Look Beyond the Score

Credit reports have always been considered the single most valuable screening tool because of the wealth of information contained in the report. However, reading through a credit report is one thing, understanding the substance of the report may be quite another thing.

It is important to educate yourself on how credit reports are complied and how credit data is presented in reports. There can be variables in collection and presentation of credit data among the three major credit bureaus. When you choose a tenant screening vendor and select from credit screening options, make sure you know what you want before you order. Study a sample report to familiarize yourself with its data presentation and terminology.

An available report option is a scored credit report. Such an option is generally well worth any additional fee imposed by the screening vendor. In fact, many landlords prefer to use a scored credit report as this quickly gives them a benchmark to compare against their rental qualification criteria. They choose a scored credit report to make a more consistent, objective determination of the applicant’s creditworthiness. The cost is minimal compared to the time and effort that must be expended to adequately protect your rental investment. Furthermore, in most states, a credit report fee can be collected from the applicant.

The three major credit reporting agencies in the United States are: Experian, Equifax and TransUnion. Each reporting agency gathers information from various credit providers and supplies credit data on individual consumers, using its own formulas for calculating credit scores.

Information in the credit file is compiled into a three-digit credit score. The numeric value helps predict future credit performance based on past credit behavior. In general, the higher the score, the more likelihood the applicant will have the ability and willingness to pay as agreed and the less likelihood of default/delinquency.

The most commonly used credit scoring model is the Fair Issac Model expressed as a FICO score. In 2009 Fair Isaac Corporation, officially adopted the brand FICO™ as its corporate identity. The company retains its legal name, Fair Isaac Corporation, however, the company logo, website, and other company materials now reflect its new identity: FICO.

The FICO scoring range is expressed as between 340 and 850. Many landlords consider a good score to be 700+. However there is no magic score that guarantees a good tenant. There are life events such as extended illness, death, divorce, or student loans that, while having a major effect on credit scores, may warrant consideration under your rental policies, your particular type of property, and market conditions. Each landlord must set his rental criteria at the level of risk that is acceptable for his business. Some landlords will be willing to accept more of a risk than will other landlords.

FICO scores take into account the consumer’s payment history (35%), amounts owed (30%), length of credit history (15%), amount of new credit (10%), and the mix of credit types (10%). If your applicant does not use credit or is newly establishing credit you will likely not be able to obtain a credit score. If a score cannot be calculated the report will carry a notation such as “risk score not calculated due to lack of credit history” or note that the credit file does not contain any trade-line account which meets the following criteria of (1) the status date is within the last six months and (2) a balance updated within the last six months.

A score by itself is indeed only a number, but if a credit report is the only tenant screening done, then a credit score is likely to provide the best guess of future credit behavior.

While a credit score alone won’t predict every aspect of the applicant’s future behavior, for those landlords who “know the score,” a credit score speaks volumes.

It may be, however, that the reasons behind that score speak even louder. By reviewing the “reason codes” on the credit report as to why the score was not higher, a landlord can focus on patterns of behavior that could indicate potential problems or highlight current difficulties. Looking beyond the score to recognize potential problems is a way to reduce risk.

There are red flag conditions that can exist even with an acceptable credit score. Perhaps there are occasional missed payments even though a serious pattern of delinquency has not yet been established. This fact coupled with other information in the report or negative information received from previous landlords or employers could indicate potential trouble for the future. One red flag indicator is late or skipped utility payments. If utilities are unpaid, think that rent will fall behind very soon. A collection item for a previous utility balance requires careful investigation to evaluate the root cause and/or subsequent action.

The scored credit report will show the reasons, negative reasons, why the credit score was not higher. The credit bureau’s risk score factor reason codes allow credit reviewers to better understand the consumer’s credit behavior, warn of potential future problems, and indicate actions that could help improve the individual’s credit score.

Each reason category has an approximate weight assessed against the total credit score. Reason codes can be categorized as follows:

• Previous payment history (credit performance – 35%)
• Ratio between current balance and credit limit (level of indebtedness – 30%)
• Length of credit history (15%)
• Types of available credit (10%)
• New credit inquiries (10%)

The following code descriptions are only a sampling of the several dozen code explanations that could be shown on credit reports.

• Serious delinquency
• Serious delinquency and public record or collection filed
• Derogatory public record or collection filed
• Time since delinquency is too recent or unknown
• Level of delinquency on accounts
• Too many accounts with balances
• Number of accounts with delinquency
• Amounts owed on accounts

• Length of time accounts has been established
• Proportion of balances to credit limits on revolving accounts is too high

The following credit message illustrates how negative codes might appear on a credit report:

Credit Score: 561 (Fair Isaac Model)                                                                        

Score Factors:

Account(s) not paid as agreed and/or legal item filed

Length of time (or unknown time) since account delinquent

Number of accounts delinquent

Proportion of balance to high credit on bank revolving or all revolving accounts

Credit reports can also carry advisory messages to alert of potentially fraudulent or inconsistent information based on the data submitted for input – address, date of birth, phone number, driver license, and Social Security number.

