Rookie Reply: Screening Tenants, Using Hard Money, and Raising Rents

Ashley:
This is Real Estate Rookie, Episode 374. One of the things we’re going to talk about today are different ways to screen a tenant. Normally, you hear about the credit check, the background check, but we’re going to go over a third report that you should be verifying when screening applicants for your rental unit. I’m Ashley, and he’s Tony.

Tony:
And welcome to the Real Estate Rookie podcast, where every week, twice a week, we bring you the inspiration, motivation, and stories you need to hear to kick start your investing journey. Now, Ash touched on what we’re going to hit on today, but we’re also going to talk about ADUs, what they are, how can they help you get approved for mortgage? We’re going to share some hard truths about real estate investing that you might not realize as a rookie investor. But first, let’s talk about hard money loans. What are they, and how can they help you as you’re building your real estate business? Our first question today comes from Nicholas A. Nicholas says, “When it comes to hard money lenders, do they usually fund the purchase and the rehab, and are holding costs separate? I just want to make sure I understand things.” Ashley, your experience working with hard money lenders, what are they usually covering for you?

Ashley:
When I did it, it was 80% of the purchase price and 100% of the rehab. But there are so many different variations you can actually get with a hard money lender as to what they will cover. I don’t think there’s any set fast, hard rule as to what you can get covered. There are some people that can get 100% of their property covered, 100% of their rehab. A lot of the factors that go into determining what you can get, what kind of terms with a hard money lender really go off of your experience and also what kind of relationship you have with that hard money lender. So if you already did 10 deals with them, you may be getting better terms than, say, me just coming in for the first time getting a loan, even though I have experience, maybe my first time doing it with them. Or if you have no experience coming in, the lender is definitely going to be a lot more conservative with what options they’re going to be able to give you.

Tony:
I also just want to clarify for everyone that’s listening or watching the difference between LTV and LTC because they’re very similar, but from a financial perspective, they can make a big difference. LTV is loan to value. LTC is loan to cost. Say that you’ve got a property and your total project budget, so your purchase price plus your rehab is $100,000, 80% on the LTC is $80,000, because your total project cost is 100, 80% of 100 is 80. So that means the most that a bank is going to give you if they’re focused on loan to cost is 80% of 100 or $80,000. Let’s say that same property has an after-repair value of $200,000. If they’re going 80% of your LTV, right now they’re looking at the 100 versus the 200, and 80% of 200 is $160,000. So you guys can see, that’s a big difference there, $80,000 versus $160,000.
So just make sure when you’re talking to these hard money lenders, the percentages that they want, is it a percentage of the loan to cost or a percentage of the loan to value? Are they going to give you 80% of your project costs or 80% of the after-repair value? Again, I’ve never personally used hard money. We’ve gotten a lot of quotes, but we’ve just had an easier time using private money instead. But for the hard money lenders I spoke with, I think all of them were focused on loan to cost and not necessarily loan to value.

Ashley:
What your hard money lender will do, too, is do an appraisal. So it’s not even the after-repair value. It’s more of the value right then. So if you’re buying a property at $100,000 but it appraises for $120,000, they may give you 80% of that 100, or they may fund the whole 100% if it is 80% of that 120 or whatever the actual value is on the property, too.

Tony:
There are so many different ways to go about it. I remember my first deal, I was a long distance borrower, and that bank, they were focused on after-repair value or loan to value, but they did two things. They did an appraisal of the property in its current condition. Then they took my bid and then they did a desk appraisal pretty much to say, “Okay, if you can make all of these changes, here’s what we predict the after-repair value to be.” Then they said, “As long as your total project cost is 70% or less of what we project the after-repair value to be, then we’ll fund it all.” So I think the point in sharing that is that there’s no one size fits all. Every bank, every hard money lender, every institution’s going to be slightly different. Just make sure you understand those nuances there.

Ashley:
Then the second part of Nicholas’s question is, “Are holding costs separate?” I don’t know of a hard money lender that pays the holding cost also. Holding costs are if there’s interest being paid back to the hard money lender during that time period, so maybe you have monthly payments back to them. Or this is your utilities. You got to have the electric on for the contractors to plug in all their D volt batteries or wonky tools. Then also your insurance on the property. You want to have the property insured while you’re having people work on it or you’re working on it yourself. So there are different holding costs, including maybe even cutting the grass, having the grass cut nice so you don’t get a fine from the town. So those are things to understand, too, that those are things you have to pay out of pocket while the project is going on.

