Screening In a Bad Economy

As we move toward the end of the year, high unemployment rates continue their impact on rental housing affordability and availability. Landlords are facing increased competition for qualified applicants to fill their vacancies. In some markets, properties are staying vacant much longer than even just a year ago. It is a renters market in many areas of the country where supply of rental housing exceeds the demand, sometimes by significant margins. How much of an impact the current economic conditions have on your business may well be determined by your perspective.

While it may be true that the pool of applicants to fill vacancies is likely to include less qualified applicants and while it is true that more people are unemployed and/or have had other problems that affect their rental qualifications, logic would indicate that an unemployment rate that is 5 percent higher than usual does not translate into 100 percent of applicants being unqualified.

So while it isn’t business as usual it is still business. As we have discussed before, risk management becomes ever more important during changing conditions. Tenant screenings remain a critical component of risk management practices.

Unfortunately, we are seeing evidence of landlords reducing screening efforts based on their thinking that there is now less reason to bother with screening because all applicants will have blemished credit records. Unless this is your first landlord experience, you will have come across bad credit scores before. Current conditions notwithstanding, what was your procedure to accept or reject?

However, we believe landlords should be putting even more effort into adequate screening during bad times using a wide variety of screening tools.

While landlords may choose to lower the minimum qualifying credit score, some of the risks of doing so can be offset by more aggressively utilizing other screening tools. This includes a closer examination must be made of the other detailed information provided on credit reports, more extensive rental history checks with previous landlords, check of eviction records in multiple jurisdictions, careful employment and income verifications, and extensive criminal record checks.

A brief review of some of those screening tools follows.
Credit Reports

A credit report is the most important screening tool and should be utilized even if no other tool is used.  It is the one tool that does not require cooperation of previous landlords, cooperation of employers, knowledge of which county in the country may have a record of eviction, or knowledge of which state or county may have a record of conviction. Furthermore, credit reports provide a variety of information that often provides clues regarding which of the other tools might be useful and which state or county should be of interest.

With a full credit report, you can corroborate information shown on the rental application; review the individual’s payment history including credit accounts, account balances, and collection accounts; and view reports compiled from public records on bankruptcies, liens, and judgments. You also see who has recently requested a copy of the applicant’s credit report.

If the report shows a positive pattern of responsible credit management before the date of a significant affecting event (foreclosure, bankruptcy, major medical bills, divorce, etc.)  you could infer that the event was the contributing factor resulting in derogatory items in the credit file. While the event cannot be overlooked, the data can be analyzed in the overall context of credit use and payment history. As is often the case, honest discussion of events with the applicant may give more detail that may allow the applicant to be considered for the vacancy.

Past Rental History

It is important to check each applicant’s rental history in addition to his credit history because many types of tenant problems do not make their way into a credit report.

When checking rental history be sure that you are really speaking with the actual past landlord. There are many ways to do this including checking ownership records and obtaining the correct phone number independently of the applicant.

Some current landlords may be unwilling to say anything derogatory about bad tenants because they would like to be rid of them and would be happy to transfer the problems to you. Accordingly, it is always best to also contact the applicant’s landlords prior to the current one, the reason most experienced landlords require the applicant to provide rental history for at least the past three years. For an applicant who has rented the same unit for more than a few years, it can be difficult to get history from more than the current landlord, but a long-term tenancy often is indicative of a good tenant.

At a minimum, you will want to confirm basic information such as dates of residency, the rent amount, the security deposit amount, and whether the landlord would rent again to this tenant. If only one question could be answered, it would be “would you rent to this tenant again?”

Employment & Income Verifications

Employment and income documentation can consist of requiring the applicant to produce the last several paycheck stubs. Note that last year’s W-2 provides no certain information regarding current income, although it might be useful as additional verification if other items are questionable.

Self-employed individuals can be asked to provide copies of 1099s and tax returns (as can employee applicants), but one must keep in mind that it is easy to createW-2s, 1099s, and tax returns that say whatever is desired using a personal computer.

Verification of non-earned income, including interest, dividends, and other investment cash flow and entitlement items, including disability, social security, and private retirement, are all relatively easily verified because the recipients are
provided official statements of the amounts.

Eviction Searches

It is good practice to conduct a search of eviction records as recorded in the court of jurisdiction for the counties where the applicant is known to have resided. You may want to review the rental application, the applicant’s driver’s license or motor vehicle registration, and current/previous address history as shown in the credit report to determine applicable search areas. Most tenant screening vendors offer regional, statewide, and national eviction searches of landlord-tenant filings.

Criminal History Checks

A criminal history check generally includes a search of statewide, multi-state, or regional criminal records databases and sex offender registries. For a more detailed search, most screening vendors can provide a “hand search” of a specific county’s criminal records index and court documents.

Criminal background reports generally include the defendant’s name (and any aliases), the defendant’s date of birth, gender, race, physical description, dates of the offense, and the date of disposition or conviction. To help ensure accurate results, be sure you have the correct spelling of the applicant’s full name, a verifiable date of birth, and a list of known aliases used by the applicant before purchasing a report.

A search of convicted sexual offender records may be included in a comprehensive criminal report or in case of some vendors, ordered as a separate report. Be aware, however, that some states restrict the use of this information to deny housing.

In general, landlords are free to reject someone with a criminal background, as ex-cons are not a protected class under federal fair housing laws. An exception is that past drug use, even when resulting in a conviction, is considered a disability under federal law.  Those currently using drugs or those who have been convicted of drug manufacturing or dealing are not protected. Landlords must also consider any protections provided by state or local laws.

