thousands of dollars of renovations. These properties ultimately attract the type of tenant that nobody desires. The good news is they can often be purchased for great deals and turned into highly functioning properties with good tenants and great cash flow. To understand if it is worthwhile to get involved in such a project, it is important to ask yourself the following questions:
a) Is this an ugly property in a good area?
b) Are the repairs required cosmetic?
c) How much will the repairs cost?
d) If I repair the property, can I raise the rent enough to offset the costs?
e) how long will it take to retrieve my capital expenditure at the proposed new rental amount?
f) If I do the repairs and raise the rents accordingly, will this property attract the type of tenant who will want to live in the neighborhood and afford the “new” rental amount?
Not taking the initiative in your eviction process.
An incompetent owner who allows delinquent rent to perpetuate for months or is unfamiliar with the landlord/ tenant guidelines can create an inefficient property, producing negative cash flow and tenants who often take over the property. These owners can be very accommodating when negotiating for purchase as they constantly look to get out fast. Properties do not have to be in a bad area to get to this state; they have an inexperienced or neglectful landlord. These properties can be turned into gems by demanding vacant possession, doing the necessary repairs, and creating a new tenant base.
Records mismanagement
It surprises the number of owners who run their businesses with cash and little documentation. Poor record-keeping of rental income, repairs, employee payments, property management documents, and even lack of formal lease agreements can “catch up” and are signs of an incompetent owner. type of owner eventually must “wake up and smell the taxman.” A business can only survive like this for so long before the owner must change their ways or sell.
