Using the new tenant’s Security Deposit to pay off the last guy

March 24, 2011
1967 Elcona Mobile Home

Image via Wikipedia


My friend and I were looking through a group of very low end mobile homes in a rural setting. These homes were for sale dirt cheap but had great cash flow numbers to back them up. How great?  On the order of 60% cash on cash return before expenses.  I say before expenses because the guy who was selling the homes had no real records to speak of.  Just a hand written rent role on the back of an envelope.  It appeared to be the kind of thing he may have whipped up ten minutes before we got there so that he had something to show us.

It was clearly not enough to gather any sort of fiscal assessment.

The best I could do was to take a reasonable guess at what the expenses might be and interview a few tenants to see what they pay for.   I wasn’t really interested in using these as rentals, but instead my idea was to start getting tenant buyers into the mobile homes. Instead of $200/month in rent, I could likely get $1000 down and $300 per month for someone who wanted to buy the home.

Since the buying mindset is different than the rental mindset, I could also make the new tenant buyer responsible for maintenance.   Homeowners always take care of their own repairs, but renter will look for the landlords phone number at the first sign of a problem.

The opportunity, something you should always be looking for with a real estate investment, was that I thought I could increase the income and nearly eliminate the expenses by getting in “Buyers” instead of “Renters”

I then asked the seller how much money he was holding for security deposits. I use this seemingly innocuous question to verify how much income he is actually getting, as landlords typically set the security deposit at about one months rent.  I also ask  “so security deposit is usually one month’s rent then?” as a follow up question later on.

What he came back with surprised me:

“I just use the security deposit from the guy who moves in to pay off the guy who moves out.”

It was a great example of the old phrase robbing Peter to pay Paul.  Of course, you can see the problem with this – what if you can’t find a new tenant?

It also told me that he was running his business really tight, or possibly had the habit of blowing any cash he got in his hands.

In my mind security deposits are funds that you should never touch, but instead set aside in a separate account.  By spending the funds he was supposed to hold this guy was breaking a level of trust that could get him into trouble later.

If , for any reason , you find yourself dipping into the security deposit’s you are holding, it is a warning sign that your business, and possibly your moral fiber, is in trouble

We eventually passed on the group of mobile homes, mainly because there was too much deferred maintenance and they were a bit too far from where we like to operate, but the lesson has stayed with me.


Renting vs Buying

March 9, 2009


Renting vs Buying

By
James Miller

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I saw this article on Yahoo about the benefits of Renting over buying a property. This fellow seems to make a broad statement that Renting is better. My take on this familiar argument is that it really depends on your situation.

1. It’s not apples to apples.
You can rent a decent two bedroom in the area where I live for anywhere from $600 to $750 per month.  A small, two bedroom house is going to set you back about $70,000 to $90,000.

Costs will be comparable on both.

But a house is not the same thing as living in an apartment.  Sure they are both “places to live”, but so is a cardboard box alongside the highway. You could argue pretty low living expenses for the cardboard box when compared to a house or apartment, but it’s a lot different.  Human taste and comfort comes into play. How much value do you put on not being packed into a building with other people? How much value on not dealing with a landlord or management company.
These intangibles make a difference too.

2. “Rent instead of Buy” pundits always make this mistake:

As Taken from the Yahoo Article:
“Houses looked like smart investments in 2007. They had returned 9.3% a year for a decade, while stocks had returned just 5.9%. This year, with investors fleeing both houses and stocks, both probably look like a waste of money.”

Sounds reasonable. Until you realize that the return on investment only makes sense if you buy your house all cash.  Since most of us don’t, you have to take into account the return on the amount you have in the house, which is usually the down payment plus some closing costs.  If we use numbers from his example and you are getting 9.3% on your $100,000 home, but only put 10% down You are getting an equity return of $9300, on a $10,000 investment, or about a 93% return.
Try that in the stock market.
I am sure it can be done…..under very speculative conditions.

3. The final thing to keep in mind is that too often people get more house then they need, and as of late can afford.  If you stick to a reasonably sized house for your needs, the payments are often comparable to renting, and the lifestyle is much more comfortable.