Preparing For Vacancies

Some landlords do not adequately prepare for vacancies. When landlords don’t prepare, they can only react, and reacting to rather than preparing for vacancies usually makes the vacancies more costly.

Changing conditions in the economy, changing conditions in tenants’ needs and wants, and effects of life events will have significant impact on the landlord’s ability to fill vacancies. Timing of vacancies is not always controllable by the landlord, but planning how to handle vacancies is under the landlord’s control. By having a plan, the landlord may ease some of the stress and minimize downtime and expense in filling vacancies.

Scheduling

Adequately preparing for vacancies includes keeping track of when vacancies might occur. Although landlords cannot always totally control the timing of vacancies, there are some things that can be done to minimize surprises. This includes the very basic item of not scheduling your vacation near the date of a potential vacancy and being sure that your favorite handyman or other vendors used in preparing vacancies for re-leasing will be available at the time of a likely vacancy.

Landlords have potential control over scheduling vacancies by properly choosing the termination date of lease agreements. Even month-to-month  agreements give some control if the landlord writes all agreements so as to terminate at the end of a month rather than related to a mid-month date of lease origination.

Tenant’s Notice of Intent to Vacate

Neither landlord nor tenant want any surprises or delays during the final days of the lease term when stress levels are usually already at a higher level. The
landlord will want to start as soon as possible to begin clean-up and repair and the tenant is under pressure to coordinate his move and perform according
to his ending lease and a new lease or home purchase elsewhere.

Lease agreements should include a clause that requires the tenant to give written notice by a specified number of days prior to the end of the lease term of
intent to vacate. Written notice to vacate is a requirement by law in some states. A notice requirement reduces the chances of misunderstanding or
misremembering the important details by either party.

A written notice is of benefit to the landlord should the tenant not move-out as planned.  The tenant, through no fault of his own, may be held up because his new residence is not ready as scheduled and want/need to stay over a few days. The landlord having anticipated the move-out date may have signed a lease with a new tenant and promised a set move-in date for the new tenant that he cannot now deliver. The new tenant may choose to sue the landlord for default of possession date and the landlord can then in turn file suit against the holdover tenant for failing to move-out as noticed. The written notice will be of value in proving the landlord’s case in court.

The written notice signed by the departing tenant will also help convince the tenant to make other temporary arrangements regarding housing if necessary so as not to delay the replacement tenant’s move-in. When there is not a waiting replacement tenant, the departing tenant will probably be less likely to argue about whatever rent the landlord demands for a holdover period.

On a related issue, landlords should require advance commitment from tenants who they wish to retain. Landlords should deliver or mail  renewal/extension agreements to tenants well in advance (say, 60 days) of lease expiration dates and require response by at least 30 days prior to expirations.

Landlord’s Notice to Tenant of Non-Renewal of Lease
In most states a landlord has the option to not renew or extend a lease beyond the termination date. In most jurisdictions, the landlord does not need to provide the tenant any reason for not renewing or extending the lease term. When a reason is not required by law, it is almost always better to not provide a reason, as an improperly stated or misunderstood reason could give rise to a claim of a fair housing violation.

Some landlords may think it unnecessary to provide additional notice to the tenant that the lease term is expiring on a certain date and such notice is not usually required by law. However, doing so well in advance is of value to the landlord because it serves as a record that the tenant was notified that the landlord did not wish to renew the lease.

If the tenant stays on after the expiration of the lease, the tenant becomes a holdover tenant. Despite the expiration of the lease, in order to remove the holdover tenant from the property, the landlord in many states must serve the holdover tenant with a notice to vacate the property, stating the date upon which the tenancy ended. If the tenant does not vacate by the end of the notice period, the landlord can file an eviction lawsuit. Some states do not require a notice to a holdover tenant and allow the landlord to immediately file an eviction lawsuit upon expiration of the lease.

Most month-to-month tenancies can be terminated with 30 days written notice to the tenant. However, as a particular state may require a longer notice period for certain tenants – e.g., those who have been occupants for at least a specified period. Landlords should consult their state’s landlord-tenant law for current requirements.

Market Surveys

A market survey is the first line of defense against the costs of filling vacancies.  Supply and demand for rental units and in particular, type of property,
condition, and location, will have a significant impact upon a landlord’s ability to attract and retain good tenants and to command market rents. Accordingly, minimizing the length of a vacancy is dependent on asking the appropriate rent when marketing the vacancy.

As conditions change, the landlord can adjust his rents and, when necessary, his qualification criteria, in order to stay competitive in his market area.

Have a Maintenance Plan

Not Staying on top of needed maintenance and repairs is one of the most shortsighted and costly mistakes that landlords can make.  It is easiest to stay on top when one has a good maintenance plan in place.  It is impoirtant to stay on top for a number of reasons.

First, the best tenants will not want to live in badly maintained property.  Accordingly, badly maintained units attract less qualified applicants.

Second, if the property is not kept in good repair and the problems are not repaired during a vacancy, the new tenants will start out having a bad experience.  Furthermore, the fewer defects for a property when a tenant can have when the tenant moves out.

Third, many types of maintenance items that are not taken care of when initially discovered, or within a short time thereafter, not only become worse as time passes, but can eventually be the cause of other problems that are substantially more costly to correct.

Fourth, without a plan, you have less control over your expenses.  Emergency (unplanned) repairs will usually be more costly in terms of money, stress, and tenant dissatisfaction.

Fifth, failure to take care of repairs, particularly those related to health or safety can result in withholding of rent, a government inspection, and/or citations with fines.

Types of Maintenance

We like to divide the tasks that should be part of a maintenance plan into eight categories.