For example, a report option provided by TransUnion offers:

ID MISMATCH ALERT message appears when: the input address, SSN or surname does not match what is on file; when a minimum of four inquiries have been made against the file within the last 60 days; or when an invalid ZIP code is entered.

HIGH RISK FRAUD ALERT messages appear if: address, SSN, or phone number have been used in suspected fraudulent activity; the information on an application is inappropriate, such as a commercial or institutional address; or if the SSN has not been issued by the Social Security Administration or is that of a deceased person as reported by the Social Security Administration

Special messages may highlight specific credit file conditions such as:

• Presence of consumer statement
• No subject found

A good source of training on how to read credit reports can be found on the major credit bureaus’ Web sites as well as major Internet based screening vendors’ Web sites. Knowing how to correctly interpret credit report information is a matter of education and experience and will be the key in your selection of tenants.

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

I have a family that has been leasing my single-family rental home now for almost two years, and they still have another year on the lease. Unfortunately, for reasons I won’t go into, the wife has asked her husband to leave the house. She has changed the locks on the doors (at her expense), and wants to have his name removed from the lease. I guess her concern is that he has a legal right to live there if he’s on the lease. She has, and will continue, to make the monthly payments. My questions are: (1) can I legally remove his name from the lease or do I need his consent (and signature), (2) Should I cancel her previous lease and draw up a new one, and (3) should I just keep the remaining lease in effect?

A1

You need to be careful what you do. I am not an attorney, but will give you my opinion based on a lot of experience as a landlord and property manager as well as having some knowledge of other legal issues.

First, your current lease is with both husband and wife. Absent a Court order, you cannot legally remove the husband from the lease without his agreement. Doing so would put you in the position of breaking the lease as far as he (or she) is concerned, possibly reducing your chances of recovering future rents owed under the lease, even potentially making you liable for damages.

Second, if there are marital problems and a possible legal separation and/or divorce, you could get yourself into a major hassle by siding with one of the parties against the other.

Third, it is to your potential disadvantage to allow removal of the husband from liability on the lease to begin with unless you are certain that the wife is in fact capable of paying the rent herself.

You could consider refusing to allow removal of the husband from the lease during the remainder of the lease term. Consider that many divorces result in the wife’s financial position becoming significantly reduced. It is more likely that she might not be able to pay the rent for the remaining year of the lease than that both together would be able to pay it. You could also consider telling her that she should get a Court order against the husband trying to live there if she is concerned about him claiming that right.

You should have no obligation to release one party from the lease even if there is a divorce. Both parties usually remain legally responsible for all liabilities following a divorce even though the Judge might assign liabilities between the parties when dividing the community assets and liabilities. For example, if the Judge awards a particular jointly held Visa credit card to one of the parties, Visa can still collect from the other party if the first party fails to pay and failure to maintain credit accounts by one party after a divorce will often damage the credit record of both parties. The same principles would usually apply to a lease or any other contract.

If, however, you are willing to release the husband from the lease because (1) you are certain that she will have the ability to pay the rent no matter what happens regarding her life, including if there are significant legal costs from a protracted divorce action or (2) you wish to provide charity, then you could tell the wife that you cannot remove the husband from the lease without his written agreement that it be done. She could point out to him that removing him will eliminate his liability for the lease, perhaps providing incentive for his cooperation.

If he consents to removal and you agree to do so, then you will need to think about documentation. Whether you have the wife execute a new lease or adequately amend the existing one is probably not significantly critical. However, keep in mind that either way, you should (1) have the wife execute the required document(s) prior to accepting removal of the husband, (2) consider this an opportunity to make any other changes to the lease that you might consider desirable, and (3) make sure documentation makes it clear who is responsible for any damages to the premises as of the date of amendment or new lease – that is, any changes in condition of the property from the move-in condition at original possession date. Related to those issues, if you haven’t recently done a comprehensive inspection of the unit, I suggest that an inspection prior to document execution be part of the deal and that any serious problems be paid for by one or both parties prior to execution.

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Q2

I know that the site is income real estate from a landlord’s side of the fence, but, since I’m a new member, I thought I’d ask my question anyway. I’m considering opening a small sandwich shop business, something my wife has long wanted to do, so that she can have her own business. Can anyone give me any pointers about picking a location?

A2

As with everything related to real estate, the key is the often stated term “location, location, location.” Unfortunately, if you’re in the midst of creating a spectacular menu for your dream sandwich shop, that might not be the most important thing on your mind. However, you need to put location at the top of your task list. Prior to looking for a location you should have a business plan and you must keep your business plan in mind at all times while looking for your location. The right location is often the principal factor for success of a retail business of any kind. You, of course, need good products, food in your case, but no one will know how great your wife’s sandwiches are if no one comes in the door. Obviously, the key question is “how does one determine a good location?” This can be as simple or as complex as you make it. You need to get a demographic overview of the area you’re looking at – age, income, households, etc. You should also look at neighborhood traffic generators, such as other retailers that draw people to the area, industrial or office parks, schools, colleges, and medical facilities. You’ll also want to look at both motor vehicle and foot traffic.