Tony:
So that’s hard money. Nicholas, hopefully that answers your question. Our next question is going to be about dealing with a property or buying a property that already has tenants and what’s the best way to approach that. First, let’s take a quick break to hear a word from our show sponsors.
All right, guys, so we just wrapped up a question about hard money lending. Hopefully that was super informative for you. Now we want to jump into a question from Cody W. Cody’s question is, “I have my first property under contract. It’s a triplex. It currently has tenants. How or what can I or should I do to transition them to having me as their new landlord?” My recommendation is to kick them all out and turn it into an Airbnb and then you don’t have to worry about it anymore. No, I’m totally kidding. I’m going to have so many people mad at me for the housing crisis here. No, totally getting there, Cody.
Ash, you’re obviously the expert here, so I’ll defer to you. The one thing I will call out is we just interviewed Dion McNeeley on Episode 369, 369, and he talks about the binder strategy, which I thought was incredible. It was actually a way to get his tenants to, on their own, suggest a rent increase when he took over their leases, when he took over as the new landlord. So go back to 369, Episode 369 with Dion and get some insight from there. Ash, obviously you’ve done this a ton of times. What’s your approach? What’s your process for this transition period?

Ashley:
I just want to say you said the wrong episode number. It’s 369er to clarify there for you.

Tony:
There you go.

Ashley:
What I have done when I inherit tenants is first I talk to the seller and make sure this is okay to do. I send each tenant an estoppel agreement. This agreement just verifies all the information the landlord is telling me and all the information that’s in the lease agreement that he gave me, if any, is the same as what the tenant says, so just their name, what unit they’re in, their contact information so I do have their information for the day I take over. Do they own the appliances? Do they have any pets? Who else is living in the property? Are there any repairs that they need to have done?
I actually have a tenant that’s moving out that has lived in the property the whole five years, I think, that I’ve owned this property. She was an inherited tenant. I was going through some of her old files and I was looking at the estoppel agreement from when she first moved in. Under where it says, “Are there any repairs?” it says, “Many. We’ll send a letter with specifications,” and attached is this three-page handwritten cursive letter of just all these things that she wants fixed and things like that. But we are so sad she’s leaving. She is been a great resident, and we loved having her. But she can’t do the stairs anymore, but we’ll miss her.
Anyways, so the estoppel agreement, to ask certain questions like that. Also, when did your lease start? When did you move in? When does your lease end? Are you month to month? Are you on a one-year lease? What rent do you pay? Do you pay any other fees? Who pays the utilities? Do you? Do the landlord? Things like that. Then have them sign it, send it back to me. Then I let them know usually on the day it closes, just in case it doesn’t close that exact day, but I contact them with information.
I’ve done this different ways. I don’t like to talk to people on the phone, so it’s usually having somebody deliver letters to them the day we close saying, “Here’s the new property owner’s information for you to contact. Here’s who you contact for maintenance, who’s here you contact for this.” If you’ve got their email, you can easily send this out by an email. You can text. Set up a Google Voice number. That’s your property contact number so not everybody’s calling your personal cell phone. You can send a text even with, “Today, I took over as the new landlord for the property. Here’s all the information you need. Please let me know if you have any questions.”
I think just setting expectations as to, “Things might have went this way with the old landlord, but now I’m taking over and here what the rules and policies are.” Of course, you can’t violate the lease agreement by demanding these new things that happen or how they should do things, but being very clear cut as to, “Here’s how you pay rent, here’s who you contact for maintenance, here’s the maintenance process,” and just giving them as much information as possible on that first day.
I’m sure there’s still going to be a ton of questions that come in, but document, document, document, document. Keep a list of all these questions or all the things that happened. Because a tenant could ask you a question the day that you take over and be like, “Oh, I didn’t include that in my welcome letter. Okay, I’ll just answer it real quick.” You answer it. Well, then you completely forget to update your welcome letter with that information because it just took you two seconds to respond to them, so keeping track of all the questions. Eventually, when you’re 83 years old, you will have the perfect welcome letter where nobody will need to ask a question.