Emergency – This maintenance must be resolved within a very short time in order to minimize harm to individuals or prevent further property damage.  In order to minimize the implact of many types of emergencies, it is a good idea to provide tenants with basic information including location of utility shut-off valves and switches, instructions on how to turn off utilities, and when such action might become necessary.  Also, since even the best maintained properties can experience unexpected problems, a good idea is to be prepared ahead of time with a list of contractors and tradespersons who can be called to handle maintenance problems during and after regular business hours.  The do-it-yourself landlord is best prepared with a ready tool box kept in his vehicle.

Deferred –  This is maintenance, which, while not necessary critical, should have been done long ago.  A policy of deferred maintenance will likely result in higher cost for labor and materials, including for collateral damage, when work must finally be done as emergency maintenance.

Preventive –  Maintenance preformed on a regular schedule, as a result of a regularly scheduled inspection, or noticed during a visit to the unit for other purposes can prevent or minimize costs of emergency repairs or replacements.  Preventive maintenance also extends the operating life if the building and its systems and usually saves money in the long run.  By having a schedule for inspection and for repair of any items found, the landlord can avoid minor problems becoming major (think expensive) repairs.

Corrective –  This is maintenance that gets the property back to good working order when there has been a breakdown or malfunction.  Preventive maintenance significantly reduces the need for corrective maintenance.

Custodial –  This is routine upkeep of the property.  for many single-family properties, routine maintenance responsibilities are transferred to te tenant by the landlord’s lease agreement.

Cosmetic – Unsightly repairs and maintenance are noticed by the type of tenant that you would like to have in your unit.  Tenants who don’t care about such “cosmetics” are more likely not to care about how they treat your property.  Paying a little more to have drywall properly repaired by someone with adequate ability and other issues of a cosmetic nature will make it maore likely that you will attract good tenants.

Upgrades – Upgrading your property can mean improving the quality of your tenants and your cash flow.  Improvements such as new light fixtures, better floor and window coverings, or additional amenities make a property more desirable to the type of tenant you want and may bring significantly higher rents.  One example of and upgrade that usually both reduces long term expense and increases rents is replacement of vinyl flooring with ceramic tile flooring.

Renovation or Rehab – Unlike the TV home improvement show where it seems that renovations and rehabs happen quickly and effortlessly, in the real world they can take a long time and involve a great deal of work, particularly if you’re trying to do it yourself while holding down a day job.  If one is not careful, they can also cost a lot more than expected.  Major work is not always cost effective, partcularly in the short term.

In Summary

The positive benefits of good property maintenance are (1) better tenants who pay their rent on time and take good care of your property, (2) increased tenant satisfaction that can lead to longer tenancies,  (3) improved landlord-tenant relations, reducing stress, (4) higher rents, (5) less likelihood of regulatory complaints, (6) less worry about governmental inspections, and (7) reduced vacancy costs.

Tenants who are content with their rental units usually don’t move unless required by external circumstances.  One of the ways to keep good tenants is to be diligent in providing good maintenance.

Lease Buyouts

It is often advantageous for a landlord to allow a tenant to buy out his lease.

Reasons for Buyouts

There are basically two reasons for a lease buyout. One is the tenant wanting or needing to break a long-term lease. The other is the landlord wishing to be rid of a tenant even though the tenant has not defaulted on the lease in a manner that
allows the landlord to terminate the lease for cause.

Examples of a tenant-initiated buyout are (1) the tenant needing to downsize to a lower rent or upgrade to more bedrooms (or larger commercial space), (2) the tenant being offered an improved employment opportunity in a distant city or another state, (3) a marriage requiring consolidation of housing, or (4) a married couple splitting up and needing separate housing. When the tenant approaches the landlord regarding early termination of a lease, the landlord has the option to refuse. Of course, in most states if the tenant simply breaks the lease and leaves, the landlord is obligated to minimize damages and re-lease the property as soon as possible rather than leave it vacant and require the tenant to continue paying the rent for the remainder of the lease term.

Examples of a landlord-initiated buyout are (1) a tenant who is often the cause of complaints from other tenants, (2) a tenant who regularly complains about petty issues, or (3) the landlord becoming aware of the tenant’s deteriorating financial situation that will likely result in default.

Advantages of Buyouts

A lease buyout can be primarily of advantage to one of the parties, but is often of benefit to both the landlord and the tenant.

The tenant is able to terminate his lease without financial penalties beyond the buyout fees and without risk of a lawsuit and/or damage to his credit record.

The landlord eliminates the need for eviction and/or other legal actions when the tenant eventually quits paying rent due to his financial situation. Depending on the amount of the buyout fee and market conditions, the landlord may be able to fill the vacancy without any loss of income. Departure of the tenant may also minimize the need for cleaning and repairing the vacant unit if the buyout agreement makes condition of the property a contingency of the deal.

Determining Buyout Fees

What might be considered a reasonable buyout fee to either the landlord or tenant or to both parties can vary widely depending on the reasons, the current rental market, and various other factors.

The landlord usually has the upper hand when a tenant approaches him regarding early termination of a lease. However, the landlord must temper his desire to maximize his profit by sticking it to the tenant. The maximum amount of
compensation the landlord can obtain for allowing termination of the lease depends on various factors including the tenant’s financial condition. If his condition is dire, he will likely leave anyway and may even be “judgment proof.”
The landlord must remember that although the tenant wishes to avoid damage to his rental history by simply leaving, the landlord may be stuck with a significant financial loss if the tenant stops paying rent long before giving up
possession, leaves the premises in bad condition, and “disappears” so that it is difficult to serve for legal action.