Five things you need to know before becoming a landlord

January 22, 2009



Five things to know before becoming a landlord

by James Miller


These are things I didn’t really give much credence to until I started investing in Real Estate.  I share them with the hope it will raise awareness for those just starting out.

These five items are targeted to those of you starting out who will become landlords in the process.

Note that if you think that the lease option exit will not make you a landlord, you are mistaken.  While you do seem to get a higher caliber of character as a  tenant-buyer (probably because as they have more money on the line), you still have to do most of the same babysitting duties as you do with a  straight rental unit.

1) If you are going to be a landlord, you will have to evict tenants.

There is no “if it ever happens”. You will eventually have to evict someone.

People who seemed so nice moving in are the very same ones who will be saying how terrible  you and your apartment are to the Judge when you are in court.

I knew this was a possibility when I bought my first property, but by the time I got to 20 rental units, it seemed I had to start the eviction process more often than my lawnmower.

I have really only had to go through with a full blown eviction a few times, but I have had to serve “pay or quit” notices at least 30 times.  As with a lot of things in Real Estate investing, the things you really don’t want to do, are the very same things that you most urgently need to do.

Serving notices and evicting tenants goes with the territory of being a landlord.  You should accept this and start learning the eviction laws and court system in your area.

Getting a good attorney to guide you in this area is crucial.  If you don’t serve papers correctly, or miss a step in the process, they may hold the case over for a later date, costing you money as the defaulted tenants continue to live in your apartment. And once they know you are taking them to court you have zero chance of the tenants willingly paying you anything.

2) Paperwork, bookwork,  and paying bills will take a lot of time.

Before I started obtaining properties, I could bang out my monthly bills in about 15 minutes.   It now takes me over two hours,  just to get bills for the properties written out every two weeks.

I really should be assigning this task to someone else, but never seem to get around to it. I have to admit that part of it might be my controlling nature not wanting to let go of something so integral to the business.

Paperwork and bookwork take a lot of time too,  getting the paperwork done for a new tenant or tenant buyer to move in involves: a lease,lead based paint disclosure, move in move out sheet, welcome letter, and a schedule of security deposit withholding fees.

Most of these I have multiple copies of, but they all need explaining when turn over the keys.

My brother who is my partner in the majority of our properties is in charge of the bookwork. We use Quickbooks as our accountant seems to speak to that software very well.

Even with this premium software package to speed our bookkeeping, I am sure my brother spends no less than five hours a week on entering information. This is mainly due to the fact that we have several rehab projects that generate a lot of receipts.

The properties are  costing us ten hours per week just to keep the papers in order and get bills paid.  This doesn’t even include the periodic phone calls and letters to the tenants.

3) Advertising expenses will be a lot more than you think.

The classified ads we place are a lot more expensive than I thought they might be.  When I have vacancies, it is normal for me to ring up a classified ad bill of over a $100 before we get the right person in.

Now there are a lot of places where you can advertise for free, like posting flyers at the local convenience store, or on Craigslist, but for us the newspaper classifieds out pull the free ads by about 4 to 1

When you have an empty apartment that is costing you $150 a week to hold, you want to generate as many leads as possible as quickly as you can. Newspaper classifieds becomes a necessary expense.

4) You will have to clean and touch up most apartments after tenants move out.

The law allows for “normal wear and tear” to an apartment. What this means to you is that you can’t force the old tenants to make the place move in ready for the new ones.

Some tenants are really good about leaving things in good shape when they leave, but in most cases you will need to have someone go through and clean the apartment after they have left.

In my experience no one ever cleans the stove.

You will be able to deduct for some cleaning and repair expenses, (I do deduct for a stove cleaning) but this is  a built in cost to apartment turn over.

5) You will need to keep a bigger reserve amount than you think.

“Reserves” is the money that is set aside each month for replacement of things like a worn out carpet.   The problem is that the big ones can take a huge bite out of your checkbook.  A water heater will set you back about $300 if you install it yourself.  A furnace can easily be $5000.

Even if if you have  reserve amount of $50 a month being set aside, a new furnace will take over eight years of reserves to pay for it.  This assumes you don’t use the reserves for anything else during that time, which in eight years, is pretty unlikely.