There are sophisticated location analysis tools available that include traffic pattern information, demographic and lifestyle data, and competitive analyses. For a price, a retailer can get useful answers to almost any question he can think of. You will find a lot of services using a search engine. Many experts will tell you that the best place to be is as close to your biggest competitor as possible because you can benefit from their marketing efforts. They probably chose their locations based on the ideal demographics of a particular area and may have already spent significant percentages of their advertising budgets toward driving traffic to their locations. Why spend your money for this task if not necessary? Competition usually generates more business, more traffic, and that’s a good thing. Being located near your competition can be a plus for your business, provided you’re confident enough in your product to compete.

However, you still want to do your own due diligence regarding a particular property, even if your competitors appear to be thriving in the area. Finally, you should consider utilizing a real estate agent who has long experience specializing in leasing in the area of interest in addition to looking around yourself. You shouldn’t necessarily commit to an agency agreement, but agents often know of available properties that not publicly known to be available and properties that will soon be available. Of course, once you find an available space for lease in a good location, you need to negotiate a lease that works for you and your business and this can be just as important as location itself. However, that’s a topic requiring a lot of consideration in itself.

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Q3

I’m evicting a tenant who has until Wednesday to be out. I have not seen the tenant in over two weeks, most likely because he has no power. We had an arrangement for him to pay half his rent on the 16th and half on the 23rd. He never showed up on the 16th, nor 17th nor 18th. On the 18th, I hung the eviction notice.

I went thru the Texas eviction law on this site and didn’t find anything on abandonment of property, as the tenant still has property in the apartment. Therefore, I don’t know when I can remove this property in order to lease out the apartment. I also don’t know what happens if the tenant doesn’t show up to even read the eviction notice before the 3 days expire. Any direction would be most helpful.

A3

Your posting is somewhat confusing. You claim that you are evicting a tenant, but then state that you “hung the eviction” notice. First, an eviction is a formal court action that requires a default notice (usually a “pay or quit” notice if an unpaid rent issue) being served in accordance with the requirements of state law. If the tenant does not correct the default within the time allowed by state law, the landlord may then begin the eviction process, again as provided by state law. Some states, including Texas I believe, allow Unconditional Quit notices, meaning that the tenant needn’t be allowed to cure the default if served with an “Unconditional Quit” notice instead of a “Pay or Quit” or a notice regarding some other default. Actual eviction can take place only after the court issues a ruling on the matter in favor of the landlord.

“Hanging a notice” does not constitute legal service of notice in many states, although it does in some. Some states require regular, mail, certified mail, or personal service on the tenant or specific other persons found on the premises or more than one of those ways I’ve listed. Texas landlord-tenant statutes should specify what constitutes legal service.

Whatever is required regarding notices, if the tenant fails to leave, a formal eviction must be done through the court. Although it is often obvious that a tenant has abandoned the premises, taking possession when the tenant can claim possession, whether or not in default of the lease, can result in problems if the tenant chooses to claim he had not relinquished possession.

Whether or not there is an issue regarding possession, there can still be an issue regarding personal property left on the premises. The rules vary greatly among the states. At one extreme, the landlord can do whatever he wants. At the other extreme, the landlord must secure and hold the property secure for months while going though specific notice requirements and holding a formal sale of the property, with the proceeds being applied to debt of the tenant and the landlord providing a detailed accounting to the tenant, perhaps even being required to pay the tenant any amount received that is higher than the amount owed.

Even after evicting a tenant who owed thousands of dollars in rent and did thousands of dollars in damages, the landlord is often required to follow procedures. Failure to follow the procedures of the state can make the landlord liable for the value of the tenant’s property and tenant property sometimes becomes very valuable after the landlord has hauled it to the dump. Some states require formal liens be filed against the tenant property, followed by publishing of notices before the proceeds of a sale can belong to the landlord. Some states require return of items necessary for basic living no matter what the tenant owes the landlord. The procedures in some states depend on why the tenant left.

In all states, landlords must be concerned about property that belongs to someone other than the tenant – e.g., rented furniture, TVs, or computers.

The above issues are some of those that can be a concern anytime that a tenant leaves without formally “checking out.”

I cannot advise on the specific requirements of Texas law. I would guess that they are less onerous than some states, but the only way to know is to track down the current abandoned property statutes of Texas. It should be relatively easy to do this, but doing so may require a little time to both find current statutes and to interpret them. If you don’t want to do the research on your own, consider consulting a competent attorney specializing in landlord-tenant law, preferably one who usually represents landlords.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Marketing

As was stated in an earlier newsletter article dating Jan 5, 2011 regarding basic issues related to disposing of income property, most of the same considerations apply when selling an income property as when buying one. This includes selecting an agent, determining the value of the property, maintaining control over the deal, being careful about contingencies, and financing issues.

