Today’s guest post written by a great real estate investor and friend of mine, Chad Carson.
Chad, now 37 years old, began real estate investing from scratch right out of college at the age of 23. Since then Chad and his business partner have bought, sold, leased, and financed hundreds of properties in and around Clemson, SC. Their current holdings include houses, mobile homes, and small multi-unit buildings.
Chad focuses on using real estate income to retire early and do what matters. For example, in 2017 he’s traveling with his wife and two young daughters to live in Ecuador in South America. He also enjoys working on local community projects like pedestrian/bike paths.[/fusion_person][fusion_text]
I love his site because it’s not your typical real estate investing site. It’s focused on Financial Independence and long-term wealth building through rental income, similar to this one. A couple of my favorite articles right now are about 35 real estate niches to invest in and I really like his house hacking guide.
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Systematizing your real estate business
Real estate investing is an amazing tool. Over the last 14 years, I have personally used it to earn a living, build wealth, and produce passive income. I’m personally a fan of the small, DYI style of real estate where you directly own a few residential properties, get them stabilized, and live off of the income. Compared to any other investment method I’ve found, this style of investing provides more control, more predictability, and more income for an early retirement.
But there’s something you should know if you’re also a fan of this type of real estate investing. Rental properties do not become passive on their own. For better or worse, real estate is a hybrid investment. It’s one part small business and one part investment. It requires your ideas, your time (at least up front), and your money. You must be both the CEO and the investor.
Most real estate articles are about the investment side of that equation. But in this article, I want to help you out with the CEO role. What follows are the 5 key systems of passive rental properties and how to use them in your real estate investing business.
Let’s get started!
The 5 Key Rental Property Systems
Systems permit ordinary people to achieve extraordinary results predictably … Systems run the business and people run the systems.” – Michael Gerber, The Emyth Revisited
Here’s paradigm #1 as the CEO of your real estate investment business. You need systems.
And every part of your real estate business can be systematized. When documented physically or online, these systems become what’s called an operating manual for your business. Originally I had mine in a 3-ring binder, but today I keep it online in a set of shared folders on Google Drive.
A business system is just a documented process of doing something. For example, the monthly processes of keeping good accounting books is a system. It often looks like a checklist or a set of instructions. The system both tells you the expected result and the current best practice to get that result.
Systems can get very detailed. My personal real estate investing operations manual contains checklists, forms, contracts, software, and more. I obviously don’t have room to provide every single detail here, but to fill in the gaps and get more specific recommendations, you can combine this guide with Eric’s awesome 18 Ridiculously Awesome Ways to Put Your Business on Autopilot. You can find a lot of your local documents and best practices networking with other investors.
I’ll explain each one of these systems in detail. But first, I want to begin with an important distinction: delegation vs abdication.
To Delegate or Abdicate – That is the Question
If manage your properties and do everything yourself,you will follow these processes yourself. You are both the creator and the person running the system. But if you outsource some of your systems to someone else, like a property manager or a bookkeeper, you have chosen to delegate.
While this sounds good, many real estate investors and business owners think they delegate but instead, they abdicate their responsibilities. I know, because I’ve been there! I’ve asked contractors to fix things without correctly delegating, and the results were the opposite of what I wanted.
Delegation means you, as the business CEO, hold a person accountable for expected results. Abdication, on the other hand, is sticking your head in the sand and hoping the other person gets done what you need. With abdication, you’ve given away your responsibility as the CEO to ensure the systems work.
Delegating does not mean you need to micromanage. Depending upon the size of the system you’re delegating, you may just have one upfront conversation to clarify expectations. But for bigger projects, like outsourcing your entire property management operation or hiring a bookkeeper, plan to have more in-depth training and discussions to ensure the person understands and can execute the business systems as you want it.
That is why the content of this article is important whether you will do everything yourself or delegate 99%. If you want to enjoy peace of mind as an owner of a rental portfolio, you need to have clear communication with the people on your team entrusted to do things for you. The systems that follow will be the framework to help you do that.
System #1 – Leasing
Leasing is the system that quickly fills your rental properties with qualified tenants that take care of your property and stay for a long time (at least that’s my goal!). As you may have experienced, not all tenants fit that qualification. And as I’ve experienced, it sometimes takes longer than I like to fill the property.
