Real estate investors instinctively pass on deals presented to them simply because the numbers don’t work. This is quite understandable; however, a little 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 simply is not realizing. Owner incompetence typically comes down to six major issues. In most cases, these issues can be remedied simply with a combination of good management practices, an understanding of fair market value pricing and rents in your neighborhood, and, of course, 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 property owner having to cover any shortfall.
The solution is clear. Raising the rents 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 province.
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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. Not until you have set the rental amount are you bound by most provincial Landlord & Tenant guidelines as 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 you must be either moving into the property yourself (or a family member) or you 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. 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. Lack of initial tenant qualification, absence of urgency in collecting rents, and not having proper eviction procedures in place are common characteristics of a mismanaged property.
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, there could also be mismanagement of reserve funds. This is common and results in excessive monthly fees. Being on the condo/strata board and having a hand in how money is being spent can potentially bring down the monthly fees, thus enhancing the bottom line.
Ultimately by leaving 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 get out of property ownership.
Lack of routine maintenance
Lack of response to tenant requests of routine maintenance is the number one reason for turnover and vacancy. This obviously 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 who has 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 repairs 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 make sure my tenants get a repair request sheet which forces the tenant to document each repair and creates a paper trail. This helps avoid hearsay if an issue arises and gives the landlord incentive to get the repairs done within a reasonable amount of time. This goes a long way in creating long-term tenants, which in turn creates 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 around 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, will I be able to raise the rents enough to offset the costs?
e) At the proposed new rental amount, how long will it take to retrieve my capital expenditure?
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 not familiar 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 are often looking to get out fast. Properties do not have to be in a bad area to get to this state, and they simply 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.
Poor record-keeping of rental income, repairs, employee payments, property management documents, and even lack of formal lease agreements can “catch up” are signs of an incompetent owner. It surprises the number of owners who run their business with cash and little documentation. This 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.
Repositioning means turning a property into its highest and best use, which we have been talking about this far, essentially ensuring the highest potential earning capacity of a property. Let’s touch on the repositioning process.
A property that is very accessible to all amenities and transportation could be categorized as an “A” area. Still, the property could be older, run-down, and may have a significant vacancy, categorizing it as a “B” or even “C” property. A cash injection to improve the property to the standards of the “A” area may allow a significant rental increase. Once the building is renovated and can justify higher rents with less vacancy, it is easier to refinance to get most or all of your renovation capital out, allowing you to repeat the process on another property.
Unfortunately, we can’t reposition all properties. There are many buildings where the improvement cost is higher than the increased income expected, or perhaps the area doesn’t warrant the effort. Proper diligence is everything.
When repositioning a property, implement a strategy for both the repairs and the management simultaneously. For the repair phase, make sure to:
Get at least 3 repair quotes to formulate a budget
Hire a project manager if the repairs are extensive; otherwise, hire handypersons specializing in particular trades. Make sure they have referrals of past clients you can call, proper insurance, and are willing to work within a schedule
Schedule the maintenance with the contractor or handyman for the quickest turnaround time and put the expected timelines in the contract, including bonuses for being on or under budget and time or penalties for being over
Base your contract on materials and labor separately
For the management phase:
- Hire a reliable caretaker or property manager, making sure they have referrals (call the referrals!)
- Create a marketing plan to attract higher-income tenants
- Create a screening system and a tenant retention program for your caretaker or property manager
- If you are keeping existing tenants, have your new manager:
- Notify each tenant of the new management and give them a schedule for the upcoming renovations to their unit and the grounds
- Give each tenant a repair request sheet(s)
- Give the tenants a copy of the new “house rules” outlining the expected behavior of both tenants and guests.
- Collect any rents which are in arrears and begin immediate eviction proceedings on those who refuse to comply
- Alert the tenants of new rental rates on all renovated units. You can get exceptions from some Landlord/tenant boards to raise your rents higher than the annual allotment based on significant renovations or additions.
- Pay any non-compliant tenant a “moving” fee to leave
- Begin new leases with all compliant tenants if possible
Repositioning properties is kind of like becoming the new coach of a losing sports team ¾’s through the season. (Sounds like the Leafs!) Use your skill and experience to inspire and help coordinate many non-functioning parts into an entity with chemistry and gels.