It is usually best to take the middle ground and calculate the fee based on a conservative estimate of the actual costs of an early vacancy, remembering that there would be a vacancy at the end of the tenant’s lease anyway. Items to consider usually include (1) costs of preparing the premises for the next tenant, (2) lost rent during preparation down-time, (3) marketing expenses (including advertising and commissions), and (4) lost rent during the marketing period until rent begins from a new tenant. Items 1 and 2 can be significantly affected by the condition that possession of the property will be returned to the landlord. Items 3 and 4 depend on current market conditions.

In an improving rental market it can actually be significantly advantageous that the lease be terminated early, particularly when the departing tenant was at a low rent and the lease still has a long time to run. This is of most importance for
commercial property where leases typically are multi-year in length, with limited increases along the way. Under such circumstances, the landlord might only ask for a token couple of weeks or a month of rent to cover item 4.

At the other extreme, in a deteriorating market one must make a guess at how many months will be required to find a tenant who will pay at least the rent that the departing tenant was paying. This might require many months of rent to cover item 4. One must also add in additional costs if the new rent is expected to be lower than that of the departing tenant.

The Buyout Agreement

The complexity of a buyout agreement depends on a number of things including the reason(s) for the buyout, but the thing common to all buyouts is that the agreement should be a written document that covers all material issues. Accordingly, as soon as agreement has been reached between the two parties regarding the terms, prepare a written document.

Among issues that should be covered in the agreement are:

State that the document is the full and final agreement regarding the lease.

State whether or not any part of the deposit will be applied against the buyout fee, whether or not any part will be refunded if the unit is immediately re-leased, or whether no credit for the deposit is to be given.

Most states require, at least for residential rentals, an accounting for any part of the security deposit not refunded within a specific time frame. The buyout agreement should cover this issue in a way that will eliminate the need for
further action regarding an accounting.

Being a Successful Landlord

Most landlords get into the business because they think that owning rental properties would be financially rewarding either in the short-term, the long-term, or both. Many landlords have been successful, some spectacularly so.

It is important to understand that landlording is a business that requires knowledge, organization, and a lot of hard work.

Ways to improve your chances of being a successful landlord include the following.

Education

Knowledge is important for success on a number of levels. At one extreme it will make your job easier. At the other extreme it will keep you out of serious financial and/or legal trouble.

Education is not a one-time thing, but requires a continuing commitment. Investors and managers must keep up to date regarding laws at federal, state, and local levels. Additionally, they must keep up with market trends.

Properties

The chance of being a successful landlord is greatly improved when the investor makes good choices when purchasing properties. It is not always possible, even with the best of management skills, to make up for buying bad properties.

Location – As we’ve all heard many times (probably ad nauseam), the three most important things related to value of real estate are “location, location, and location.”

Physical Condition – A property that is a good candidate for purchase often looks to be in bad condition. That’s OK if it has the “right things wrong with it.” “Right thing” examples include needing paint and having ugly wallpaper, things that are usually easily and relatively cheaply fixed. However, the “wrong things wrong” such as bad floor plans or unstable soils are not usually economically corrected.

Tenants

Landlord-tenant interactions can potentially result in both financial losses and a variety of legal problems. Having “good” tenants means both selecting good ones in the first place and retaining good ones for as long as possible.

Adequate screening is critical to obtaining good tenants and proper selection from those who have been screened is important in order to both end up with a good tenant and to avoid claims of discrimination.

You should try to keep good tenants as long as possible. Vacancies are one of the largest expenses in the operation of income property. Vacancy costs can be minimized in three ways – first, by minimizing tenant turnover; second, by minimizing the length of unavoidable vacancies; and third, by minimizing the delay in commencing an eviction when one appears necessary.

Accounting

In order to have a successful business of any kind it is necessary to know the financial status of its operation at all times. There are a number of ways for real estate investors to implement accounting and property management systems that
are easy to use and provide the information required to (1) manage their properties effectively and profitably, (2) easily file accurate tax returns, and (3) have the necessary records in case of an IRS audit.

Documentation

A wide variety of documentation is generated by a properly operated landlord business.  Documentation can be divided into two categories – (1) property related and (2) tenant related.

For both categories, landlords must create adequate documentation and retain it for appropriate lengths of time.

Maintenance

Not staying on top of routine maintenance and necessary repairs is one of the most shortsighted and costly mistakes that landlords can make.
First, poorly maintained property does not attract the best tenants. Second, if the property is not kept in good repair the new tenants will start out having a bad experience and after complaining to the landlord they may also file a formal
complaint with governmental housing agencies. Third, many types of maintenance items that are not taken care of when initially discovered, can eventually be the cause of other problems that are substantially more costly to correct.

Risk Management

Real estate investing includes numerous potential risks and it is important that these risks be managed. Most landlords are aware of the importance of using limited liability entities as a means of providing asset protection, but asset
protection is only one aspect of risk management.

Asset protection becomes important primarily when all other risk management measures have not been totally effective – that is, asset protection actually becomes the protection of last resort.

All risk management measures, including asset protection, are like insurance in that you have to put things in place prior to occurrence of the catastrophe, not after the fact.

I Bought a Rental House with and Existing Tenant.

Q1

I bought a rental house about 5 months ago that had an existing tenant. I was told by the seller that the tenant had no security deposit. The tenant is now leaving and claims to have a $600 deposit that he wants returned. Who is responsible for returning the deposit?

A1

You need to first determine who is telling the truth. Did you not obtain a copy of the lease agreement prior to buying the property that confirmed what the seller told? The original should have been turned over to you upon close of escrow. Additionally, even when copies of lease agreements are provided by the seller, one should NEVER buy a property occupied by tenants without requiring that each tenant execute an Estoppel Certificate.

