You bought your first rental property. That’s great news.
But what keeps you up at night? Are you worried about something happening that might cause you to lose or be forced to sell your rental property?
There is also the question of personal liability. Does the operation of your rental property create risk for your personal property or assets?
You can do several things to ensure you don’t suffer a major catastrophe. Some of these set up legal protections for you while others are best practices to keep your rental property running profitably.
Of course, you can’t entirely prevent a fire from destroying your rental property, but you can ensure you don’t suffer major financial losses.
Let’s take a look at 8 different ways you can protect yourself and your rental properties.
Set Up An LLC
The first step to ensuring separation between your rental business assets and your personal assets is to create an entity for the business. This can take many forms, but an LLC is the most common.
Considering that maintaining an LLC costs about $100 per year, it is one of the least expensive forms of protection you can buy.
An LLC protects you because the LLC holds the liability of the rental property. This means, for instance, if someone is injured on the rental property you cannot be personally held liable for their medical bills. Instead, only the assets of the LLC are vulnerable.
The LLC protection, however, is not bulletproof. You need to be diligent about operating your business as a separate entity. If there is a perception of a lack of separation, you can still be personally liable along with your business.
We recommend the following actions to best keep the protection an LLC affords.
- Open separate financial accounts for your rental property business
- Do NOT make personal transactions in your business accounts
- Do NOT make business transactions in your personal accounts
- Sign contracts as an agent of the LLC rather than as yourself
If you own multiple rental properties, LLCs can also provide protection between your properties. You should consider setting up an LLC for each individual rental property. This will protect all of your other properties (and the assets within those LLCs) in the event something bad happens to one.
Purchase Insurance
Your rental property is a real asset that you can’t afford to lose. You need to insure it.
Rental Property Insurance or Landlord Insurance is designed to protect your property in the case of peril. If your property is damaged or destroyed, a rental property insurance policy can reimburse you for your loss.
In addition to covering the physical property, rental property insurance provides you with liability coverage. This covers you in the case your renter or a guest injures themselves on your rental property.
Rental property insurance policies offer different levels of coverage. You should review the specific coverage terms for any policy you are considering. The following questions can help you decide what coverage is right for you.
- What perils or disasters does the policy cover?
- Are regional natural disasters (tornado, hurricane, earthquake, etc.) covered by the policy, or is an endorsement necessary?
- Does the policy reimburse you based on a replacement basis or an actual value basis (which factors in depreciation to reduce the payout)?
- Is vandalism or damage from aggrieved tenants covered by the policy?
- Does the policy include coverage for lost rental income?
- What is the liability coverage limit?
Rental property insurance provides coverage for most of your needs but can fall short when it comes to liability coverage. Depending on the amount of liability coverage offered by your rental property insurance, you should consider additional Landlord Liability Insurance (sometimes called Business Liability Insurance or Umbrella Insurance).
Landlord Liability Insurance adds coverage for personal injury that occurs on the premises due to a negligent action on your part. This can be due to a hazard that you did not fix promptly or simply failing to inform your renters about a hazard.
If someone sued you due to an injury, your liability insurance will cover the legal costs as well as the actual cost of settlement within the policy limits.
Get a Lawyer
A good lawyer is a key member of your real estate investment team.
The first thing a lawyer can do for you is set up your rental property business as an LLC. While you can do this yourself, a lawyer will make sure everything is filed properly and correctly.
If you are investing as a sole proprietor, the LLC is simple to set up. But if you invest with other partners or syndicate a deal, it gets more complicated. In this case, the peace of mind that comes with a lawyer filing the paperwork is well worth the cost.
Beyond setting up the LLC, a lawyer can create or review all legal forms you need in your rental property business. This includes rental agreements and addendums as well as other contractual agreements.
Finally, if you are sued, you will have a lawyer to represent you. And your lawyer will already be familiar with your business and be able to better represent you.
Focus On Positive Cash Flow
What is the best way to ensure you never have to sell your rental property? Making positive cash flow.
If your rental property is turning a profit, it will sustain itself. You never have to worry about investing additional money just to keep the asset. Ensuring sufficient cash flow can also cover any vacancies or repairs.
Creating positive cash flow starts before you purchase the rental property. You need to do your homework when evaluating the returns from the rental business. Have your property manager help you determine realistic rental income. And be sure to account for ongoing maintenance, vacancies, and repairs in your expenses.
It is best to be overly cautious with your expectations for your rental income. If not, you run the risk of having to continually put more money into your investment. Wouldn’t it be best if you were confident your asset will produce income for you?
Address Maintenance Issues Promptly
The easiest way to lose a lot of money is to get sued. Keeping up with the maintenance of your rental property reduces potential hazards and drastically reduces your chance of being sued. The faster you address hazards on your property, the less chance someone can get injured.
If you can’t address a hazard immediately, be sure you post sufficient warnings and try to prevent access to the hazard. Rope off a section of the sidewalk if necessary. You don’t want to appear negligent in your handling of a hazard.
In addition to preventing injury, maintaining your rental property will attract and keep tenants longer. You will reduce vacancies and turnover. Renters want to live in a nice, well-kept property.
Have Well Defined Processes
You don’t want to be accused of rental discrimination. The penalties can be in the tens of thousands of dollars.
If you establish and stick to your processes, you can easily defend yourself in court. Showing fair and equal treatment of all current and prospective tenants is your best defense.
You should have the following processes defined for your rental property business.
- Application and screening
- Handling late payments
- Evictions
- Repairs and maintenance requested by tenants
- Handling emergencies
- Regular inspections
As long as you document, clearly communicate, and enforce these equally for all tenants, you can defend yourself against a discrimination case.
Screen Your Tenants
How do you reduce your problems as a landlord? High-quality tenants. You want to have tenants that can pay rent on time and don’t attract problems.
You should have a stringent set of requirements for rental eligibility. And you should apply it fairly to prospective tenants. Do a background check with every rental application to verify employment and check for any criminal activities.
Your rental eligibility should include the following requirements.
- Monthly income (typically a multiple of rent)
- Verifiable employment, and solid work history
- Solid rental history
- Specific exclusions for criminal activities
- References for employment and previous landlords
- Specific exclusions for pets or breeds
If a prospective tenant doesn’t meet all of these requirements, you can follow up with their references to get clarity. This is particularly useful for tenants with short employment or rental histories.
Use Quality Contractors
Always use licensed, bonded, and insured contractors.
Thinking of doing the work yourself? You may be good at handling many repairs or remodeling tasks, but you assume the liability for the quality of the work.
It may also be tempting to have your brother-in-law fix the stairs to your rental property, but what if his work is sub-par? What if he gets injured when doing the repairs?
With licensed, bonded, and insured contractors, you don’t have to worry about any of these scenarios. The contractors assume the liability from the quality of their work and are insured in the case of injury.
Before signing any contracts, you should ask for references and examples of the contractor’s work. You want to know you are getting what you pay for before the work is done.
Summary
Protecting your rental property is an important part of your business. A plethora of perils awaits if you haven’t taken action to protect your business and your investment. But a few key steps can ensure you don’t suffer a major financial hardship.
You need to insure yourself against disaster and limit the liability to your business and yourself. You will sleep better if you take these steps to protecting your investment.
If you didn’t start your rental journey with these protections in mind, it is never too late to take action.
What steps do you take to protect your rental property?