Real estate investing is a great way to increase net worth, build generational wealth, and create cash flow.
But getting good tenants is the Achilles’ heel of buy-and-hold investing.
We’ve seen windows broken, driveways destroyed, and investments lost because of bad tenants.
All real estate investments have inherint risk, but the story is usually the same — the investor accepted the tenant too quickly and with too little screening process.
In this guide, we’ll show you how to screen your tenants so you don’t get duped.
But first, allow us to explain why the screening process is so important.
Why You Should Wait For Good Tenants
Holding costs aren’t cheap.
The longer a property sits unoccupied, the more mortgage, tax, and utility you have to cough up.
But you know what’s more expensive?
Letting bad tenants live in your house.
Check out the video below to see how tenants wreaked havoc on one investor’s driveway and refused to pay the bill…
This is a lesson most landlords only learn once.
They either research how to properly screen their tenants so that something like this never happens again. Or they quit real estate investing altogether, believing they’re not cut out for dealing with the risks involved.
But the truth is less dramatic.
Finding good tenants for your properties isn’t about your own competence or a lack there of. It’s just about creating processes and systems that practically guarantee you find good tenants for all of your properties.
And it’s about having the patience to not accept tenants who fall short of your minimum criteria (even if it means paying holding costs for another month).
Let’s talk about how to create just those sort of processes and systems.
Step 1. Understand Fair Housing Laws
The last thing you want is legal trouble.
So before you start rethinking your tenant screening process, make sure you fully understand what the law requires.
The most important laws to be aware of are called “Fair Housing Laws” or “The Fair Housing Act”, which law-makers created in 1968 and forbids discrimination on the part of landlords when screening tenants for any of the following…
- National Origin
- Sex (including gender identity and sexual orientation)
- Familial Status
Here are some actions, for instance, that the law states as being discriminatory…
- Refuse to rent or sell housing
- Refuse to negotiate for housing
- Otherwise make housing unavailable
- Set different terms, conditions or privileges for sale or rental of a dwelling
- Provide a person different housing services or facilities
- Falsely deny that housing is available for inspection, sale or rental
- Impose different sales prices or rental charges for the sale or rental of a dwelling
- Use different qualification criteria or applications, or sale or rental standards or procedures, such as income standards, application requirements, application fees, credit analyses, sale or rental approval procedures or other requirements
- Fail or delay performance of maintenance or repairs
This list is not exhaustive, of course, and it’s better to be safe than sorry.
One particularly important part of that list is the following…
“Use different qualification criteria or applications, or sale or rental standards or procedures, such as income standards, application requirements, application fees, credit analyses, sale or rental approval procedures or other requirements”
Imagine, if you use different systems, processes, or criteria for each tenant, how easy it would be for someone to claim that you were discriminating against them in their application?
This is why it’s so important to have good systems and processes in place. It not only ensures you get high-quality tenants… but also that you’re protected legally in the case that someone claims you’re being discriminatory.
It’s also a good idea to look into fair housing laws in your specific state. A quick Google search for “fair housing laws in [your state]” should give you the details you need.
Step 2. Set Minimum Requirements
Once you understand fair housing laws, the next thing you need to do is set your minimum requirements for accepting new tenants.
You can thing of this like the “required experience” list on a job application.
It’s the level that you’re unwilling to dip below when accepting tenants.
Here are the metrics and indicators that you need to set minimum requirements for (this will protect you legally and help you systematize finding good tenants). We’ll also provide some recommended minimum requirements you can use…
Income — Obviously, you want to make sure the tenant makes enough money to pay their rent on time every month. The industry standard rent-to-income ratio is 1 to 3. This means that your minimum standard should be for your tenant to make at least three times the cost of rent (if rent is $2,000 per month, they should make at least $6,000). You can verify this by requiring applicants to provide either paystubs or tax returns.
References — One of the most sure-fire ways to avoid bad tenants is by requiring at least two references from at landlords and/or employers. Then you’ll want to call those references and see what they have to say.
Credit History — A person’s credit history will show you their track-record of paying (or not paying) their debt on time. It’ll also show you existing debt. We recommend a minimum credit requirement of 600. It’s also a good idea to make sure the person doesn’t have a lot of other debt and that they’ll still be able to comfortably pay rent.
Evictions — As a rule of thumb, don’t accept tenants who’ve been evicted. You can see evictions when you run background checks.
Criminal History — This rule is a little more gray, becuase if someone has some speeding tickets, maybe that’s not such a big deal. But if they have other more serious crimes under their belt, it’s a good idea to steer clear. You can also see this when you run the background check.
Now there’s one caveat to all of these criteria that you might occasionally consider.