Tony:
Really, really great breakdown, Ash. Obviously, you’re the queen of long-term rental property management. I think the one piece of advice that I’d give to our rookie audience as well is remember that one of the biggest costs for a traditional long-term rental is turnover, so having your property sit empty and the time between a current tenant leaving and your next tenant coming in. Sometimes we can get super excited around the idea of like, “Man, the current tenant’s only paying me 1,000 bucks for market rents or $2,000. I could give them a notice of non-renewal and then have a tenant that’s paying double.” But say it takes you four months to get that increased rent, how much money did you actually just make because you had four months of vacancy? Just as you’re making that transition, Cody, and I don’t know if your goal is to increase the rents, but just for folks that are going through that process, just remember vacancy cost is a big expense for traditional long-term rentals.
Our next question here comes from Erica R. Erica says, “What do folks use for pulling background checks/credit reports?” Again, Ash, what’s your go-to platform for pulling background checks, credit reports? Just one caveat or one additional question to that is, and I’m sure this will vary from state to state, but are there laws or rules around at what point of the process you can pull that background check? I guess give me how you manage that.

Ashley:
Well, you need their social security number to do that, pull a background or credit check, so you can’t really pull that information until they’ve filled out an application. So what a lot of landlords do is they actually don’t do the credit check themselves. They outsource it to a third party where they actually go directly to the applicant and ask the applicant. They fill in their information directly so that I’m not given their social security number to enter it into the data to pull their background or credit check, so it’s all done on their end where they get an email from the third party service, and the email says, “We’re going to do a background credit check on you to apply you for this unit.” Then they fill in all their information, and then we just get the final reports on the end.
Almost every single property management software has this integrated in them now. There’s Avail. There’s RentRedi, which if you’re a BiggerPockets Pro member, I think it’s like $1 or it’s free to use. Then I use AppFolio. I have used Buildium. They all have some kind of service integrated into them where you literally just click a button that says, “Screen now,” and it will do a credit check and it will do a background check. One thing that we also do is an income verification. This is where they have to upload their bank statements, and it actually verifies that, if they say they made $50,000 a year, that we’re going through looking through their deposits showing, yes, on a monthly basis they’re pulling in $3,500 a month or whatever it is. What’s $50,000? That’d be like $1,000 a week.

Tony:
Just under or somewhere around there, or, yeah.

Ashley:
Anyways, so the income verification is something that we have added on additionally to the credit and the background check. But if you don’t want to use any kind of property management software, I have used before TenantReports.com. That’s another one. You just set up an account, and you go ahead and have them do the background credit check for you, too.
Then sometimes when you’re doing this, if you do use a property management software, you actually have to get verified as far as how much information you’re going to pull from the tenant where they will do a Zoom with you and be like, “Okay, we want to make sure that you have a lock on your office door. We want to make sure that you have the filing cabinet. You have a lock for that. You have a phone line.” They call the phone line to make sure that’s… Basically, they’re just verifying that you’re a trusted person in a trusted office to actually take people’s information, too. There are some companies that require that for you to actually go and do the credit and background check yourself, but to have the applicant do it through email. There are the issues with people who don’t use email or don’t use technology well when they’re trying to figure out the online application and entering their information for the credit and background check, but usually not that many.

Tony:
Let me ask this question to you, Ashley. I’m sure there’s some rookies out there who are listening that don’t want the added expense of maybe paying for an AppFolio or Buildium or paying for these background checks. What’s your word of advice to those folks that are worried about the additional cost of doing this?

Ashley:
Well, depending on your state, you can bill it back to the applicant, so it’s an application fee. In New York State, there’s a law, I think it’s like $20, you can’t charge an application fee over that amount. So you have to be careful what your state regulations are. But you can bill it back to the tenant, or you have them pay it directly. When you sign up for TenantReports or whatever, you can have the tenant pay for their own credit and background check when they’re actually getting… So they put in email, their name, the TenantReports company, or whatever company you’re using, will actually bill them directly, so it’s not an expense to you at all.

Tony:
Say that you’re in a situation where maybe you can’t bill back or, I don’t know, maybe you don’t feel comfortable or the other properties in your market aren’t billing back, would you recommend that someone maybe just skip the background check altogether to avoid that cost?