But a system will ensure you apply the best techniques to accomplish your leasing goals. And as you learn new techniques (like from all of the IdealREI articles!), you can improve and replace your existing systems.
I actually have 5 sub-systems within the leasing system. Each has its own checklists and instructions. I’ll summarize each of these sub-systems here.
Lead Generation For Tenants
This is the process of telling the world about your rental property so that prospective tenants contact you and want to apply. In some cases for your most popular properties, you won’t even need to promote it. Your existing tenants will just their friends and they will call YOU to be first in line when the existing tenant leaves. This is a BIG reason to buy in-demand properties, by the way.
But for normal rentals, you need a process of advertising online, taking good photographs, describing the property well, printing flyers, putting up signs, and then managing all of these promotion channels.
In terms of advertising online, most of my own prospective tenants come from free websites like zillow.com, trulia.com, craigslist.com, and other local websites. You can do a google search for your area to find the websites most tenants use.
Once a tenant shows interest in a property, they’ll usually want to view the property before applying to rent it. You want a system at this stage so that you can track how many people are viewing the property and so that you can manage your time.
This system begins with great photos and videos of the unit. You’ll be surprised that some tenants will rent a property without visiting in person if you provide a great online tour. This is especially true if the tenant is moving from out of town.
But when people do want to view the unit, you have a few choices for showings:
- Drive across town on-demand to show the unit (not recommended)
- Schedule open houses 1-2 times per week
- Put a lockbox on the property and give pre-qualified prospects the code to let themselves in (my favorite)
I prefer #2 and #3. If the house is occupied, someone will likely need to meet the tenant to let them in. In this case it’s best to schedule 1-2 open houses per week. Don’t be afraid to keep these windows of time relatively short, like 30 minutes or an hour. If prospects see other prospects viewing the unit, that will only incentivize them to move fast!
For 12+ years we have used lockboxes to show our vacant rental units. After a phone call to prescreen them a little bit we give them the lockbox code. On the initial phone call we ask general questions like why they’re moving, when they want to move-in, whether they have pets, where they work, etc. Then we write down what time they are going, and we ask them to lock the door behind them and text or call us when they’re done. We used to leave flyers and applications on the kitchen counter, but today all of our applications are done on our website.
This is one of the most critical systems of the entire rental business. Don’t short-cut it! And trust me, when you have a vacant unit hemorrhaging cash flow you will REALLY want to short cut it. In the long run, however, you’ll lose more money than you gain by lowering your tenant standards.
The goal of this system is to objectively screen tenants to ensure they qualify. I hope you know by now, but you can not discriminate based upon qualities like race, religion, national origin, sex, age, disability, or familial status. But you can and should screen tenants for other criteria that demonstrate their ability to pay and to be a responsible steward of your property.
I recently had a guest post from a national expert on tenant screening. She wrote a fantastic step-by-step guide to screen for the best tenants, including a helpful infographic you can print as a reference. But in summary here, you can screen for things like:
- Employment status
- Debt to income ratio
- Prior landlord references
Be sure to document your tenant screening criteria in writing and communicate them with your property manager, if applicable. And once you have these in writing, stick to them. You will get yourself in trouble with the law and with your own cash flow by deviating from your stated criteria.
I once read a great property management book called Landlording on Autopilot by Mike Butler. His own systems included something called a “Rent Talk.” This was a one-hour meeting with the tenant to review the lease, receive their upfront money, discuss the landlord rules and expectations, and listen to any questions or concerns of the tenant. I think it’s a great idea.
At the meeting, the core document is your lease (aka rental agreement). If you have your real estate license, you can probably get a reasonable lease from your local Realtor board. You can also get leases from property management seminars and courses, from your local attorney, or from online document resources like at BiggerPockets.
The important point of this system is to communicate clearly your expectations and the consequences (aka late fees and an eviction) if the rules are not followed.
Once you’re tenant signs the lease and pays their deposit and first month’s rent, it’s time for them to move in. I have a checklist to remind us of the taks involved at this stage. It includes things like:
- Ensure we have current video/photos of unit’s condition prior to move-in
- Give and receive tenant walk-through inspection checklist (or meet in person)
- Transfer utilities out of our name before move-in day
- Remove staging materials and lockbox from unit
- Leave tenant welcome package & house-warming gift (we plan to start this one soon)
- Add tenant lease information and documents to accounting/property management systems
As we forget different tasks and it costs us money, we end up adding to the checklist to make it longer!