Using an Agent

A good agent will often increase your net proceeds by significantly more than the amount of his/her commission. Furthermore, if the buyer has an agent, his purchase price will likely be reduced by the commission paid to his agent.

Pricing

To determine what your property is worth when it’s time to sell, you follow the same procedures as when you bought and as covered in much more detail in our “Valuing Income Property” eCourse or “9 Fundamentals of Real Property Valuation” Mini Training Guide. You should have valid reasons for your asking price because the buyer will have good reasons for the maximum he will be willing to pay.

Sale Preparation

Regarding both physical and legal issues, it is usually best to correct even expensive problems that might be considered an issue by a buyer.

This applies to issues known by the buyer before writing an offer, which can result in a lower offered price, and issues that are likely to be discovered during the due diligence performed after acceptance of the offer. Having them become an issue in the middle of a deal can result in cancellation of an escrow or re-negotiation of the price or other terms. The seller is often at a disadvantage when having to re-negotiate the price after a long escrow when the idea of starting over can cause the seller to give in to demands he wouldn’t have considered in the beginning. A buyer may also discount the value by more then the costs of fixing problems because he will worry about what other unknown items might later cost him money.

Physical issues include inoperative sprinkler systems, out-of-code electrical or plumbing systems, and cosmetic issues such as cracked windows and components in need of paint. Also consider various relatively inexpensive cosmetic upgrades that might make a difference. New exterior paint, cosmetic landscape improvements, re-coating of asphalt, correcting roof problems, and repairing superficial defects that make the property look ragged can have a significant impact on a potential buyer’s initial reactions even to the point of his writing the offer.

Legal issues include tenant disputes, building code violations, delinquent taxes, and missing licenses or permits. If there are any problems regarding inability to obtain legally required licenses and permits, get them resolved before putting the property on the market. One reason to take care of these issues before even putting your property on the market is that some might suggest to a savvy buyer or agent that you are having financial difficulties that could make you desperate to sell and could result in lower offered prices.

Legal Issues

If there are any issues regarding zoning or building codes, it is best to disclose it up front so that it doesn’t become an issue two months into the escrow where it could either kill the deal or require re-negotiation of the price and when you will likely be more compliant after investing so much time into the deal. If there are things that you can’t fix ahead of time or at all, it is best that they be considered in negotiations up front rather than after everyone is expecting escrow to close.

Counter Offers

When you are selling your property it will be the buyer who will be writing the original contract terms and they will likely be written to his advantage. It is almost certain that no offer written by the buyer and/or his agent will be ready for the seller’s signature. You should be particularly concerned about certain items and should try to change them to your own advantage or at least make them neutral. There are a number of general principles that you should follow when trying to modify contingencies in your counter offer.

• It is to the seller’s advantage that all contingencies are automatically approved if not disapproved in writing.
• As we recommended to you as the buyer, it is usually in your best interest as the seller to require the buyer bear the cost of inspections and then take that fact into account in deciding the minimum price you will accept. The reason in this case is that you want the buyer to be responsible for timely completion of inspections and that it not be your fault if a contingency is not met in a timely manner.
• Rather than wanting maximum time for contingency periods as you do as the buyer, you want to be sure that the requested periods are not unreasonably long to avoid them being used to buy time for a non-performing buyer. If the buyer requests a time that is too short, that’s his problem and you can always give him additional time if desired.
• To the degree possible, inspections should be scheduled in order of importance relative to decision making by the buyer in order to force him to cancel as soon as possible if there are problems.

Financing

In order to avoid tying up your property with a deal that has impossible-to-meet contingencies, be sure that all specified terms including maximum interest rate, discount points, and other costs as well as the minimum number of years of the loan are realistic in terms of the current market, with room for probable changes.

Sellers need to be careful when agreeing to pay closing costs for a buyer. They must define exactly (1) which closing costs are to be covered, (2) whether or not any excess from the maximum amount agreed to can be spent by the buyer to buy down the interest rate for his loan, and (3) the maximum amount that can be paid in fees so as to prevent the mortgage broker or lender from increasing commissions or other fees in order to burn up the seller’s allowance.

Financial Records

The value of the property and the amount that a buyer will be willing to pay for it, particularly for commercial properties and for larger residential properties, are dependent upon the income and expenses so you should expect to provide sufficient financial documentation to enable the buyer to make his decision.

Documentation

Be prepared to provide the same documentation when you sell as you should have required when you bought, as discussed in an earlier article. This should include accurate income and expenses data, verifiable from source documents, for at least two years.

Provide good readable copies of all leases and other documents, including amendments, checklists, and house rules so that the buyer can provide copies to lenders rather than you having to make additional copies.

Physical Inspections

As stated elsewhere, you should have taken care of any deferred maintenance before putting the property on the market, so that physical inspections don’t find serious defects that haven’t been disclosed.

