This is the third part of my series in which I want to share my experiences and thoughts regarding the risks around investing in real estate. You can read Part 1 here and Part 2 here.
Today I’ll be talking about the risks associated with your renters. I wouldn’t over dramatize this. We have personally not had any really big problems yet. But it’s important that you know the ropes so you can be prepared.
As always: I’m not a professional financial, real estate or tax advisor. You need to do your own due diligence and may want to consult a certified specialist before making any investment. And, this post applies to the situation in Germany. In a lot of countries your position as a landlord is actually much better than here (that’s no ethical judgment, I’m only referring to the legal situation). But as in the US for example some cities like Portland seem to be tightening laws, this information might be of interest none the less.
Let’s jump right in.
Partner by contract
If you rent out apartments or a multi-apartment properties you ideally only have nice renters – and you’re a pleasant landlord as well. The renter is your contractual partner and has – just as you – certain rights and obligations. In Germany in fact, he has rather more rights than you. And it doesn’t look as if this will change in the near future, quite the contrary. If you currently rent an apartment you benefit from this yourself.
Up to a certain point I think that pro-renter laws are not a bad thing. Having a home is a basic need and not everyone can afford to buy his or her own home. And if I look at the situation in the UK, as another example in Europe, I definitely feel renter protection is way off there.
But disregarding any personal feelings: if you buy a property as an investment, you will most probably want to earn money and make a profit from your investment – that’s in exchange for the risks you take and which this series is all about. And that’s why it’s in your legitimate interest that your renters can afford their rent – and continue to be in this position.
Selecting a renter
Most probably, the location of your property will effectively pre-select by attracting a specific demographic. In regions with economic problems, the risk for becoming unemployed is higher. If you rent to students, the fluctuation tends to be higher. This means you have to find new renters more often. If you rent out a luxury apartment in one of the top neighborhoods your potential renters might be equally ‘sophisticated’, aka demanding, Which might come with more frequent requests and more involvement on your part.
So think about what kind of renters the property is going to attract and whether that’s fine with you before you buy. Also think about whether you really want to deal with renters yourself. If not, you can outsource this. But you you have to include the associated costs in your return on investment calculations.
A real estate agent, yes or no?
That goes for scanning and selecting renters as well. If your property is not in or close to where you live, I would include costs for a real estate agent in my calculations. At least for the first time you need to find a new renter. There’s no legal obligation to use an agent, though. You can advertise the apartment on platforms like Immobilienscout or Immonet (no affiliate-links). And organizations like Haus und Grund (no affiliate-link) provide standard rental contracts.
A real estate agent should have an established process from which you can learn, a template for the “Mieter Selbstauskunft” (a ‘voluntary’ disclosure of personal and financial details), and maybe access to specific databases for requests on solvency. But again, you can find appropriate templates and a vast amount of additional information on the internet.
What kind of documents do you need to ask for? I would always ask a potential renter to fill in the “Selbstauskunft”, and provide proof of salary (usually employer salary statements for the past three months) and a “Schufa-Auskunft” (documentation of credit score). I’ve come across a landlord myself once who additionally wanted a statement from the employer that the employment contract was not under period of notice. What does make sense in my view is a certification of the current landlord that rents have always been paid on time/that no rents are outstanding.
If a potential renter is self-employed or a business owner, his certified tax advisor can provide proof of income for the past year. And if your potential renter is on state benefits you could check whether the job center can pay the rent directly into your account.
When checking the documents I would make sure that the total rent is not too high in comparison to the net income. My personal opinion is that the rent shouldn’t make up more than 30 to 40 percent. That’s in line with the fairly recent average in Germany.
An additional guarantor?
If the net income of your potential renter is not sufficient or if he or she doesn’t earn an income at all, e.g a student, a third party can guarantee the rent. Apart from the student situation I would personally be hesitant to use this construction. But everybody is different. If you want to accept a guarantor, their income and credit rating must meet your benchmarks as well, of course.