Ashley:
Well, first of all, look into what your laws are as to what you can deny someone for regarding a background check and what you can and you can’t deny them for. I think that that’s very important. If you are renting a single family home, I would say that I would be more lenient on not checking the background check. But the problem with the background check is I don’t want to have four different tenants and one have a criminal history and it affects the whole four-unit or something. So we’re definitely more cautious of that when moving somebody into multiple units.

Tony:
I would say spend… Because how much is a background check? It’s like, if you just spent several hundred thousand dollars maybe to buy this property, spend the $50 or $100 or whatever it is to get the background check to-

Ashley:
It’s usually not even that much. It’s 20 bucks, usually.

Tony:
Yeah, right. So it’s like, spend the money to do it, invest a little bit of time.

Ashley:
That just brought up a big point as to do not have them give you their Credit Karma report. If they say, “Oh, I actually have my own credit report. I’ll give it to you,” don’t accept that. Pull your own. There’s this amazing photo out there that’s me photoshopped next to Tony and a Celtics basketball player that everybody thinks is real. You could think that this credit report is real.

Tony:
That’s true.

Ashley:
Because it’d be easy to doctor a credit report.

Tony:
A credit report, yeah, super true, super true.

Ashley:
And if this is your first time ever renting it out and you’ve actually never really seen what a credit report can look like, and they can all look so different no matter where you’re getting them from, it’s the same information but different style of format on the report that you couldn’t know any better as to what you’re looking at.

Tony:
Well, super important point, get your background checks. Rookies, let’s make sure that you check that box. Guys, we have two more questions for you. We’re going to talk a little bit about, what are some of the things that no one tells you when you get into real estate investing that you should be aware of? Then we’re also going to talk about ADUs and whether or not they can be factored into your ability to get approved for a mortgage. But first, let’s take a quick break to hear a word from our show sponsors.
Ashley just gave an incredible breakdown about the importance of background checks. Now we want to jump into a question from Katie Miller, who’s actually the head of BiggerPockets Publishing. She posted this in the BiggerPockets forums. She said, “What’s something nobody tells you about real estate investing but they should tell you?” I feel like this is opening up Pandora’s box a little bit.
I think it’s so easy to get enamored with the successes that you see on social, on YouTube, reading the books, wherever it is, that people oftentimes forget the hard work that goes into the success that you’re seeing. When you listen to the BiggerPockets Real Estate show, you listen to Rookie podcast and you hear the stories of people who have built these big portfolios, it’s easy to latch onto that. But if there’s one thing that I want to remind rookies of is that it takes time, it takes sacrifice, and it’s not something that happens overnight. You’ve got to be willing to grind long enough. You’ve got to be willing to have that grit to stick with it long enough to really build the foundation for a business that will eventually give you the life you’re looking for. But most people give up way too soon. So that’s one big thing that jumps out at me, Ash. What’s something that you think folks need to know?

Ashley:
I would say the emotional roller coaster. First of all, the acquisition piece, you’re pumped up about a deal and then you don’t get it or falls through, things like that. You actually put so much work into trying to get a property, and then it falls through or they take someone else’s offer.
But more importantly, dealing with residents, you’re dealing with somebody’s home. That’s been a real struggle for me is kind of balancing how to handle that because you have to have somewhat of thick skin order to say, “No, I’m sticking to the lease agreement. You haven’t paid your rent in three months. I’m sorry, but this eviction is going through,” but also realizing at the same time that that’s somebody’s home. For whatever reason it may be, and some people choose to spend their money on other things, and, yes, that also agitates me to see them out the next day buying a brand new iPhone and waving and smiling at me.
I think that was a really hard thing for me to learn is how to balance that as to how not to feel guilty, how not to have almost… build up such a barrier inside that I become cold to residents because I want to stick to my guns and I want to be like, “This is my property. This is my kid’s future. I need that money. It’s not some big corporation you’re scamming. It’s just me.” So that was a really hard thing for me to struggle with for a very long time is to how to balance that, how to show empathy and compassion for my residents, but also to stick by my beliefs and stick by what was also fair and right for me, too.