Additional Information

Additional brief discussions regarding several issues related to disposing of income properties will be provided in future newsletter articles. Currently, significantly more detailed discussions regarding a wide range of related issues can be found in our “Buying & Selling Income Properties” eCourse. For additional discussions regarding a wide variety of real estate investing and management issues see our other eCourses and our Mini Training Guides.

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

I’m considering buying a small retail/office strip center and am concerned about how to be sure the leases provided by the seller are legitimate?

A1

You should certainly study the lease agreements, but you should not depend upon only the documents provided by the seller, as there could be some missing documents. Some other scenarios include (1) a tenant has paid rent for months in advance, meaning the buyer won’t be receiving rents for those months, (2) a tenant’s security deposit has been applied to rent or damages, (3) a tenant currently has a larger security deposit than stated in the lease agreement, with the buyer being liable for the full amount even if not receiving escrow credit for the full amount, or (4) a tenant has oral agreements with the seller that have not been disclosed and, although such agreements may not stand up in court, it could be costly to resolve the matter. You don’t need to be dealing with a dishonest seller, only a forgetful or disorganized one, to potentially have problems after closing.

The best way to avoid such problems is to make sure that your purchase offer requires that Estoppel Certificates be executed by all tenants. Basically, an Estoppel Certificate is a document executed by the tenant wherein he/she verifies the terms of the lease as disclosed to you, including any amendments(usually best to have all relevant documents as attachments) and confirms the amounts of deposits currently held by the owner, the current rent amount, and the date to which rent is paid. For more discussions regarding Estoppel Certificates see our “Buying & Selling Income Property” eCourse (Lessons 5, 19, 20, and particularly Lesson 26).

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Q2

My tenants moved out and left big holes in 1st floor carpet. Also, they damaged a sink and other stuff. The house was brand new when they moved in 2 years ago. I have to keep their security deposit and bill them for another amount of dollars to cover the whole repairing cost as I estimated. The estimation is based on average market value.

1. Does landlord have obligation to provide detailed receipts and photos etc to tenant or their attorney? What if the carpet replacement has not been done yet?

2. Can I hold all the proof to present only in front of judge, since I have already gave them itemized descriptions of damages. Also I noticed them regarding the major damages the last time when I visited the house before the lease expires. They also signed a detailed Move-Out List where specific damages/charges cost are there.

3. The last question relates to legal. Their attorney sent me a letter. Do I have right to ask the attorney to give me a proof that he is authorized by ex-tenants to talk with me? Anyone has similar experience?

A2

My layman’s answers to your questions are as follows:

1.& 2. You probably are not required by law to provide receipts and photos before going to court, but you need to weight the cost (of at least your time) of going to court against your concern about providing such information ahead of time. You also need to keep in mind that the problem is more likely to go away if an attorney sees that you have irrefutable proof. In fact, it might be that the more the attorney sees of your proof, the more likely he will tell his clients that they’re wasting time and money to argue about the matter. If you have detailed move-in and move-out checklists signed by the tenants and photos of the condition at both ends of their tenancy, I don’t see how you can lose in court. You didn’t mention that you also had a signed move-in checklist, but if it was a brand-new never-lived-in house at the beginning of their tenancy and this fact is provable, not having a move-in checklist shouldn’t be an issue unless the law of your state specifically requires a move-in checklist.

3. You could certainly require proof of attorney representation, but I think it is just as important, perhaps more so, to verify that it is a real attorney who sent you the letter rather than the ex-tenant or a non-attorney representative. I would verify the name, address, and current licensing with the Bar Association of your state and check for a listing in the White Pages and an ad in the Yellow Pages. If those items check out compared to the letter you received from the attorney I would then call the listed phone number and see if they will confirm representation. You might even try to talk with the attorney in order to run up the tenant’s bill, assuming that the tenant is not obtaining free legal help from a friend or relative or from a tenant association. People who pursue obviously losing legal actions usually do so because of the availability of free legal help. Just be careful what you say and present yourself as the reasonable and knowledgeable landlord that you are.

If a lot of money is at stake, you should consider having a competent landlord-tenant law attorney (preferably one who usually represents landlords) answer the request, as a phone call or letter from your own attorney can have a lot of impact regarding such a matter. You should be able to get such minimal help for a reasonable cost, so it might pay to call a couple of attorneys.

If and when you provide info to either the attorney or the ex-tenant, provide only copies, retaining originals for your possible trip to court.

An important factor is whether or not you provided detailed accounting to the ex-tenant in full compliance with your state’s security deposit law, particularly that you can prove that you supplied the accounting within the required time period. Many states have serious penalties for failing to follow the law in all respects, including forfeiture of rights to the deposit and/or damages against the landlord for 2 or 3 times the amount of the deposit – although, depending on the state, you might still retain the right to file a lawsuit for the damages. Be sure that you take proof of doing so with you if you end up in court.