If a tenant doesn’t meet one of your criteria — for instance, their credit history isn’t great — but all of the others check-out quite well, then you might allow them to get a lease with a cosigner so that you have a safety net.
But generally speaking, you want to be as strict as possible with your criteria so that you get the best tenants possible.
Step 3. Create Your Application
Remember: the goal is to create systems and processes so that your tenant screening processes automatically finds good tenants.
The first filter through which all potential tenants should come is an application — and this application should be the same for everyone.
Look at your list of minimum requirements and make sure that the application requires people to provide the information necessary for you to run background checks, credit scores, and call references.
This is pretty easy.
But it’s always easier to copy than it is to create your own.
So here’s an example of one you can pull inspiration from to create your own.
Step 4. Run The Obligatory Checks
As you market the property, you’ll collect a stack of applications.
The next step in the process is to do the following (or hire someone to do it for you) for each application…
- Check credit score
- Run background check
- Review financial documents
- Call references
Software like Rentme makes it pretty simple and inexpensive. You can use their software to get background checks, credit scores, and even eviction reports. The only other thing you need to do is call references.
Beyond the stuff we’ve already discussed, the main thing to watch for is the potential tenant’s debt-to-income ratio. That is, how much debt do they currently have and how does that impact their monthly income? Most importantly, do they still have plenty left over to pay rent every month?
If they have a lot of debt, then that could be a red flag.
Step 5. Ask These Questions
After reviewing applications, make a stack from best to worst and call them in that order. You want to contact them and see if they have time to answer some additional questions.
Here’s a pretty thorough list of questions to ask (we pulled from RentPrep)
- Do you currently rent, and if so, where?
- How long have you lived in your current home?
- Why are you looking for a new place to live?
- What date would you want to move in?
- What kind of work do you do?
- What is a rough estimate of your income?
- How many people would be living with you?
- How many people living with you smoke?
- How many parking spaces would you require if you rent here?
- How many pets do you have?
- Do you think your current landlord will give you a favorable reference?
- Does your current landlord know you are thinking of moving?
- Have you ever had an eviction?
- Are you familiar with our rental application process?
- Are there any issues I should know about before I run a background screening for all the adults in the household?
- Have you filed for bankruptcy recently?
- Will you be fine to pay our lease application fee of ($ amount) if you fill out the application?
- Would you be able to pay the security deposit of ($ amount) at the lease signing?
- Are you willing to sign a 1-year lease agreement?
- Do you have any questions for me about the process?
These questions are partly to confirm what you found when checking their income, background checks, and credit scores. And it’s also just to make sure that they’re still interseted in moving into the property.
Step 6. Accept Or Reject Applicants
Then it’s just a matter of letting the best possible applicant know that they’re approved and signing a lease.
You’ll also want to send emails to all of the applicants who didn’t get accepted (you are not required to give a reason for the rejection!). We recommend something like this…
Thank you for a applying to rent our property at [address]. After reviewing all the applications, I am sorry to say that we have chosen another tenant. However, I hope you don’t mind if I contact you in the case that the approved application falls through.
Wish you the best,
This is a tasteful to let people know their application has been rejected, but also give you the chance to reach back out in case something happens with your accepted applicant.
Step 7. Set Clear Expectations in The Lease
Screening tenants is ground zero for getting good tenants.
But it’s not the entire picture.
Creating a lease that protects you is just as important. Below, Ryan Dossey will show you five clauses he puts in every lease to protect him and his properties. You can keep reading for a quick overview of the four main ones from the video…
- Bugs & Pests — This clause ensures that bugs and pests brought in by tenants are addressed in a fair way so that the tenant is required to pay a specific portion of treatment.
- Commercial Vehicles — Ryan Dossey had to pay $12,000 to repair a driveway destroyed when a tenant drove an 18-wheeler onto their residential driveway. It’s a good idea to put a policy in your lease ensuring people don’t park in the yard or hurt your property with commerical vehicles.
- Disturbing The Peace — It’s a good idea to have quiet hours for your property from 10pm to 7am to ensure your tenants aren’t disturbing the neighbors. This should be outlined in your lease.
- Criminal Activity — Clearly, you don’t want criminal activity in your property. A lot of states still allow landlords to do emergency evictions if there’s criminal activity involved. You might do a one-strike or three-strike policy. But it’s important to outline those expectations in your lease.
The quality of your tenants will be a direct result of how thorough and effective your tenant screening process is.
If you want better tenants, you’ve got to have a better process.
Fortunately, it’s not rocket science.
We outlined above exactly how you can create systems and processes to ensure you always get the bet tenants possible. If you’re still dissatisifed with the tenants you’re getting, then you might want to consider investing in properties or markets that appeal to better tenants.
If you want to learn how to find great deals on real estate, check out our guide to finding off-market properties here.