REQUIRED READING: The world of commercial real estate finance is filled with numerous people who have become successful and wealthy after years of working to build and maintain equity in their properties. And there is still plenty of opportunity in this sector, especially with renewed interest in the development of multifamily properties.
However, not every commercial real estate expert is qualified to be a landlord. Rather, this is a responsibility that requires a high level of patience.
I can speak from personal experience: My parents made a significant portion of their net worth by owning apartments. They put nearly all gains back into the buildings and paid off their loans early. But the biggest headache for them was not the renovations or maintaining financial stability as landlords – in fact, they thrived at purchasing property and turning it into living space, and they never had problems finding tenants to fill their buildings.Â
Their biggest issue was tenant evictions, which often required the assistance of the county sheriff. Whether you are currently a landlord or are thinking of becoming a landlord of multi-unit housing, you are likely to wind up in this pitfall from time to time.Â
In some ways, the landlords are responsible for the problem – especially if they believe it is better to rent to anyone rather than no one. While many landlords adhere to proper standards of credit, references and an examination of the prospective tenant's character, many others will likely bend these rules in order to start collecting rent on the unit.
That is an understandable response, especially in view of the current economic situation. But it is a major mistake made by nearly all commercial real estate owners at some point – and any rent that is collected will likely be offset by damages to the property by the these types of irresponsible tenants plus legal fees and other assorted expenses. Trust me, I've seen numerous apartments ripped apart by awful tenants – and, in many cases, these were the same people who hadn't paid rent in months.Â
Of course, a landlord can sue a tenant who damages property and/or refuses to pay rent. But doing this successfully is actually fairly hard and, more often than not, is likely not worth the effort.
For example, let's assume the tenant from hell is a middle-aged person without a savings account or any known assets or collateral. What can a legal judgment do – garnish the wages of whatever temporary job they have at the time? Collecting rent – let alone legal judgments – from such individuals falls between ‘impossible’ and ‘not worth the time.’Â
So how can a prospective landlord avoid this dilemma? For starters, always finance your buildings on long-term, fixed commercial mortgages. Do not be another statistic that just assumes it will be easy to refinance someday before interest rates skyrocket – and don't over-leverage yourself under an optimistic belief that you'll have ideal tenants without vacancy for the next 30 years.Â
Second, unless you're exceptionally wealthy, you should never rely on property management as your primary source of income. If you rely on tenants to pay their rent in order for you to pay your commercial mortgage, you are putting yourself in a predicament that usually leads to having subpar tenants.Â
Third, take your expectations and cut them in half. The real estate infomercials and real estate gurus may have brainwashed you into believing that being a landlord is nothing but passive income – when, in actuality, it involves quite a bit of risk, including significant property taxes, possible court appearances, the occasional lull of higher-than-average vacancy and impossibly bad tenants.
Ultimately, time is on the side of the prospective commercial real estate landlord. Holding out for a worthy tenant is the correct approach, even if it means the property remains vacant for longer than you would like. Property management is one of the few professions and activities in life where being a pessimist will actually benefit you.
Eric Smith is director of marketing for Clopton Capital, a commercial mortgage provider in Chicago. He can be reached at (866) 647-1650.