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Q3

In March, 2010 I gave 30 days notice to the tenant that her rent will be increased by 5%. She does not pay the increased rent consistently. From April to June she paid only the old amount. I gave her a 3-Day Notice to Quit or Pay the 5% and she complied within the 3-day limit. However, she paid the increase as a separate check. Then starting in July she started only paying the old amount again. She has been out of town on and off for the last few months and she promised to take care of any unpaid rents. She hasn’t so I finally gave her a 3-day notice again for the 5% not paid from July – September about 2 weeks ago. The 3 days has now passed and she has still not paid the increased portion.

Can I proceed with the eviction process for her not paying her 5% for the past several months? 

If I file the Unlawful Detainer because the 3 days has passed, should I not accept any rent from her, even if it is only the old rent (partial rent)?

A3

Based on my understanding of the matter, it is my opinion that you can proceed with eviction based on your most recent 3-day notice because the 3 days should be considered only to be a minimum. In hindsight, you might have been in a better position if you had served a notice when the July rent did not include the increase, as judges sometimes consider failure to proceed in enforcing lease terms in a timely manner to be a waiver. If your lease agreement has provision for late charges, you should have been collecting them along the way each time she failed to pay the new amount. Failure to do so may have set a precedent that might prohibit you from doing so now. However, it probably won’t hurt to add them into your unpaid amounts, as this may itself get her attention.

Under the circumstances the “waiver” issue would not likely be a problem if you can convince the judge that you postponed collection of the increases under mutual agreement as a favor to the tenant. For future reference, remember that any agreement to defer your enforcement of lease terms should be in writing and signed by both parties.

Whether or not you should accept payment may depend on the landlord-tenant law of your state. Some states require starting over with a new 3-day notice for the balance upon acceptance of partial payments. Other states allow the notice to remain in affect. Still others do not require starting over as long as the tenant signs an agreement to that effect. You need to check the law of your state. As a practical matter, you may be better off to accept the rent and serve another 3-day notice for the total of unpaid increases after her check has cleared. Since there has been a history of her paying the increase, even though late, a judge would likely not accept any claim that you waived the increase. Even if that happened, you’d likely be ahead of the game in having the old rent for October. Furthermore, you could give her a new 30-day notice of a significantly larger rent increase and proceed appropriately if she continued to play games.

If you have any worry about the 2-week delay you could give her a new 3-day notice for the full amount owed including all late charges accrued and the full proper October rent, as it will only require an additional 3 days and should avoid any issues regarding the old notice. If it were me, I would proceed immediately and not worry about the delay. Filing may get her attention because she will now owe you yet more because of your filing costs, assuming an adequate lease clause or state law regarding legal costs.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Document Retention & Security

In this short article, we’ll briefly discuss basic requirements for both the retention and the security of documentation.

Retention

Landlords need to keep records on all applicants, current tenants, and past tenants. Records should be kept that show periods when vacant properties were available.

Documentation related to all applications, whether withdrawn, rejected, or accepted, should be retained. Included are the following items:

Advertising copy, including flyers or other handouts related to marketing of vacancies

Phone logs for all in/out calls with applicants

Application forms and supplemental information provided with application forms

Third party screening reports

Written memorandums of all landlord conducted investigations

Screening criteria, checklists, and logs

Selection criteria, checklists, and logs

Contemporaneous memorandums or notes regarding oral conversations

Communications to and from tenants, including emails

Adverse action reports (rejection letters)

Lease agreements and amendments thereto

Move-in/out checklists

Maintenance requests, logs, and work done

Security deposit accounting records

In other words, absolutely everything related to every inquiry and application should be kept. While the retention period will usually be in the range of 2 to 5 years, depending on the possible future reason for which the information might be important in defending an action taken, the statute of limitations periods for potential litigation begins only on the date when the plaintiff discovers that he has been damaged rather than on the date when damage occurred.

The minimum retention period can depend on the content of the document. A landlord should consider the following guidelines for records retention:

The Federal Equal Credit Opportunity Act requires a creditor to preserve all written or recorded information connected with an application for 25 months. This is a minimum period which could be increased by technicalities related to a particular case.

Under federal law for fair housing discrimination claims, claims must be filed within 2 years of the claimed discriminatory action, but some states may have longer filing periods, so landlords should know the law of their particular state and, if the period is longer, keep records for a period of at least the greater of the two.

The best defense against a Fair Housing claim is being able to produce both documentation related to a particular person making a discrimination claim and a set of records that shows long-term consistent nondiscriminatory application of written screening and selection criteria.

Landlords who have or have had employees need to be concerned with many of the same items in the above list regarding employment, but must understand that the requirements for some items can be different for employees than for tenants.

The IRS can audit a return within 3 years after (1) the April 15^th due date, (2) the date the return was filed, if filed later than April 15^th, or (3) the date the return was last amended, whichever period is longer. However, the more prudent real estate investors will retain all documentation related to both the purchase and the sale of a property until at least the above-mentioned period after the sale of a property. This is because the taxable gain upon the sale is dependent on the purchase documentation and depreciation taken during the period of ownership. When a property is in a chain of tax deferred exchanges, this includes documentation for each property that was within that chain. There is no limit if fraud is involved.