If you have a lease agreement copy confirming that there was no deposit, ask the tenant to provide a copy or an amendment or addendum showing something different. If there is a discrepancy, you will need to resolve it by comparing dates of execution and signatures between the documents. If there is only the tenant’s version, you may have to go by that unless the seller is willing to testify differently.

By law in most, perhaps all, states, the current owner is responsible for the deposit even if not given credit for the amount at close of escrow. If there is in fact a deposit you will have to fund any part of it being returned. It would then be
up to you to attempt to collect the deposit amount from the seller.

If, by chance, there is no written agreement, it could be a bigger problem because it will be the word of the tenant against the word of the seller.

Unless adequate documentation was used by the seller, including a detailed move-in checklist that was provided to you by the seller, there will be additional problems if you try to deduct from the deposit any amounts for damages that occurred prior to your documentation of the condition of the property during an inspection following close of escrow. Of course, return of the deposit and/or an accounting for any portion not being returned must be provided the tenant within the time required by your state’s law.

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Is There a Max Amount on Security Deposits?

Q2

I am interested to know if there is a max on what a landlord can charge for security deposits and for performing credit checks.
A2

Most states limit the amount of deposits that can be collected and there can be serious penalties for violating the rules. Although a few states have no statute limit, the maximum allowed varies from one to two times the monthly rent in most states. Most states do not allow landlords to avoid limitations by calling the amount of funds something other than a security deposit. You need to check the landlord-tenant law of your state.

Some states have specific limits by statute regarding the amount that can be charged for credit reports. Other states limit the charge to the actual cost of obtaining the reports from outside vendors. However, in most states if the matter were to come before the court, the requirement is that the amount be reasonable, taking into account your cost for a report and the time required for you to process it. Typically, $25 to $40 is acceptable. Experienced landlords or property managers in the area of your property should be able to tell you what is acceptable.

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When a Contractor Does the Job incorrectly.

Q3

When a contractor does the job incorrectly, is it easier to have the job corrected when the contractor is licensed than when he is not?

A3

One of the many reasons to utilize licensed contractors is that it is often easier to resolve such problems. For a licensed contractor, one can often get satisfaction through the state agency that licenses and regulates contractors. Most states
require that licensees be insured (which protects you against certain liabilities). Many states provide for a recovery fund that covers consumers and/or require that licensees be bonded.

If the work was not up to standards or if there was any fraud involved, the contractor, whether licensed or unlicensed will often resolve the problem rather than have the owner file a complaint with the state contractor’s board, after which the matter will be on his record or even result in suspension or loss of his license. The degree of help one can get varies among the states. If all else fails, one can still sue the licensed contractor. Of course, one can always file suit against any contractor, licensed or unlicensed, but, lawsuits take time and money even if involving an amount of money that can be done in small claims court or a similar level of court in states which don’t call them small claims court.

Be aware that many states severely limit the type of work (e.g., no electrical or gas modifications) and the maximum dollar size of the job (typically $1,000 or  less) that unlicensed contractors can legally perform. Be sure to check the law
of your state if you are considering use of an unlicensed contractor. Usually, one would not be able to utilize the contractor licensing agency to deal with an unlicensed contractor when the work done does not require a license.

If you are considering withholding payments in a dispute with a contractor, be sure that you understand mechanic’s lien issues.

It is important to always use care when selecting a contractor. Due diligence includes verifying that (1) the contractor is properly licensed for the particular tasks associated with the project if required by law, (2) there have been no unresolved complaints filed against him with the BBB or, if licensed, by the licensing agency, (3) the contractor carries adequate liability insurance and, if the contractor has employees, the required workers’ compensation insurance, and (4)
prior customers have been satisfied. For detailed discussions about this subject see the LandlordOnline.com “9 Steps to Avoiding Problems When Hiring a Contractor” Mini Training Guide.

Oral or Written Lease Agreement?

In general, contracts of almost any kind can be either oral or written and each can be equally valid and enforceable no matter what the legal purpose or dollar amount involved.  However, most states have adopted a legal doctrine called the Statute of Frauds and put the doctrine into their statutes.  these laws are fairly uniform among the states and cover a number of contract issues.

Specific to real estate, Statute of Frauds laws require contracts related to most real estate transactions to be in writin.  As examples, contracts to list real estate for sale or lease with a broker must be in writing to be enforceable in Court and oral contracts for those purposes are worthless.  This is usually so even though there might be indisputable non-written evidence as to the contracts, for example, unrealted third party witnesses.  Many states further specify certain items that must be included in such contracts.

Statute of Frauds laws of most states require a lease of real estate for a term of more than one year to be in writing.  However, an oral lease for a term of one year or less is binding and will be enforceable regarding most terms normally found in a lease.  An oral lease can be amended orally.

As a practical matter, all leases of any duration should be in writing because the written document provides a record of the terms of the landlord-tenant relationship so that its terms and conditions can be easily and clearly discernable by the parties, their heirs, or assignees.

As for any type of oral contract, oral leases regularly cause problems for both landlords and tenants because it is often difficult to determine what the terms of the lease are.

This can be the result of a number of factors, including the folowing:

• Misunderstandings by either party at inception of the agreement,
• Misremembering or forgetting terms later by either party,
• Purposeful distortion of terms by one party or the other, and/or
• Limited or no way of proving the lease terms.

Often a witness to the oral lease can be of value, but that may require that the witness be impartial or at least not a beneficiary of the lease in any way.

