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Cliff Hockley, CPM
President, Bluestone & Hockley Real Estate Services
Never name your property The Black Cloud apartments -- who knows what can happen? It is an invitation to the Gods to wreak havoc with your tenants, and you as the landlord.
Dolly Madison recently purchased a 50 unit apartment complex in her name. She had sold a small plex in San Francisco and had managed to come up with a significant down payment to buy the apartment property. The location was great, most of the units were rented, and the closing took place on a cloudless sunny day, “a good omen,” Dolly thought. She decided against hiring a property management company, and instead hired her own onsite manager. This is where her problems began. Lets start with day one.
Day 1:
It is the first of the month and Martina, the onsite manager, is out collecting rents. Records show that there are 47 tenants and 3 vacant units. Martina goes from door to door to collect the rents. Most tenants’ pay, but a few have to wait for their paychecks to clear. Martina says that if their rent is late, they need to pay her an additional $50 late fee. The tenants understand this, but what they don’t realize is that their rental agreement calls for only a $25 late fee. Martina has decided to create some additional income for herself. (Let’s do the math: $25 x average 10 units late a month = $250.00.)
She then visits the equipment storage room and checks in with the homeless man that camps out there every night. “Hi Rufus,” she calls “got your rent?” He hands over $100. Martina lets him sleep in the storage room and wash-up in the laundry room.
About 10:00 a.m. a young Latino couple with one child show up to rent a two-bedroom unit. Martina only rents to Russian immigrants so she can control the property and ensure her cut of the rent. The applicants earn enough money, both are employed, have good references, clean credit and no criminal records, but Martina tells them there are no vacant units. Disappointed, the couple leaves the property. An hour later an elderly gay couple shows up to rent an apartment. Again she disappoints them and says nothing is available. Finally close to the end of the day, a Russian family shows up. She makes a big deal about it. Invites them in for coffee and cake and tells them about the special deal she has for them if they pay their basic rent and a little more for her party fund. She does not bother with any background checks, even though he has a history of petty theft and no job prospects in sight. She just moves them in.
That night when Dolly checks in with Martina she is told that the rents have been deposited and that no one showed up that day to look at vacant units. “Maybe we will have better luck tomorrow,“ Martina says. (Note: Martina does have rental applications and screening criteria that point out that they meet all Fair Housing guidelines, and that they do not discriminate on the basis of race, color, religion, sex, handicap, national origin, familial or marital status, sexual orientation or source of income. But of course she ignores the info. She is the Property gatekeeper and she likes it that way.)
Day 2:
Martina has a live-in boyfriend, Boris, who does some limited work at the property. Today is his day to clean the gutters. He gets the 25-year-old wooden ladder out of the shed and leans it up against the two-story building. It barely reaches to the lip of the gutter. He is young and nothing scares him. He puts on his gloves and up the ladder he goes. As he reaches the top, his foot slips and he almost falls off the ladder, but he catches himself and pulls himself towards the gutter. All of a sudden the gutter spikes (nails) pull out and he is hanging, and then falls to the ground. His back is badly hurt. Martina discovers him five minutes later and calls an ambulance to takes him to the hospital. The ladder lies in pieces on the ground. Dolly has no record of Boris on the rental agreement, nor any records of him as an employee. She definitely does not intend paying workers compensation coverage for him. Boris unfortunately had no insurance to cover the medical expenses to fix his broken back.
Day 3:
A child playing in one of the units lights several candles. One falls over, and the carpet catches fire. The unit burns. The heat of the fire causes a gun in the unit to discharge, which goes through a wall and hits a neighboring tenant in the arm. Due to quick response by the fire department, only one unit is destroyed and two others have extensive smoke damage. Dolly had just purchased a new fire policy with a $5000 deductible, so she had coverage for most of the costs of the fire.
Day 4:
It is 8:00 a.m. Dolly answers a knock on her door. A process server delivers a lawsuit notice from Boris to cover his medical costs, pain suffering and wage losses for the rest of his natural life. At 8:05 a.m. a different attorney for fair housing violations serves her. At 8:10 a.m. her manager Martina calls to tell her she is quitting. Dolly pulls herself together, and goes to inspect the property, review the fire situation, and visit with the tenants. She finds utter chaos. All the tenants have problems. She finally sorts through them, then heads to the maintenance closet for some spare parts and discovers Rufus sleeping. She asks him what he is doing; he tells her he’s paid his rent and to leave him alone. When she goes with the insurance adjuster to inspects the apartments adjoining the fire, the Fire Marshall finds that none of the units have smoke detectors. They were all there when she closed on the property a week ago, but it appears Martina collected them because none of the tenants had paid their smoke detector fees. Instantly the Fire Marshal red tags the property and the insurance company pulls its coverage.
Day 5:
Dolly Calls her attorney. She has an empty building, burned units, two lawsuits on her hands, and she did not even think to put the property into a single entity LLC so all of her remaining personal assets are at risk. What had been a great idea has turned into a nightmare. Clearly she could have used the help of a professional property manager.
This scenario can happen to any owner of investment property. As part of the purchase of investment real estate, you need to make sure that policies are in place to prevent:
- Fair housing discrimination
- Manager theft
- Poor manager choices
- Lack of essential service ( i.e. smoke detectors)
- Worker accident lawsuits
You need to protect yourself and you assets by using a single entity LLC. Consult your attorney, CPA and Property Manager prior to closing a sale.
Epilogue:
Dolly found a property manager who helped her get temporary insurance. While the fire and smoke damaged units were being fixed, the property manager started re-renting the other units. With the help of her attorney, Dolly formed a single entity LLC and puts her property into that entity. She renamed the property “Happiness Hill Apartments” to try to dispel the Black Cloud image, and finally settled the lawsuits.
It could have been worse; Dolly could have had a chemical spill at the property on the same day.
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