January 25, 2010

Rental #3 - The out of state property manager horror story

Before we were married my wife lived on the East coast for a few years during college and afterwards.   Eventually she decided to move here to the West coast.  She owned a house on the East coast at the time and decided to keep it as a rental after moving here.

My wife bought her East coast home about 7 years ago.  She bought it a few years before the real estate bubble burst.   I'm going to take the more conservative view that the house is at the lower end of its value range on Zillow which would mean the value is about equal to the mortgage balance so we've got 0% equity right now.   It could be worth a bit more than that if you take Zillows high end so best case we might have 10-20% equity.   The house has not appreciated much if at all.

We are currently renting the property for a little less than the mortgage payments.   We also pay a property manager 7% of the rent to manage it.  We're losing money every month which is not a good thing.    The negative cash flow isn't substantial but any negative amount isn't good.  If you add in the tax deduction impact and the principal payments on the loan we're actually coming out a little ahead.  But I generally wouldn't recommend buying a rental that has a negative cash flow.  

Note this story started before I met my wife and then continued through when we were engaged and proceeds now after we've been married.   I'm not sure of the exact chronology about what things happened before or after we met or were married.  So my references to my wife or we are mixed up here its cause I don't know which points I was more or less involved. Sorry if its confusing.


The property manager nightmare

When people think of buying rental property they often decide that hiring a property manager is the easy way to avoid doing much work.  That is a good idea in general as long as the costs work out, but you are very dependent on the property managers abilities and trustworthiness to make your rental a success.   Unfortunately one property manager my wife eventually ended up with was not trustworthy at all. 

When my wife originally decided to rent the home she did the research and found a good property manager and signed her up.   Everything worked great with that first property manager until she abruptly decided to leave the business.   My wife was then left scrambling to find another property manager form the other side of the country.  My wife hired another property manager that the first property manager referred her to.  It turns out the second manager was just someone the first manager "heard of" not a trusted peer.   That very important detail wasn't clear at the time.

The second manager was OK but she generally didn't answer the phone but instead called back after you left a message (red flag).   Things were fine for a while until the tenants moved out.   That is when the second manager started to show how bad they were.  She failed to get work done when she said she would (red flag).  It took two or three months to get the home cleaned up and it sat vacant that whole time.  (red flag)  Thats one or two months longer than it should take and thats lost rental income out of our pocket.   Furthermore they did not give us real receipts or invoices direct from contractors for work they said was done  but instead only gave an invoices they created (red flag) so in hindsight we don't even know if the work was really done or if they just pocketed the money.  That may sound cynical but just keep reading.

After 2-3 months of inaction and run around by the manager my wife gave up and decided she couldn't keep paying a mortgage without rent coming in.  So she called some realtors and decided to just sell the property. As soon as the manager found out my wife wanted to sell the home they ran out and found a tenant.  Its remarkable that they couldn't find someone for 2-3 months then magically rented it in a day or two.   (red flag)  Now that the property was rented the pressure was off and the rent coming in would pay the mortgage (mostly).    At this point it seemed as far as we really knew the manager had not done anything worse than been too slow to find a tenant.   That isn't necessarily something you fire someone for on the first offense and its hard to say if that kind of thing is the managers fault entirely or not.   My wife decided to hang on to the property at this point.   There wasn't a clearcut case for firing the manager plus selling the home from 3000 miles away would have been pretty difficult to manage.

Less than a year went by and the property manager failed to get us the rent payment a couple weeks into the month.   The manager claimed to be having some personal financial problems (giant red blinking neon flag) but they said they would fix it soon.  I think this is the point that the red flags added up and it really sunk in that the property manager was not capable or trustworthy.  So my wife waited and called and called.  They didn't answer the phone nor return calls much and when she did get ahold of the manager she gave assurance they'd send the money soon.  The old "check is in the mail" routine.  Then next month came around and we were now owed two months rent by the manager.   My wife found out the renters had in fact paid the manager the rent but the manager then apparently spent it or simply pocketed it.   The manager stopped returning calls.   So at this point we hired a new manager to immediately take control of the property.  In hind sight we should have fired the bad manager much earlier but the extent of the problems weren't clear.

The problems created by the bad manager didn't end after we fired her.   The tenant they rented the house to was not a great tenant.  They mostly paid their rent on time but they did a fair amount of damage and we didn't have a copy of a lease or a security deposit.   When that tenant left about a year later there was significant damage and repairs needed that ended up costing us several thousands.  Its not clear when the damage was done.  It might have been problems that occurred during previous tenants under the bad managers management.   But either way the bad manager either rented the unit to tenants who did a lot of damage or failed to properly repair earlier damages.

Our current manager has done a great job and we're very happy with her.  The property has actually had three managers now and two of them have done a great job.   I would assume that the majority of property managers will do a decent job and that the chances of having a property manager basically steal money from you is not likely.   But it only takes 1 bad apple to ruin it for you.

The red flags probably should have added up

I noted a lot of red flags above.   At the time some of these weren't obvious or they gave us excuses that we bought.  Maybe we should have acted much sooner to fire that manager but its hard to know when someone is just a little slow or makes an excusable mistake.   It can take a little while for all the red flags to add up.   We hadn't dealt with a bad property manager before.   If we encounter problems with a manager again then we'll be better able to spot the red flags as they happen instead of recognizing them in hindsight.

No effective legal recourse



My wife investigated taking some sort of legal action against the property manager but given the amount of money owed it wasn't practical.  Generally the main option in this situation would be small claims court and you have to do that locally which would mean flying across the country.  We figured we'd win the case but thats no guarantee we'd get any money, as far as we know the manager is bankrupt or has since moved out of state.  Local law enforcement in that area were no help.

Out of State Rentals are harder

If this rental was local then we wouldn't have needed a property manager at all.   Or if we did hire a property manager for a local rental then we'd have a much easier time keeping an eye on things.   Worst case if a local property manager ripped us off then we'd have a much easier time taking legal action locally via small claims court or local legal system.    I wouldn't recommend doing an out of state rental investment unless you have a very trustworthy person to manage it for you.   This is not to say an out of state rental can't be a success but the horror story above can and does happen so make sure you trust your property manager.


Be Thorough When Screening Property Managers

You should be careful when hiring a property manager.  This person is going to be your employee in a way.  You'll be trusting them with your money and giving them power to get work done.   Get references and check up on them.  Interview them like you're hiring an employee.  When you have hired a manager make sure you get before and after pictures as well as receipts for everything.  

To sell or not to sell?

Since the rental has a negative cash flow and the problems we have had it would seem like we should sell it.  We've thought about selling the house more than once.   But after the real estate bust selling a property wasn't exactly easy.   If we sold it now we'd have to pay a realtor commission and end up losing several thousand dollars out of pocket in the deal just to offload the property.   Our expectation (hope) has been that the property would go up in value within a few years so if we could hang on to it for a while it would be in a better position to sell it.  However we didn't expect to have to pump several thousand dollars into repairs the past year either.   It may very well be a mistake for us to hold on to the property, but hopefully the market will turn around and we can recover our costs.   Honestly I am torn about this and I don't know if we should cut our losses now and sell it at a lost or if we should hang on a few years and wait for it to recover value.

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