When an oral lease ends up in Court, the judge can sometimes make a reasonable decision based on circumstantial evidence.  for example, if the disagreement between landlord and tenant related to the amount of rent, then cancelled checks or recipts would prove what the rent was for those past months.  However, it would usually not support or deny any rent increase.

Sometimes a judge makes the decision based on which party can provide the best circumstantial evidence whether or not that evidence is directly relevant to the disputed issue.  However, when there is no clear evidence of who might be telling the truth, the judge may make a decision based on who was the best liar.  If both parties are equally believable or equally unbelievable, the decision is most likely to be in favor of the tenant.

Judges sometimes will not enforce certain terms of an oral lease.  Non-typical lease terms will li,kely not be enforcecd.  Even certain typical terms may not be enforced.  for example, it is not uncommon that a judge will refuse to enforce a late penalty provision that is not in writing.

A month-to-month oral lease can continue for many years so long as it remains a month-to-month lease or a lease for a term of no longer than one year.

The bottom line is that oral leases are only as good as the paper they are written on.

Applicant Bankruptcy on Credit Report.  What should I do?

Landlords have the right to set specific tenant selection criteria to include any factors based on valid business principles. As a landlord, you are free to choose to use almost any standards as long as legitimate business criteria have been applied, consistently, without discrimination, and in full compliance with all applicable laws.

With that in mind, you may legally reject any applicant who has previously filed for bankruptcy, (even if the bankruptcy discharge was completed several years ago) if you have a firm (preferably written) policy of “no bankruptcy” (within a specific period, if desired).

Federal fair housing laws do not include a protected class for financial status. If the landlord’s criterion is rejection of an applicant who has filed bankruptcy and the criterion is applied to every applicant without discrimination, the rejection of the application is a legitimate business decision by the landlord.

On the other hand, you may not wish to have such an absolute policy. You may decide that a more flexible policy regarding bankruptcy filing is appropriate for your properties and applicant pool, for example, a filing within a certain recent number of years. The key issue is that you absolutely must apply the same standard to every applicant.

A bankruptcy filing will be reported to the major credit bureaus and appears in the public records section of a full credit report. If, as recommended, you have prepared a rental information packet, including your written selection
criteria, the prospective applicant will know your eligibility requirements, know his personal bankruptcy history, and decide whether to submit his application.

In general, adverse credit information remains on a credit record for 7 years. However, a person’s bankruptcy may be reported for a longer period from the filing of the case. The bankruptcy will appear even if the person voluntarily dismissed it before the discharge, but the credit reporting agency must report the dismissal.

For bankruptcy, the length of the period depends on which Chapter was filed. Chapters 7, 11, and 12 may remain for ten years from the filing date. Chapter 13 usually remains for seven years from the filing date. Accounts from creditors listed in bankruptcy will usually remain seven years from the date they were reported as included in the bankruptcy.

Bankruptcy is governed by federal law found in Title 11 of the United States Code. The Bankruptcy Code supersedes any conflicting state law by reason of the Supremacy Clause of the Constitution. Although states may not regulate bankruptcy, they may pass laws that govern certain specific aspects of the debtor-creditor relationship.  Accordingly, bankruptcy law is much the same from state to state except for the types and limits of exemptions. Exemptions are those assets of the debtor that are legally beyond the reach of the bankruptcy trustee and, hence, of the creditors. The debtor in bankruptcy keeps the exempt property. Federal and state laws define the kinds and values of property that are exempt and the definitions vary greatly among the states.

Although tenant bankruptcy is probably not particularly common, it is an issue about which landlords be knowledgeable. While this article is concerned with applicants whose credit reports list a bankruptcy, there are a number of other reasons that knowledge of bankruptcy law is relevant to landlords. Regarding existing tenants, landlords need to (1) know what to expect when a tenant files bankruptcy, (2). What they can and cannot do after a tenant’s bankruptcy filing and (3) how a bankruptcy affects the continuing tenancy of a tenant filing bankruptcy. These issues will be only briefly touched on in this article.

Bankruptcy law seeks to benefit both debtors and creditors by seeing that debtors get relief from debts they can’t pay and creditors get paid from certain assets of the debtor or from his future income.

The primary purposes of bankruptcy law are to (1) give a debtor an opportunity for a new start by relieving the debtor of debts or rescheduling payments in a way that the debtor can handle and (2) repay creditors to the extent that the debtor has assets that can be used for payment. Both procedures take place under a Court approved and supervised plan.

The impact of an applicant having previously filed bankruptcy can depend greatly on which type of bankruptcy was filed. The types of bankruptcy proceedings are referred to by the chapters of the federal Bankruptcy Code that describes them.  The most commonly used chapters are Chapter 7, Chapter 11, and Chapter13 filings.

A filing under Chapter 7 is called a liquidation proceeding in which the debtor’s non-exempt assets, if any, are sold by the Trustee, with the proceeds being distributed to creditors according to the priorities established by law. In many Chapter 7 bankruptcy cases involving liquidation of property, there is little or no money available from the debtor’s estate to pay creditors. As a result, in these cases, there are few issues or disputes and the debtor is normally granted a “discharge” of most debts without objection. This means that the debtor will no longer be personally liable for repaying the debts.

Chapter 11 is a reorganization proceeding, typically for businesses, where the debtor remains in possession of the business assets and continues to operate the business subject to the oversight of the Court and the creditors’ committee.

