Renting to Strangers: How to Become a Spy, Lawyer, and Private Investigator

As banks foreclose on more properties, more Americans are finding themselves in a position to rent a dwelling rather than buy one.  And as homeowners move and are unable to sell their homes for a reasonable price, we're seeing a proportionate increase in the supply of rental properties.  If you're upside down on your home and need to move (a previous topic on this site), I've always recommended renting your home for whatever you can get for it.  Or if you just bought your first investment property, you, too may be searching for that perfect tenant. But being a landlord is not for everyone.  So before you put pen to paper, consider some of these points to prevent some headaches that are often associated with renting to strangers.

Become a Spy

My parents have been landlords for two rental properties that are adjacent to their primary residence.  For them, having their tenants as a neighbors has improved their relationship with the renters while enabling them to keep a close eye on the homes.  When you rent to strangers, you usually don't know much about their lifestyle.  They may drink, smoke, have destructive pets, throw wild parties, or bury human bodies in their spare time.  Unless you have some view into who and what is going in and out the front door on a regular basis, you could very well find yourself with a tricky situation.  In hindsight, I can't imagine how quickly I would have been kicked out of my college apartment if my landlord (or parents, for that matter) saw the terrible, evil debaucheries that we commited on a daily basis...

If you are renting out a home that's located in a place that you can't regularly visit or at least drive by, consider hiring a property manager -- you may well save yourself time and money in the long run.  If you're still close with your neighbors, they can work as great accomplices in your spying operations, too.  You certainly need to give them their privacy, but your home is too valuable to be trusted to an unknown, unsupervised tenant with nothing to lose but their $1,000 security deposit.  So if you don't live nearby, make sure that you have either a trusted neighbor or a hired property manager to check in on the place every now and again.

Become a Lawyer

When my wife and I first moved to Wilmington, we rented a house on the southeast side of downtown.  After living in the home for a few months, we realized that we were in a somewhat tough neighborhood and were turned off by the fact that someone had come onto our property twice to steal something.  Eight months into our lease, we bought a house.

We contacted our landlord to see how we could legally break our lease.  However, she had protected herself when she had us sign a bulletproof lease which gave her unlimited power during our negotiations.  We asked her if there was any way we could move out and pay a penalty or forfeit our security deposit.  Nope.  We offered to pay the finder's fee for a new tenant.  Nope.  As unreasonable as we thought she was, she was able to show us, line-by-line, the language in our lease that prevented us from moving out before its termination date.  There was nothing we could do.  She had successfully protected herself from the likes of Scott and Michelle Bliss and she ended up receiving every penny of rent that was due until our termination date.  Phew -- I'm glad those days are over.

She had language in the lease that was so detailed, it discussed who would pay the legal fees if we had a dispute in court.  It detailed how many people could occupy the property and how many nights our guests would stay.  It nitpicked over the maximum allowable weight of our dog and what constituted a proper cleaning when we left.  It had warnings and legalese and penalties regarding any possible risk that could ever arise.  And as stuffy and annoying as it was, it protected our landlord from losing any money in the event that we wanted to move out early.  Though you should certainly be a reasonable human being with your tenants, you should always do as our old landlord did and allow yourself to be as nice (or not nice) as you wish by protecting yourself on paper.  If you're ever at war with a tenant, it will serve as your coat of armor; and the heavier it is, the more protected you will be.  Pay the money and get yourself a professionally prepared lease that is fair and resilient.

Become a Private Investigator

Most of the time, tenants are honest, hard-working people that pay their bills on time and will treat your home as they would treat their own.  And sometimes, they're unemployed, broke, transient, dirty liars that will tell you anything that will convince you to rent to them, upon which time they'll take you for a wild ride that would make even Mr. Toad wet his pants.  Consider this short story:

When we were trying to legally break our lease, our landlord told us that we could only get out of our last four months' rent if we found another qualified tenant that would be willing to sign a new one-year lease at a higher monthly rate.  So we started our search.  We had applications coming in left and right, but every vagrant that applied had some sort of complicated story that received two thumbs down from our landlord.  And then we met "Alex."  Alex had no pets and a documented steady income.  He was well-dressed, well-spoken, and ready to put down the full security deposit and first month's rent.  But when I called his most recent landlord as a reference, here's the story I got:

Apparently, Alex destroyed the rented house with a combination of wild parties and equally wild live-in beast that was once classified as a dog by a clearly inexperienced vet.  Surprised, I asked why Alex would have given the landlord's name as a reference if he had demolished the home; the answer made the story a bit juicier.  It turns out that Alex didn't pay his rent for a few months and owed the landlord a couple of thousand dollars by the time he was evicted.  Alex said that he would only pay the money if the landlord swore to give him a good reference.  He agreed and Alex paid his money, but, as I was figuring out, the landlord wasn't keeping his word.  Naturally, Alex never rented our house.

So while it's true that most would-be tenants are fully capable and willing when it comes to their rent payments, you need to remember that there are still a few axe murderers out there.  As long as you are renting to a stranger, make sure that you verify -- and double-verify -- your prospective tenants' income, credit history, and references.  Unless you play the part of a private investigator, you're setting yourself up to get screwed.  If you're renting a home for money and not running a charity, you have to verify an applicant's information before signing anything, no matter what anecdotal self-victimizing story he or she gives you.  The minute that you accept to a sob story in lieu of three months' worth of pay stubs is the minute that you hand your house keys the Tasmanian Devil inside.  Check out E-Renter.com: it will probably prove to be $35 well spent.

I welcome any previous landlords to share their tenant horror stories to help encourage their fellow readers to become a spy, lawyer, and private investigator.

Liquidity: The Apples and Oranges of Your Financial Health

It's important to periodically assess your personal financial health. I enjoy using a free tool, NetWorthIQ, to determine my overall net worth. Essentially, the tool works by applying generally accepted accounting principles to your accounts, summing all of your assets and subtracting all of your debts to produce your net worth. It's just like high school accounting where Assets minus Liabilities equals Owner's Equity. Though this tool is useful for numerically and graphically tracking progress from month to month, it can't be interpreted as a realistic assessment of your financial health. Here's why:

All of your assets and liabilities aren't quite as simple as apples and oranges. Some liabilities have tax advantages and disadvantages, and some assets have costs associated with turning them into cash. For example, a student loan and an auto loan may look similar on paper if they have a similar balance and interest rate, but the interest paid on a student loan is tax deductible. $10,000 in a 401(k) and $10,000 in a RothIRA may seem equal, but the Roth money will never be taxed while the 401(k) will be once it's withdrawn.

So when you're determining your financial health, it's important to figure out not just your net worth, but also your liquidity. Liquidity is essentially your ability to turn your assets into cash. I'm sorry to say that these dorky financial terms don't just apply to corporations and accountants -- they apply to you. Think I'm full of it? Consider this:

Some friends of mine bought a house a few years ago for $190,000 and got a zero-down loan. Today, they owe about $187,500 on the place. After a recent life change, they need to move to a different state. Though their house is listed for several thousand dollars more than they paid and now owe, they're still worried about being able to afford to move. According to Zillow, their home's value exceeds what they owe by about $20,000. But when calculating their liquidity, they need to take into account the likely sale amount and their real estate agent's commission, which happens to be an exceptionally low four and a half percent.

Yesterday, a potential buyer offered $195,000 -- $6,500 more than what they owe. But in order to not lose any money, they'll need to sell the house for at least $196,355. The current offer leaves them bringing $1,300 cash to the table at the time of sale. Sure, they could counter offer, but who's to say that they'd ever get a higher offer?

I'm a big proponent of bean counting. It's an important step in the road to wealth. But when you decide to count your money, be sure to do a second analysis that considers only the liquid value of your assets. Obviously, cash is completely liquid. But when considering at your home's value, use a pessimistic market value (depending on how quickly you need to sell) and subtract whatever you would expect to pay a real estate agent. When considering the value of your retirement savings, subtract any taxes and penalties you would need to pay as well as any non-vested employer contributions. When calculating the value of your vehicles and personal property, think about how much cash you would realistically receive for them from a sale.

You'll probably find that your liquid assets are much smaller than your total assets. Though it might not be fun to look at, it's an important truth factor that speaks wonders about your genuine financial wellbeing.