You might be surprised to learn how many owners claim to have their units 100% occupied but are not coming close to collecting 100% of their potential rent. You may also be surprised at how many people buy investment property with the assumption that it will never be vacant. That is what I call magical thinking.
When planning for an occupancy rate, an essential task for any investor or real estate owner, I try to anticipate how many months a year I can realistically count on collecting rent. Certainly, there is a difference between someone occupying a property and actually paying the rent they owe.
How many months of rent should you count on collecting a year?
On a lower-end property, and depending on your experience in the neighborhood, it may make sense to only budget for collecting rent 10 months of the year. I do this, and it means I am planning on collecting rent 83% of the year, in the worst case — though I tend to round down a bit and project my vacancy rate to be 15%.
So, if the unit’s monthly potential or market rate rent is $500 a month, or $6000 a year, build your budget with the understanding that you may only collect 85% of that, or $5,100 a year.
On average, you may plan to collect rent 90% of the time and to be vacant 10% of the time. This equates to successfully collecting rent roughly 11 times every 12-month period. In my experience, it is virtually impossible to collect rent every month during the life of an investment. Even if a tenant stays in a unit for two full years, it is very likely that you will miss at least one month’s rent between tenants, and more likely two, depending on the time of year and the time it takes to prepare the home for the next tenant. One vacant month out of 24 equals means a 95% occupancy rate, and two out of 24 brings you back to 90%.
Some property owners stipulate a late fee to the tune of $5 a day after the fifth of the month, and others charge a flat percentage of the monthly rent after the fifth. The idea of a late fee is to discourage tenants from taking their time getting the rent in each month. The late fees also compensate the owner for late income they may need to meet their monthly obligations. Unpaid late fees may be deducted from the tenant’s security deposit at the end of the lease term.
The Eviction Process
At some point, you are virtually assured to have a tenant who fails to pay their rent, for whatever reason. It is important to stress with your tenant at the start of the relationship when the rent is due in your office and what fees or eviction proceedings they can expect if it is late beyond a certain amount of time. For the properties my company oversees, for example, the rent is due on the first and if we don’t have it by the morning of the sixth day of the month, the tenant can expect an eviction notice to be posted on the property giving them three days to move out. After the three days have passed, we have the legal right to file the eviction with the local municipal court.
I know what you are probably thinking: Nice people don’t evict tenants. But most property owners are nice people too, and they deserve a consistent return on their investment. Of course, if you have a good history with a tenant and they are upfront about their situation and have a plan to get current, owners may choose to make exceptions. In many cases, you might opt to initiate the eviction process while at the same time suggesting possible sources of financial help in the community the tenant may be able to turn to.
For most people, having to evict a tenant is the most distasteful part of being a landlord. Failure to carry out an eviction in a timely manner, however, will negatively impact your return on investment. In my experience, if you act early in the month and put the eviction process in motion, you can usually get a court date early the following month and have possession of the property soon after that. In the best case, landlords will lose two months’ rent. If you hesitate just a few days, you can easily lose three months’ rent.
The Cost of Eviction
Property owners or landlords can expect additional costs throughout the eviction process, too. Filing an eviction comes with a court fee — in the county I operate in, it’s $130 — and you’ll want to have an attorney’s signature on the court documents. A writ of possession and a visit from the sheriff is another fee; in our district, it’s $25.
In the majority of cases, the tenant will come up with the money owed in addition to the court costs and attorney fees and remain in the property. In others, they will vacate the property on their own prior to the court date. Once in a while, the tenant will remain in the property up until the bailiff and the sheriff arrive to execute the writ of possession and escort the tenant off the premises. That, as you can imagine, is never pleasant, but it is one of the challenges that comes with property ownership or management.
My hope is to help property owners think through the process of creating a realistic budget for rental properties. Facing the financial realities upfront will save you grief down the road.
- Originally posted on Forbes