Chapter 13 (sometimes called a wage earner plan) is an adjustment of debt of individuals who have regular income, both current and future, that repays creditors over time through a Court approved debt management plan.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made major changes to the Code restricting the availability of discharge for Chapter 7 and substantially reducing debt relief available for Chapter 13. In addition, the Act imposed more stringent eligibility requirements for those individuals considering bankruptcy and requires approved credit counseling before they can file. Under the new Act the position of landlords and other creditors is improved over the previous Code provisions.
A key change affects the procedures landlords must follow when dealing with a tenant who has filed for bankruptcy. The Bankruptcy Code protects the existing tenant from discrimination based solely on the fact that the tenant filed bankruptcy.  Landlords cannot legally terminate a tenancy solely because the tenant is a debtor in a bankruptcy proceeding. This is not the same thing as the tenant being protected from discriminatory treatment based on the tenant’s financial history. It is simply the tenant’s right to deal with financial troubles through bankruptcy that is protected under bankruptcy law.
Why would a landlord want to reject an applicant who has filed for bankruptcy? The primary reason is financial. While recognizing that bankruptcy is a legal right allowing relief from certain debts, a landlord wants a tenant who has a satisfactory history of credit management. Specifically, the landlord wants a tenant who has the ability and willingness to pay rent. A bankruptcy filing indicates the applicant was unable to meet his financial obligations during a certain period.  The underlying event necessitating bankruptcy may have compromised the applicant’s ability to meet future financial obligations. The landlord may not want to take a chance.
However, many landlords set financial criterion that allows some flexibility in evaluating bankruptcy filings.  Bankruptcy filing is a voluntary measure that seeks to remedy a bad situation that is not always an indication of irresponsible money management. Job loss and/or major medical expenses can quickly change the financial picture of any individual. Bankruptcy filing may well be a positive step to regaining financial stability. If the applicant is otherwise qualified according to your standards you may wish to consider the overall picture and assess your risk accordingly.
You might give greater importance to the applicant’s credit management history since the bankruptcy filing. If the applicant is nearing the end of the record period, and the bankruptcy has been fully discharged, while still taking the bankruptcy into account, you may focus on the most recent year period of credit history (for instance, the last three or four years). You will take into consideration how long ago the bankruptcy was filed, the applicant’s current source and stability of income, and the amount of outstanding debt to help you determine your risk.

You may elect to offer tenancy based on acceptance of conditions such as a co-signer or guarantor, a higher security deposit (as allowable by state statute), or a shorter-term lease. You are still bound by fair housing laws and cannot discriminate by selectively offering different terms to different applicants.

There is another consideration in that, assuming an applicant has adequate income, he should be more credit worthy after a bankruptcy than before. First, discharged old debts will no longer have a claim on future income. Second, bankruptcy cannot be filed again for a number of years.

You can set your qualifying requirements as high as desired regarding financial criteria. In practice, however, you should not set standards so high that you never find anyone meeting those standards. The important issue for landlords is
to establish selection criteria that make good business sense and to evaluate every applicant against those standards without discrimination.

Q1

I closed on a rental home in Tucson, AZ a month ago which had a tenant whose lease has over 6 months remaining. The rent is due in a few days, but the tenant provided a “Notice to Terminate Lease” in 30 days. Her basis for termination is that the rental agreement does not address a transfer of ownership and so she has the right to break the lease without paying the break lease fees.

My research did not find anything supporting her position. Am I correct that the tenant must abide by the rental agreement until it expires?

A1

Change of ownership does not affect a lease agreement in any way unless stated otherwise in the document. The tenant cannot use the sale as an excuse to break the lease or to avoid adhering to any terms contained in the lease agreement.

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Q2

An applicant’s application information checks out except for one thing. The prior address listed on application does not appear on PALS results. In fact, for the period of time the applicant states he was living at a particular address, PALS comes up with a different state for that same time. Plus, the report shows two different DOBs, although they are close.

A2

The first thing that I’d do is ask the applicant if there is a reason for the address difference without giving the address except perhaps the state to see if he/she comes up with the address in that state in agreement with that from PALS. There can be many valid reasons why addresses disagree. I myself have at times had several different addresses that I used for various purposes at the same time, sometimes among several states, all legitimate.

Regarding the date of birth, have you not copied his driver license? If his driver license agrees with his application, there may be an error in PALS. Does the credit report agree with the PALS report? One must remember that different grantors of credit report at different times and do not all update records at the same time.

Incorrect digits (e.g., a 5 instead of 6), transposition of digits (e.g., 47 instead of 74), and a variety of other data entry errors are common. Also, dates sometimes end up in error because there are defaults in the system. For example, if only the month and year can be entered without the day of the month for a particular system and someone enters 5/25/64 as only 5/64, the system may default to 5/01/64.

Finally, one must remember that there are a number of workers in the credit reporting system, from creditor to reporting agency, most being low-paid employees, so there will be errors. Usually, most are not significant, so no one bothers to correct them. When using any type of screening report, one must be alert for discrepancies, but one must also attempt to resolve them and then decide which of any unresolved ones are important.

Again, when you don’t understand something about an applicant, simply ask.

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Q3

I had an applicant whose previous addresses did not match their online reports, and the ‘landlord’ they gave as a reference was not listed as the owner of the addresses, etc. In questioning this I asked to see their driver licenses (not provided with the application) and last tax return (to verify income and address). They decided not to rent the property. Do I still need to send a notice of denial?

A3

Legally, you may not need to send anything. First, as I understand it, they withdrew their application. Second, if you did in fact indicate denial, it was based on identity and previous landlord issues rather than related to a credit report. However, you did utilize reports and you would buy a lot of protection against claims by sending a letter “confirming” that they had withdrawn their application because they were unwilling to provide information necessary to resolve discrepancies in information provided to you.

