Risk Management for Owners of investment Real Estate
George is a successful real estate investor with over 400 apartment units and four commercial buildings (totaling approximately 100,000 sq. ft.). He is very proud of his investment portfolio, but he has a problem. George is frequently in court, fending off one law suit after another. If it is not a trip and fall, then he is fighting a habitability issue or a discrimination allegation. In addition, the city is continuously inspecting his properties and issuing citations. All of these issues are a serious drain on his time and cash flow.
Developing a Risk Management Strategy
George finally decided to meet with his attorney, Leah. He complained to her that he needed help dealing with these issues.
She suggested the implementation of a risk management strategy, telling George, “You need to put policies in place that your employees can follow to avoid these issues.
You and your employees need to be trained. They need to take classes on local, state and federal habitability standards and /tenant laws. They also need to understand how to take care of your property, because being a slumlord only opens you up to more claims.”
George countered, “The tenants destroy everything. If I give them a new unit, they just destroy it and I will need to rebuild it from scratch. It’s better if I just give them the unit the way the last tenant returned it to me.”
Leah, responded, “If you treat the tenants with respect, screen well, set high standards, inspect regularly and complete maintenance quickly, you will have a better chance of getting your property back in good condition and significantly reduce your risk of litigation from a dissatisfied tenant.”
She continued “ organizations like Rental Housing Northwest, Rental Housing Alliance Oregon, Oregon Rental Housing Association, and Building Owners and Managers Association (BOMA), for commercial properties, all help investment property owners understand changes in the market place and develop training and risk management classes.”
Leah also pointed out that thorough tenant screening was critical. Tenants need to have the money to pay their rent. At minimum, tenants should earn three times the rent in order not to be too financially stressed. The U.S. Housing and Urban Development (HUD) defines ‘cost-burdened’ families as those who pay more than 30% of their income for housing and may have difficulty affording necessities such as food, clothing, transportation and medical care. When tenants pay more than 50% of their income toward housing they are considered ‘severely rent burdened’ and are at the extreme edge economic survivability. History has shown that economically stressed tenants struggle to keep rental units in good condition. Therefore, it is important to screen tenants carefully and obtain previous owner references.
Leah continued, “Rule-setting is important. Using a thorough rental agreement with clear rules makes it easier for both the owner and the tenant to be accountable. Being a “nice guy” Owner does not pay off for either the tenants or the Owner. Shaking hands on the rental agreement leaves too much ambiguity. Rental rates, deposits, clearly specified move in and move out dates, maintenance, and rule-setting are critical for a successful rental agreement. Use a rental housing association form for your state and augment it by having an attorney experienced in Owner Tenant issues review and modify the rules section. Don’t just print out a form you found online to save money. Pay for one and have it reviewed by an attorney. You can be a “nice” owner but be sure to implement rules and policies that protect the tenant, the owner and the property.”
Site and property inspections
Don’t forget, you get what you inspect, not what you expect. Leah reminded George that his property managers need to regularly inspect the exteriors of properties, including laundry rooms, trash enclosures and car ports, as well as the inside of the apartment units. Properties need to be monitored and pet waste needs to be picked up regularly.
Leah explained her “Oasis” theory.
“I have an owner who has a property in a dangerous part of town. Shootings, drug dealing, and burglary occur frequently around the property. This owner fights back with constant care and attention. Nicely landscaped grounds, well maintained buildings, regular inspections and thorough tenant screening have kept poor quality tenants out and created a relatively safe haven for the tenants that live there. It’s an oasis in the desert and the existing tenants want to keep it that way. His commitment to the property is reflected by the high tenant retention and lowered crime rate. One rule that helps this and all of his properties, is that weapons are not tolerated onsite.”
Leah also explained, “Keep track of your rents and make sure your money does not get lost. In other words, have strict cash management procedures and audit your on–site managers. (Set a policy of not accepting cash for rent). Good rent collection policies and rigorous employment screening for bookkeepers and on-site managers is important. Additionally, consider redundancy and double checking to make sure rents get collected and posted correctly. It’s all part of limiting risk.”
“At the same time, you are training yourself and your staff, consider your insurance coverage. Take the time to meet with more than one insurance agent to really understand coverage options – it is very complicated.
Possible Insurance coverage options include
- Liability insurance
- Business Owners policy
- Errors and omissions insurance
- Employee liability insurance
- Tenant discrimination insurance
- Flood insurance
- Earthquake insurance
You may not be able to afford all of these coverages. However, having good procedures in place can limit risk exposure.
Leah told George, “It may pay to place your assets into separate legal entities, such as a Limited Liability Company or a Subchapter S Corporation. If structured correctly, personal assets may be protected by the corporate veil. Entities may be established for individual properties or investments may be grouped together.”
She detailed, “Combining multiple assets into a single corporate entity may result in enhanced exposure. Protecting properties individually is often the best way to protect a portfolio in the event of a lawsuit. For example, if Fair Oaks Apartments LLC is sued and the LLC only ‘owns’ Fair Oaks Apartments, it often prevents other assets from becoming entangled in the lawsuit. If you package two or three or more properties into an LLC they can all get linked in a lawsuit. If you only have one property in an LLC, then only that property can be sued. In other words, when you get sued at Fair Oaks Apartments (aka Fair Oaks Apartments LLC) they can only sue that property and not any of the other properties in your portfolio. Reading the following citation might help clarify. https://markjkohler.com/are-single-member-llcs-worth-it/
George thanked Leah for all of her advice and sat down to think. He was overwhelmed with all this information. He had so much to do. So many policies to write and implement. Maybe it would be better if he hired a property manager who had these systems in place? But first, he had to get organized and Leah was kind enough to send a summary letter, so he could start the process.
Risk management is an important part of being a successful real estate investor. All owners need to set policies and procedures for themselves and their team. Policies and procedures need to be reviewed and updated every year, as laws change and as the portfolio changes. Developing and implementing a risk management policy will help shrink risk exposure and contribute to success as an investor.