Tony:
Guys, we’re going to link to this question in the show notes because there’s a lot of really good responses here as well. But there’s one that jumped out. There’s a couple that jumped out at me. I just want to read two of them here really quickly. One comes from Llewelyn. Llewelyn says, “Real estate investing is not really an investment. It’s both an investment and a business.” Man, that is so, so true. I think a lot of people get into real estate investing expecting that it’ll be completely, completely passive, which unless you’re doing syndications, unless you’re maybe a private money lender, those are the only two that I can think of that can really get to that precipice of true passivity. Because even if you have a property manager, you’ve still got to manage your property manager. But those two, lending and investing in syndications, are probably the only two truly passive ways.
The thing that people forget is that you are building a business. Especially if you want to get to a point where you’ve got a relatively big portfolio, maybe now you’ve got someone on your team that’s helping you with different things, and now you’ve got to manage and lead people. There’s just a lot of business fundamentals that I think a lot of new investors overlook that probably makes building that portfolio a little bit harder for them. But I’ve always seen myself as an entrepreneur who works in the world of real estate, not necessarily just a real estate investor.

Ashley:
One that stood out to me was actually that Katie Miller had written as her response is, “The mail and the text, it’s overwhelming. I’ve never gotten more snail mail in my life.” The first thing I thought of was a picture of Tony, or maybe it was Sarah, one of you, which is you’re sitting on your couch and there’s just piles of mail all over the place. I was like, “That is so relatable,” having-

Tony:
100%.

Ashley:
… so much mail just piled around you, the paper cuts. But I have found a solution to that, and that’s why I was excited about this answer is because there are virtual mailboxes where you actually send your mail. You can find them locally. Mine is a Shipstore that it’s at. They actually will scan your mail so you can see what it is. Then you can select what they do with it. Do you want them to shred it? Do you want them to actually open it and scan it to you? Do you want them to forward it to you? That has been a game changer. I still have my PO Box set up where I’m going and getting the mail, opening it up, everything. There are still some bills that just haven’t been changed yet. So I spent Saturday morning going through, and I want every bill. I’m so sick of having to do some of the mail. The one I use is PostScan Mail, and it’s been working out great for me. It really reduces the amount of clutter and paper within my house.

Tony:
Our final question today comes from Maria P. Maria’s question is, “I’m looking to purchase a two-unit property with an FHA loan. There’s a property I like, a house with a legal ADU. Can I use the ADU income to help me qualify for the loan, or can I not use the ADU income?” Really quick, ADU stands for accessory dwelling unit, which is basically just like a guest house or some kind of additional structure on your property that it’s not attached to the main home or usually not attached, depend on how you set it up. Ash and I actually pulled this information from HUD.gov just to make sure we’re giving you guys the right information. There’s basically two scenarios that you’ll see. There’s the first scenario where the ADU already exists on the property. In that scenario, if you’re looking for an FHA loan to purchase that property, you can use up to 75% of the income from that ADU to help you qualify for the purchase of that home through the FHA. Ash, you want to talk about the second scenario there?

Ashley:
Yeah. In that one too, let’s just give an example. If there’s somebody renting it, when you purchase it for $1,000, you’ll be able to take $750 per month and add it to your income for the property as rental income. Then the second scenario is if you plan to build an ADU. You have to show your plans and everything like that, but they will take 50% of the rental income and apply that to your income to help with your debt to income for the loan. So with this is if there’s already a tenant in place, it’s easy to know this is what the rental income is. But if there’s not a tenant in place, you have to go and you have to find comps as to what you can rent that property for and the bank has to agree that, yes, that would be the amount. Even better if you can find a tenant beforehand that would be able to want to rent it to for whatever you’re saying.

Tony:
We hit on a lot of really good questions today. We talked about the difference of loan to value versus loan to cost for hard money loans. We touched on Ashley’s process for transitioning in as a new landlord and what an estoppel agreement is and why you should get one, the importance of background checks and how to execute a background check the right way when you’re screening a tenant. Obviously, we gave you some insights just recently on the ADUs and how that can factor into your ability to get approved for a mortgage.

Ashley:
Thank you guys so much for listening to this week’s Rookie Reply. If you haven’t already, make sure you like and subscribe to us on YouTube and join the Real Estate Rookie Facebook group. You can also check out mine and Tony’s book, Real Estate Partnerships, in the BiggerPockets Bookstore. I’m Ashley, and he’s Tony. Make sure you check out our social media links in the description below so you can find out more information about us. We’ll see you guys next time. (singing)