This type of problem and a lot of wasted time can be better avoided by requiring proof of identity when the application is submitted. I recommend that two ID documents be provided, with one being a government photo ID such as a valid driver license, military ID, or passport and the other being another photo ID or a SS card, motor vehicle title or registration, or a valid credit card. Make copies of ID documents and don’t accept an application without doing so.

You did right in verifying ownership of previous address property.

I recommend that landlords attach a document to each application form handed out that states exactly what is expected and what checks will be made for every applicant in order to avoid wasted time and expense for all parties concerned. It doesn’t hurt to include a fair amount of detail regarding what will be done as part of the screening processes including that verification of identity, ownership of previous rentals, and exactly which screening reports will be obtained. Also state that the application will be automatically rejected if not fully completed or if discrepancies found are not resolved to your satisfaction.

The bottom line is that the more written advance information provided to potential applicants, the fewer potential “bad” tenants will submit an application, the less wasted time you will spend on filling vacancies, and the less risk there will be of Fair Housing or FCRA claims.

Expenditures – Part 4 –Travel Away From Home

In previous installments of our series regarding expenditures we discussed some basic principles regarding expenditures including “travel expenses related to the property or management thereof.”  The most recent article concerned local travel. In this article we will discuss another issue regarding travel, specifically expenses related to travel away from home.

The IRS says you are traveling away from home if:

• Your duties require you to be away from the general area of your tax home (as defined) substantially longer than an ordinary day’s work, and
• You need to sleep or rest to meet the demands of your work while away from  home.

To determine if you are traveling away from home, you must first determine the location of your tax home using criteria specified by the IRS. Generally, your tax home is your regular place of business no matter where you maintain your family home.

As stated in a previous article of this series, you can deduct the ordinary and necessary expenses of traveling if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. In review, an ordinary expense is one that is common and accepted in your industry and a necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. For a landlord, such travel may be necessary for a number of reasons including:

• To attend out-of-area education related to your business,
• To purchase equipment or materials related to your business that are not  locally available or can be purchased elsewhere at a lower enough price that the travel time and expense are justified, or
• To check on rental properties are that are located in a distant location.  Even when a property management company takes care of day-to-day management for a distant property, the owner should put in occasional appearances at the distant property in order to inspect the property and to meet with management company personnel.

As also previously stated, you must properly allocate your expenses between business and personal activities. This is particularly important when traveling out of the area of your residence, when landlords would sometimes like to be
accompanied by family members or engage in personal activities during the travel.

If a spouse or other family member or another individual accompanies you on a business trip you generally cannot deduct his or her travel expenses. However, when a husband and wife travel together, the expenses of both will be
deductible as long as both spouses materially participate in operation of the business and both participate in business being conducted on the specific trip.  However, when one spouse does not usually otherwise materially participate in
the business or does not participate in the business related to the specific trip, the IRS does not allow deduction of all expenses related to the non-participant spouse.

If an employee or business associate accompanies you, you can deduct the cost if the person (1) has a bona fide business purpose for the travel and (2) would otherwise be allowed to deduct the travel expense

When  landlords utilize their personal automobiles for out-of-area travel, they need to follow the same procedures as when using them for local travel that were discussed in Part 3 of this series. The most important items are maintaining a mileage log and retaining receipts related to the trip. It is also highly recommended that an extemporaneous record be maintained for all aspects of the trip, including both those directly related to the business purpose of the trip and those that were used to fill in between business activities. The latter may be attending an evening movie, browsing in the local mall, or other activity used to fill otherwise wasted time. The government does not expect a travelling business person to spend all waking hours attending to business, so attending an evening movie after a day of conducting business should not affect the deductibility of the day’s expenditures (other than the movie cost).

Even one or more non-business days sandwiched between two business days will not necessarily prohibit one from deducting all expenses of the trip. For example, when business is done prior to a weekend and again following the weekend, the lodging expenses related to the weekend days will usually be fully deductible.  However, if one day is spent doing business, a week is spent visiting nearby relatives or participating in some other activities not related to the business,
and another day is spent doing business, expenses related to the week of personal activities are generally not deductible unless there are special reasons that justify the schedule.

If one drove a vehicle a distance of two days drive away for a particular meeting and needed to meet with the same or another party in the same area a week later or along the way at a location still a significant distance from home, it could
probably be justified that it was more reasonable, perhaps even significantly less costly to make a side trip during the week between meetings rather than return home and make a separate trip.

If you have one expense that includes another expense that is treated differently tax-wise, you must separate expenses. For example, only 50 percent of meals and entertainment expenditures are deductable, so if the hotel includes one or more meals in the room charge you must allocate the cost between meals and lodging, doing so in a reasonable way.

If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can only deduct the business-related travel expenses,
but this can usually include the total cost of transportation to and from the location where business was transacted and all expenses directly related to the business portion of the trip.

A trip to a resort or on a cruise ship may be considered a personal trip even though the promoter advertises it to be primarily for business. The scheduling of incidental business-related activities during the trip, such as viewing videos
or attending lectures on general business subjects, will not change what is really a vacation into a business trip. We will discuss the specific case of educational cruise travel in a future article.

If you travel outside the United States and spend the entire time on business activities, you can deduct all of your travel expenses. If you do not spend your entire time on business activities, it becomes more complicated and the part of
the costs that will be deductible depends on a number of factors. There are also special rules related to travel outside the North American area, with this area being specifically defined. Further discussion of travel outside the United States
is beyond the scope of this article.

This article has covered certain basic issues related to business travel away from home. Considerably more detail regarding the covered issues and discussions of still other issues related to travel away from home can be found in IRS Publication 463.