Security

Just as important as the period for which a document must be retained is the security with which it is retained. FTC regulations under Fair and Accurate Credit Transactions Act (FACTA) require that landlords and employers must safeguard the use of and eventual destruction of all documentation containing information regarding applicants and tenants. This includes everything from application forms submitted by applicants to credit reports and any information obtained from credit reports or other screening processes.

Requirements include that records are secured under lock and that reports and information stored on a computer or portable devices must be secured by password protection. In all cases, access to records must be limited to trusted individuals and only on a need-to-know basis. For example, credit reports should not be available to every employee in the office of a landlord or management company, but only to the employees who are involved in obtaining the reports and making decisions based on the reports.

When there is no longer a legitimate business need to retain an applicant, tenant or employee’s credit report, FACTA requires disposal of the credit report along with any information taken from such report. The FTC refers to proper disposal as the discarding or abandonment of consumer information and the sale, donation or transfer of any medium including computer equipment in which consumer information is stored.

Adequate implementation of the disposal rule should include written procedures for determining when the sensitive information is no longer needed and a system for effectively purging it.

Deliberate refusal to comply with the law or even failure to take reasonable actions regarding it can result in costly fines and damages by the FTC and/or state agencies as well as lawsuits by tenants’ or employees’ for actual and punitive damages and attorney fees for each violation.

In spite of a landlord’s best efforts, it is possible that there will be a security breach. Many states require that anyone (including landlords) maintaining consumers’ sensitive information to promptly notify those consumers when there is a theft or loss of Social Security numbers, drivers’ license numbers, or other sensitive account information so that they can take action to protect themselves. Consult your state’s office of consumer affairs to determine if your state has such a law. Federal legislation regarding this issue is also expected.

Whether or not you are subject to such disclosure requirements, it is probably good business practice to provide disclosure of a security breach. FTC guidelines regarding alerting consumers in the event of a breach can be found at www.consumer.gov/idtheft.

Additional Information

For additional discussions regarding a wide variety of real estate investing and management issues see our other eCourses and our Mini Training Guides.

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

Please help! We just signed a lease with a new tenant yesterday that is to begin in 2 weeks. We now have a gut feeling that we made a bad decision and we don’t know how long we have to cancel the lease. We have not deposited any money and want to tell the prospective tenant that we will not be able to go through with the lease agreement and void her check. What are the NJ laws regarding this? I haven’t been able to find anything. Please help!!!

A1

I can’t comment on specifics of NJ law, but to my knowledge no jurisdiction in the country has a law that allows either a landlord or a tenant to change his mind after he signs a lease. An exception would be if it could be shown that one or the other parties committed fraud. Some states have laws regarding rescission of a contract within a few days for contracts such as home improvement contracts. However, any consumer protection law that allows cancellation of a contract applies to the rights of a consumer, not the merchant, again unless the consumer committed fraud against the merchant.

Landlords should not make rent/not rent decisions based on gut feelings. Decisions should be made based on the results of a number of objective screening procedures, including identity verification and credit reports as a bare bones minimum. If possible, screening should also include verification of employment, eviction record checks, previous landlord checks, and criminal record checks.

You don’t say anything about the length of the lease. If a month-to-month lease you could immediately give a termination notice (30 days notice in most states) and you would likely find that the tenant would prefer to cancel the lease rather than again move in a month. Whatever the length of the lease, you could inform them that you will not be renewing the lease and perhaps the tenant would like to cancel, but this could also result in problems during the term of the lease if they don’t want to cancel because they would likely worry less about paying the rent on time or taking care of your property during their tenancy.

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Q2

What is the fastest way to get new tenants?

A2

The best way to find prospects and the lowest cost way is usually to use “For Rent” signs in locations that are visible to people driving or walking by the property. The fast way to get a prospect that has viewed the property to sign a lease is to offer good value. This includes providing clean, well-maintained, and safe units at or below market rent for the area. This can also help one get “good” tenants because those who are financially qualified and have a good rental history do not usually need to live in bad rentals.

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Q3

I have a husband and wife who signed a lease for 1 year on April 26th. They were not to move in until May 15^th, a week from now. They just called me today to say that the deal on selling their house fell through and now they will not be able to rent our home (single-family residence). This is the only property that we are currently renting out. Do I have any recourse and can I keep a certain amount of money to cover me until we find a new tenant. Any advice would be appreciated.

A3

Tenants do not usually have the right to break a lease no matter what their problems might be unless that problem was a contingency stated in the lease agreement.

First, I recommend that you require them to put their intent into writing so that there is proof it is the tenants who want to break the lease.