And, that’s a tip from someone who rented me an apartment once: Get in touch with the guarantor directly. This guy had one case, where a student had given him a guarantee signed by his grandfather – only the grandfather didn’t know anything about it…
The rent deposit
There is one type of security that you should definitely make mandatory: the rent deposit. We didn’t do that when first renting one of our apartments out short-term and had problems with one renter, more below.
You can take the deposit as cash value or via a bank rent deposit guarantee (e.g. by your renters bank). I actually find the bank guarantee more comfortable to handle since your legally obliged to keep any cash value deposits separate from your own assets and pay interest on it. There is something called ‘Kautionssparbuch’ (deposit savings account) – I only know that one from my rental contract with the people who also wanted the certification from the employer I wrote about above – maximum hassle for the renter, no work at all for the landlord.
In combination with a guarantor of the rent itself, it’s important to know, that the total guarantee cannot exceed a maximum of three ‘net rents’ (rent exclusive of heating and other running costs such as garbage disposal or a janitor). I only read that some months ago, but it seems to be the current legal situation. In my opinion this is not okay since the damages you might encounter as a landlord will not be covered by the guarantee in a worst case scenario. In that case you can only hope that the guarantor will voluntarily stick to his promise and act responsibly independently of any legal obligation. There are two exceptions to this rule that you should have looked at before considering taking on a guarantor (Link in German).
Our least loved renter
And as I hinted above, now for a bit of personal experience: Fortunately we’ve never had a case of so-called ‘rent nomads’ so far. But a renter who seemingly deliberately rented apartments that were beyond his means. He was a freelance SAP consultant and with the experience we have today we would have asked for a documentation of his income. But up till then we had only had very nice and reliable short-term renters, so we were quite spoilt.
As we later got to know, our special friend had already rented another apartment in the same complex, apparently not to the full satisfaction of the landlord either. Anyway, after the first rent that was due on signing, rents didn’t come on time. Or there were only partial payments on reminders.
Particularly spicy was that several times it was his girl fried who transferred outstanding rent. No, wrong: the most spicy was that our cleaning lady found him once – despite the usual pre-notification – in the apartment with a prostitute when she came in for the monthly cleaning service. Which resulted in her leaving angrily without doing the job – talking about the prostitute, not our cleaning lady…
What to do if the rent doesn’t come
I would advise you to contact the renter directly when there is any delay of the rent, and to send him a formal reminder with an appropriate deadline as well. In your own interest, you have to make sure that you take all the necessary steps from a legal perspective, to make sure you are in a position to actually terminate the contract and evict the renter should this become necessary.
Maybe your renter only has a short-term liquidity problem. In that case it would obviously be better had he gotten in touch with you in time. If this happens with a good renter who has been reliable so far, it’s totally fine to find an arrangement that works for both sides to solve the problem.
Don’t let yourself be taken advantage of
But there are renters as well who don’t even intend to be reliable and deliberately try to push their financial problems on you. That’s a game you shouldn’t play. In the case I outlined above, we ended up getting all rent payments. But we had to completely paint the apartment since the guy smoked in the apartment despite this being a no-go according to the rental contract (you can at this point not totally rule out smoking in a regular apartment. But we figured that short-term rentals are more similar to hotels).
Our special friend had promised – of course – to cover the costs for this. But after he left the apartment – literally – at the break of dawn, we didn’t receive any more payments at all. Instead he left us some suitcases. Empty suitcases. That might have actually been a good thing. In comparison with the state true ‘rent nomads’ leave apartments this was nothing cost-wise. But an important learning for us.
So you should take a professional perspective if you want to invest in rentals to earn money. I look at our renters as partners I do business with, and to whom I want to sell and deliver a good product. In exchange I want to be compensated accordingly. Like this, the deal makes sense for both sides.
This was my last post on ‘Real Estate Investment Risks’. I hope I’ve not scared you too much by now. But as you see, even if things don’t run smoothly all the time, we’re still into using rentals to build job-independent income streams.
Alright, now you know quite a lot already. And if you feel investing in real estate might be something for you: get started, try things out, and learn and grow by your own experiences.
Financial Independence Rocks!