System #2 – Collections
The collections system occurs once your tenant has moved in. This system is the lifeblood of your business, because it ensures you receive the cash flow that pays for your expenses and hopefully eventually pays for your financial freedom!
Collections fall into two categories:
- Regular collections
- Delinquent collections
For regular collections, our system goal is to make it easy for our tenant to pay us and easy for us to process it. We give them a few options:
- Online payment directly to your account
- Physically deposit with a teller at our bank
- Mail to our PO Box
Well over half of our tenants pay online, and the number is increasing. And we try to discourage mailing payments because of the delay and potential for getting lost (which leads to a late fee for the tenant). You’ll notice none of these require us physically being there to collect money. We don’t have an office, and we prefer to automate or outsource this as much as possible.
For delinquent collections, the key is to be fair, fast, and firm. Tell your tenants during your initial leasing appointment when the rent is due. Also tell them when late fees begin and when you’ll be filing an eviction if no payment plan has been agreed to. Then stick to your system.
Here is a summary of our delinquent collection process:
- Rent due on the first.
- After 5 p.m. on the 5th of the month, a late fee is incurred.
- A call, text, and/or email will be made on the 6th to inquire about unpaid rent.
- If we receive no response or do not notice proactive effort from the tenant, we file an eviction immediately. In South Carolina, we do not have to mail notice if the proper wording is in our lease. If that’s not the case with your state, you’ll have an additional step to give official, written notice to the tenant of their delinquency.
- We prefer to work with the tenant to stay. So, if they can demonstrate means to pay us back in a reasonable period of time, we will work with them and cancel the eviction.
- If the tenant ignores us or cannot catch up, we proceed with the eviction until the tenant moves (typical) or until the Sheriff comes with us to set them out (rare).
Being fair is both good business and the right thing to do. If the tenant has the ability to pay even though it’s late, it usually makes sense to work with them. But many amateur landlords go too far the other way and are not fast or firm.
Letting a tenant live for free is not fair to you, to your financial partners, to your lenders, or to anyone else you have the obligation to pay if your tenant does not pay you. That’s why this system is important. It helps you to be objective, because this can be a very emotional part of the landording business.
For another perspective on what to do with a delinquent tenant, read Eric’s What to Do When a Tenant Is Not Paying Rent.
System #3 – Bookkeeping & Administration
Bookkeeping and administration is the system that keeps your business finances and your paperwork organized. This system is very important for your tax purposes and for the efficient management of your business affairs.
Like everything else, you should make checklists for your own personal systems. But here are some of the important tasks we have on our bookkeeping and administration checklists:
- Reconcile bank and credit card accounts by the 5th of the month
- Label and correctly enter all transactions into accounting system (we love Avail.co for property management and Quickbooks for our rental accounting).
- All paperwork, receipts, & records scanned, uploaded, and organized (we’ve gone paperless using Evernote.com)
Quarterly and Yearly:
- File federal and state payroll reports and make withholding payments
- File annual 1099, 1098, W2, and FUTA/SUTA forms
- Prepare books for tax return filing
- Annual corporate meetings and file minutes
Then there are tasks that I (the CEO/owner) still handle and plan to handle indefinitely in the future.
- Sign all checks or send online payments (never give this up!)
- Enter HUD-1 statements into Quickbooks after a purchase or a sale
- Final audit of books for tax return filing with CPA
- Handle miscellaneous problems, anomalies and rabbit holes (and bookkeeping holes can be dark, deep, and unpleasant!)
- Oversee bookkeeper and administrator’s tasks
When you have well a well-run bookkeeping and administrative system, you can spend your mental energy on other important tasks like making money!
System #4 – Maintenance
I think the number one complaint I get about directly owning rental properties is the potential for maintenance calls. But if these people only learned how to build a system around this aspect of the business, the challenge would become a non-factor.
The maintenance systems in our business can be divided into Urgent and Preventative.