Second, you have basically two choices. One is to negotiate a written cancellation of the lease whereby you let them out of the lease for some consideration, say a month’s rent. The other is to simply tell them that you intend to hold them to the lease. In the second case, the laws of most states require the landlord to make “reasonable” effort to find a replacement tenant. The landlord can charge the tenant rent from the commencement of the original lease until commencement of the replacement lease. In addition, any other actual expenses resulting from the tenant breaking the lease, usually including additional advertising and/or leasing commission, can be charged.

In the first case, the amount of negotiated settlement would cover everything. I would recommend the first choice unless you think that it would require more than a month to find a replacement tenant or such longer time that will be covered by the amount of settlement you can negotiate.

Third, be sure to follow the law of your state regarding returning any portion of the security deposit not being applied against allowed costs, provide a detailed accounting for any amount not returned, and do both within the time limit provided by the law of your state.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Disposing of Income Property

The Basics

Many of the aspects of buying an income property are also important when selling one. One just views things from the other side of the transaction. We won’t, in this article, try to discuss every issue from the other side. However, we will discuss some of the more important issues.

Why Do It?

There are, in general, two possibilities. First, because you have to do it. Second, because you want to do it. By “have to” we mean you need to sell because of health, financial, or other issue that limits your ability to pick the market conditions in which to sell. “Want to” covers all cases other than “have to” no matter what the reason. It might be that you’re tired of dealing with tenants, want to retire with the freedom to travel, or want to utilize your equities to enjoy the lifestyle of the rich and famous. The major difference from “have to” is that you have more flexibility as to when you do it.

When to Do It

Like many other things in life, timing the disposal of your property is important. The time to dispose of property is when it’s a seller’s market – that is, when the demand is higher than the supply. Unfortunately, real estate investors must often dispose of property under less than ideal circumstances for reasons of health, divorce, or general financial condition. However, even when you “have to” dispose of property, following the correct procedures will help you realize the highest possible return.

How to Do It

You have several options regarding getting rid of a property. You can give it away, you can sell it, or you can trade (exchange) it. There are also two other ways. One is to stop paying your loan payment or your property taxes and have it taken away, but this option doesn’t require instructions. The other is to die and leave it to your heirs, and, while no instruction is usually necessary for the dying part, proper estate planning is highly recommended.

Gift It

There are several reasons why you might consider giving it away. One would be to gift it to a family member or friend. Gifting to relatives or other individuals or entities (other than charities) can have an impact on overall estate planning. Another would be to donate it to a charity. There are even ways to put a property into a charitable trust that allow you to retain control even as to future use long after your demise. All of these possibilities have tax consequences and require that you seek competent professional help. Timing of a gift can be important because the stepped up basis for the recipient is related to the value at the time that the gift is made. Lesson 32 of our “Buying & Selling Income Properties” eCourse includes a discussion about charitable trusts.

Sell It

You can, of course sell the property, just as you can sell your personal residence. And, just as when selling your personal residence, you want to maximize the sale price. However, selling income property is usually more complicated and can have significantly more tax consequences.

Arguably, the most important tax consequence is that taxable gain will be based on sales price (less selling costs) less your basis at the time of sale. And, your basis is usually the net purchase price plus amounts added to basis during the period of ownership minus depreciation taken during the period of ownership. In other words you will pay tax on all the depreciation that you deducted during the years of ownership in addition to paying tax on the actual increased value, where there may be a difference in tax rates between the two. There are ways to somewhat cushion the tax blow, for example, by structuring the sale as an installment sale.

Timing is obviously important for selling a property because you’d like to sell at the top of the market or at least not at the bottom. If in an increasing market, you might want to delay the sale if practical and add more dollars to your price, using that time to maximize rents and minimize expenses where possible.

Exchange It

Unless you want to get out of the landlord business, it will usually be advantageous to exchange your income property under Section 1031 of the Internal Revenue Code. Section 1031 provides a way to exchange one property for another without paying income tax on gain and depreciation recapture on the property being exchanged from at the time of the exchange.

Although sometimes referred to as “tax-free” exchanges, remember that there is no such thing as a free anything. Section1031 provides a deferment of taxation rather than a waiver of it. However, if you die before selling a particular property, your heirs may receive a stepped up basis that makes the deferment permanent, depending on tax laws at the time of death.

Currently (2010), the Internal Revenue Code allows owners of certain types of like kind “real” and “personal” property to exchange like kind property without paying the capital gains tax. The Code lays out in detail the procedure for turning a sale and purchase type transaction into an exchange.

In general, no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

Section 1031 provides a means of trading your existing real estate portfolio for one that is less management intensive when you want to slow down, but not entirely retire from the rental business. The main advantage of a tax-deferred exchange is that it allows you to trade up to larger property or higher quality property after your previous property has increased in equity in order to improve your leverage position, utilizing untaxed dollars to do so. As indicated by the word deferred, you will eventually have to pay the piper if you wish to cash out and retire from the landlord business.

Additional Information

Additional discussions regarding several issues related to disposing of income properties will be provided in future articles. Currently, significantly more detailed discussions regarding a wide range of issues can be found in our “Buying & Selling Income Properties” eCourse.