There are two ways to make money real estate investing. One is appreciation in the value of the property. The other is cash flow.
Cash flow must be reliable, because you need to for the mortgage, to finance another deal, or for living expenses. It’s particularly important for smaller investors or owners of single family.
If you’re feeling a cash flow crunch, chances are it’s because rents aren’t coming in on time. Why is that? There’s one likely culprit: your rental property management’s late fees policy.
In other industries, late fees are a profit center. But the same is not always true in rental investments.
Believe it or not, late rent fees are cash flow killers. These policies actually train your tenants to pay late
Late Fees Are Limited
Late fees in residential lease agreements are strangled by regulation. In the U.S. in particular, landlord tenant law prohibits landlords from charging what amounts to a penalty — which is basically any amount that serves as an incentive for the tenants to pay on time. The average allowable late fee runs about $35-$50, maybe a little higher with luxury rentals. If the fee is excessive, a judge won’t enforce it.
By its very definition, the fee collected can only cover the anticipated out-of-pocket losses the landlord faces. That includes things like penalties on the mortgage or maybe the time the property management company spends chasing the tenant down.
You won’t get any compensation for all the hair pulling and nail biting that you go through when you review your cash flow statement.
And, there’s no rolling one month’s late fee into the next month, in order to charge another fee if the first one isn’t paid.
If you’ve ever heard your rental property management company boast about using late fees as a profit center, smack them over the head, because that’s illegal!
Grace Periods Encourage Late Payment
This cash flow problem is compounded by the fact that a late fees policy forces the manager to set a date when rent is technically — legally — late. In the U.S., that “grace” period is typically five days. There’s one day when the rent is due; there’s another for when it’s really due.
When tenants see that in the lease agreement, some see it as an invitation to a free or low-cost revolving line of credit. They’ll weigh the options. Why not float the rent money and stretch the budget a little with a weekend holiday, or maybe pay the cellphone bill?
Before tenants know it, they are scrambling to get that rent check in by the 4th of the month. When they do, there are really no consequences, because the late fees didn’t kick in. The more times tenants run the scam, the easier it is to fall over the cliff and pay later and later into the month. When they do, they pay their dues, the $35 or $50 late fee, and then kick back and enjoy those latest weekend vacation photos.
A False Sense of Security is DANGEROUS!
A late fee policy creates a false sense of security. When your rental property management is relying largely on a strict late fees policy, they aren’t doing what they need to do to effectively collect rents on time.
Here’s what your rental property management company should be doing to protect your business cash flow:
Your manager should be choosing better tenants. Late-payers repeat the pattern with frustrating persistence. Your manager can spot this pattern easily. It’ll show up in the credit check, or they’ll find out about if from the last landlord. Your manager should be shoring up your real estate investing profits, not banking it all on a bet that the tenant won’t want to pay a measly late fee.
Just like in other business models, offering every reasonable method of payment protects cash flow. Your management company should make it easy for tenants to pay with digital methods like credit cards, e-checks and automatic withdrawal options. They should also avoid making payments a pain, like demanding money orders that require the tenant to make a trip to the bank or grocery store. The more obstacles to payment, the more ridiculous the excuses for not paying rent on time.
Everyone expects to get a bill for services they owe. Invoicing a tenant ten days before the rent is due encourages on-time rent payments, and keeps the rent roll strong.
Rather than seeing late fees as a profit vehicle, your manager needs to maintain a low tolerance for late-payers. It’s surprising how often you hear about chronic late payers — tenants who have paid late six out of twelve months, for example. You hear stories of tenants who pay late so often, they get a full month behind with rent. Why is this person still a tenant?
When there’s no fear of consequences like eviction, there’s little reason to pay on time. Give someone an inch, they’ll take a mile. In this case, your rental property management is actually training your tenants to pay late. But that’s too risky a real estate investing strategy. There’s too strong a correlation between tenants who pay late and tenants who skip out, break rules, or trash the rental property. That will, no doubt, cause a cash flow crisis.