The SCARLETT Method
I’ll start off this essay with a quick disclaimer, I in no way, created the idea of renting out homes by the room. All I did was formulate an acronym and implemented a few practices to keep my rentals running smoothly while taking in the maximum amount of profit. Moreover, this is not to be considered “passive income”, on the contrary, it’s a very hands-on approach to real estate investing and typically should be executed by someone who has a passion for real estate or property management. Also, this method doesn’t discuss the structure of a loan used to purchase a property, but in general anything above 20% down guarantees solid cash flow.
S- Secure Single-Family Home – The Scarlett method is a technique of managing rental properties, not a method of finding a deal or purchasing a home with 0 down. So naturally, the Scarlett method begins when your purchase a single-family home. This process could work with a townhome or condo but it becomes less lucrative and has more barriers so I won’t focus on the latter two types of property.
C- Construct More Bedrooms – While renting a home out by the room, it’s no surprise that the more rooms the better. Find a way to create more bedrooms. This is where you get to think outside the box a little bit. While most people may jump to the idea of building an addition to the house, that endeavor can be both expensive and time consuming. It’s possible that it’s much easier than that. You may have purchased a house with a living room and a large formal dining room yet tenants don’t need both. Or perhaps you have a large basement rec room that can be split into two bedrooms. Run the numbers for your local market, if a master bedroom is going for $900 but smaller room are going for $600 it may be beneficial to divide a large master bedroom in some way. Then it’s just a matter of having a decent bathroom to bedroom ratio. As always, refer to your local code when constructing bedrooms and place safety over money in every situation.
A- All Utilities and Furniture Included – In this model of management, all utilities are placed in the owner's name. Electricity, gas, water, sewage, trash, HOA fees and wi-fi should be included in the rent of the tenant. In addition to the services, any hardware such as a modem or router that goes along with utilities should also be owned and managed by the homeowner. I also include furniture for the common areas such as a couple of basic sofas, a wall mounted television, dining table and chairs and other odds and ends. Critics of this method sometimes struggle with this aspect but when you consider it along with the other theories it makes perfect sense. You can't have a major utility such as electricity in the name of a tenant who is on a short-term lease. Even if you did long term 12-month leases there is no one person who would feel ok with managing the electricity bill himself, and it's nearly impossible to split it up amongst the tenants especially when turnover rate is expected to be higher. Keep in mind, it doesn't mean utilities are free, simply factor it in to the rent and make potential tenants aware that utilities are included when marketing. Make them realize this is actually in their favor, it creates one less thing for them to worry about each month.
R – Rent it Out Exclusively by the Room to Individuals – I’ve touched on this a little bit but this is a good place to expand. You are renting out this single-family home by the room, to single individuals (single meaning one person, not single as in unmarried or unattached). At the root of this method is just basic math. A four-bedroom home in Thornton, Colorado is worth about $2500 a month in the traditional method of renting it out, typically to a small family. Yet, that same home rented out by the room is worth roughly $3500 a month (minus $300 or so for utilities). That’s $700 more than sticking a family in it. And if you find space to build additional bedrooms you begin to really get some solid cashflow. You want to set the goal of one person per room. This is for a variety of reasons. Mainly, your city code has occupancy laws and will restrict the number of unrelated tenants per home. So placing a boyfriend and girlfriend in one room legally reduces the number of other tenants you can have. Even without occupancy laws, two people in one room changes the dynamic of the house and complicates matters. It puts a larger strain on utilities and opens the door for arguments within the couple themselves. The house becomes more theirs as opposed to equally shared by all tenants. My ideal tenant is someone who functions as an adult, who lives alone with no pets, decent job, minimal criminal history and has experience living in a shared home.
L- Lay Down the Law – Formulate a specific set of house rules – A formal lease will have various guidelines with enforceable rules, yet, you want to pull out all of the key points and place them on a single page of house rules. Next, create additional rules that you want to enforce for the home. No sub-leasing and no pets are pretty standard but the rule of “Guests of tenants are not permitted to sleep or reside in common areas.” becomes much more specific but also necessary for the proper order of the home. You have a few different approaches to understanding if someone is likely to follow the rules you create. You can have a copy of them saved in your phone to quickly send to potential tenants as you are screening them. I often send them the rules and ask ‘What do you think of these house rules?”. The problem you may face is people quickly say “I like them” or “no problem at all”. So another thing I do is break down each rule into a series of questions prior to showing them the house rules. For example, regarding my rule of “no guests of tenants sleeping in common areas” I might ask “how often do you hope to have guests over?” I could probably write an entire book on screening tenants but at the very least creating a set of house rules that everyone agrees to is crucial.
E -Expect and Embrace a High Turnover Rate – In this method of management, your largest competition is the big-name brand apartments, therefore you need to be prepared to do what they aren’t willing to do. With this being said, I do all month-to-month leases. I’m not locking anyone into a 12-month contract and I’m making this point known very early on. Most people nowadays shy away from long leases as life in general has become more tumultuous. Capitalize on this, don’t force someone into signing a 12-month lease and then attempt to monetarily penalize them when they inevitably break it. You’re better off allowing them to come and go when they please, thus a higher turnover is expected. Potential tenants should feel at ease knowing they can leave in a timely manner for any reason, better deal popped up, moving out of state, got a new job farther away, don’t like the roommates, etc. Again, this should be a talking point when promoting your home and if your market allows for a higher rent because of this then feel free to adjust accordingly. I go the extra mile and only require a 5-day notice to vacate and also prorate rent back for unused portions of rent if they need to leave in the middle of the month.
T – Treat Tenants like V.I.P.s – My philosophy on tenant/landlord relationship is a little different than others. While most homeowners or property managers view tenants as customers, I view them as someone I work for. I’m cutting the grass, changing the lightbulbs, maintaining the common areas and doing the occasional deep clean in a nice property that they live in. Therefore, they’re essentially my bosses. When addressing them in text, emails or casual chats I typically say “yes sir” or “yes ma’am”. If that’s too formal for you try saying “boss”. Either way, you want your mindset to be that they’re the ones lining your pockets with thousand-dollar bills. It’s just good business and you want to remain professional and in good standing with all your tenants. This doesn’t mean they walk all over you and get their way in every request, its actually better they’re told “no” early on, in a respectful manner.
T- take in the profits – If you’ve followed this method and haven’t deviated from it you should be turning a pretty hefty profit and being paid well for the extra work you put in. Continue to stock pile cash until your next opportunity presents itself.