You can avoid maintenance crisis by building a good team of subcontractors. Here is a list of some of the important subcontractors you’ll probably need:
- Plumbers (multiple)
- HVAC techs (multiple)
- Electrician (multiple)
- Appliance repair
- Lawn service
- Pest control/moisture control
- Gutter and vinyl siding contractor
It may take some time up front, but as you build relationships with trustworthy contractors, you can learn to depend upon them to handle issues even without your presence.
For example, I specifically remember calling my plumber about a hot water heater leak while I was traveling. My wife and I were about to visit a penguin colony on the southern tip of Chile in South America! The call took 2 minutes, and he handled the rest while I visited some penguins.
You can prevent many maintenance issues from becoming urgent by performing regular, preventative maintenance. Here are some of the items we have done regularly:
- Check roof for nail pops, lose shingles and other potential water entry points
- Clean debris off roof and gutters
- Change HVAC filters
- Clean and inspect HVAC system, mechanical parts, and duct work
- Check electrical breaker box and service lines for problems
- Check all sinks and tubs for leaks
- Caulk and reseal areas exposed to water (bathrooms, kitchens, exteriors)
- Spray for bugs (especially down South)
- Enter the inside of units to check for other misc problems
My business partner and I also like to at least annually (often more) ride around to each property and make a list of any issues or upgrades we’d like to make. We then hire a contractor during a slow time of this schedule to make some of these repairs.
System #5 – Turnover
The final rental property system has to do with the turnover time between tenants. This could be as short as a couple of days (my favorite) or a month or two (not good). Here are the goals we have for our turnover system:
- FAST turn-around time. Every day of vacancy costs money.
- A high standard of property condition and cleanliness that you can hold your tenant to.
- Fixing problems and perform preventative maintenance as needed.
There are a couple of sub-processes within the turnover system.
Tenant Walk-Through Inspection & Return Security Deposit
This is an important and often contentious part of the landlord-tenant relationship. You need to walk through the property after a tenant moves out in order to determine if they have caused damage or failed to clean the property. If so, you will need to deduct money from their security deposit.
Some landlords are completely unfair and keep too much of the tenant’s security deposit. But some tenants treat the property poorly and cost the landlord a lot of money.
The key to this system actually begins with the lease signing and tenant move-in process in system #1. If you clearly explain your expectations and document the initial property condition, you can avoid a lot of problems later on. We also like to take a video before a tenant moves in so that we could show them evidence of before and after.
I used to spend a lot of time walking through properties and making punch lists for our contractors to fix before the next tenant moved in. Then it dawned on me that I was doing extra work!
We decided to make standard punchlists for the following categories that always come up during turnover:
Spend a lot of time on the front end creating detailed expectations for your contractors (instructions are helpful too). They can then print off this checklist and use it as a guide. Sometimes there are repairs needed that aren’t on the checklist, and either the contractor or the property manager will catch these while the other work is being done.
One important part of this system is your choice of paint (yes paint!). I recommend using a standard paint color and brand for all of your units. We actually found that the less expensive, Sherwin-Williams contractor paint touched up the best. Because we use one paint color for walls and another for trim, we can buy in bulk and use up every drop of a can. We can also touch-up or just paint one wall instead of painting an entire room. This is a big savings!
Make These YOUR Systems
It’s taken me over 3,000 words just to explain the basics of these 5 systems. But as you can see, the most important step is to make these systems yours.
If you like your systems in physical form, start with a big 3-ring binder and use dividers for each category or sub-category. If you’re super fancy, you can even get them color coded! Then print every checklist, form, list of rules, or procedure document to save in the appropriate place.
You can do the same process online using something like Google Drive (my preference) or Dropbox. I like the online system because I can share it with my team members and I can edit it quickly as needed.
Fill in the rest of your operations manual from experience, common sense, and borrowing from others. Feel free to borrow my own structure that you’ve read here. Also, network and borrow system and ideas from others. That should be one of your main tasks as you read real estate articles. For example, I read, borrowed, and benefited from Eric’s earlier post about How to Be the Best Landlord and Keep Happy Tenants.
Whatever you choose to do, I hope you’ve learned the value of creating systems for your rental properties. Whether you self-manage a couple of properties, start your own property management business, or outsource it all to a 3rd party, begin with these systems so that you can have greater peace of mind, control, and profitability for your rental properties.