How is it that some landlords and real estate investors have tremendous success
and peace of mind, while others have nothing but horror stories to tell? What makes one investor better than his neighbor, and how can you learn from them both how to manage your ADU, JADU, or Granny Flat, like a boss?
Before we start talking about how you will manage your ADU, let's examine an example of how most people manage their rental properties and ADUs.
The Story of average John
John is a typical guy with a 9 to 5 job. Like you, he heard about ADUs and about the option to make a lot of money by renting them out. John started the process and, within one year, his ADU and JADU were already completed. He even did it the right way and didn’t pay for anything upfront and now he has loan payments of $1,300 a month. Now because of the high demand in the area, not a day passed by that his phone wasn’t overflowing with calls about the units. He immediately schedules showings with a couple (the Smiths) for one unit and a single guy (Jeff) for the other unit. They each loved the units and signed on the spot. John was excited! Finally, all his financial problems will disappear. With both units rented, he can make $4,000 in gross rental income or $2,700 in his pocket each month after paying the $1,300 loan payment. They signed a simple lease agreement and John collected a $200 security deposit for each unit. Both the Smiths and Jeff seem so kind, what could ever go wrong? In the first two months after signing the lease, everything went well. But then, problems started to arise. Jeff missed his payment on the first of the month, and when John asked him about it, Jeff swore he would pay next week. And as the next week came, Jeff delayed again, and again, and again. Additionally, the Smiths were having parties every night until 4 in the morning, making John’s life miserable with all the noise. After 2 months of Jeff not paying rent, John told Jeff that he needs to move out. But Jeff would not listen and said that he wouldn’t leave. But how can he stay without paying rent? The Smiths heard about their neighbor not paying rent, so they also stopped paying rent. Instead of making money from renting the ADU and JADU, he was losing money and his biggest nightmare became a reality. Now, with both tenants not willing to pay rent, he had to contact a lawyer. The lawyer told him that it will cost him $10,000 in legal fees to send all the letters and take them to court, and it will take 3 months to go through the whole process. With this news, John gave up and felt like he had no other option but to sell the property. He regretted his whole decision. Sound familiar? Let's be honest, everyone has heard horror stories of owning a rental property. And in fact, most of them are true and painfully accurate. But the truth is that this is not the story of everyone. There are people who manage properties like bosses. I’m not saying that bad things never happen to them, but bad things happen only rarely. And when they do happen, the bosses approach the issues differently than John.
The 9 Commandments for Managing ADUs and JADUs Like a Boss
1. Don’t rent to the first applicant.
In other words, do your market research and list the units with very high rent compared to the area, and wait for people to call. If they don’t call for a week, reduce the price by a bit, and do it again every week until you have enough people that want to see the property. If you choose a price, and you get too many phone calls, that means that your price is too low!
2. Know your numbers!
3. Choose tenants by logic and not emotion!
4. Create commitment and scarcity
5. Collect a large security deposit
6. Get all the documents in order
7. Treat your ADU and JADU like a business, and not as a hobby
8. Violations of the agreements need to be treated immediately!
9. Start an Eviction Fund
Bonus - The 30 days' notice
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The Story of Boss Rebecca
Now let's take another scenario. This time we will take Rebecca, who also heard about ADUs and the passive income she can make by building one. She heard about John's story, but instead of being intimidated by it, she was determined that it would never happen to her. She started the process, and like John, completed building her JADU and ADU in 12 months. She has a $1,400 monthly loan payment, or $700 for each unit. She posted the units for rent and her phone was immediately ringing nonstop. She did not set any appointments, but instead raised the prices for the units by a few hundred dollars each. The phones kept ringing, and so she did
this repeatedly until the phone stopped ringing. Then she lowered the prices to the point where she got some calls, but not too many, at $4,800 total for both units. After crunching the numbers, she figured out the total monthly costs are: $720 for repairs and reserves, $350 for property taxes and insurances, and $530 in management fees (that she will not need to spend because she will manage her own property). Therefore, her net monthly income after expenses is $3,730, and her net monthly cashflow after paying off the loan is $2,330 before taxes. After consulting her tax advisor, she figured that this income would be offset in full by her deductions. Her net cash flow after taxes is therefore the same as her net income. She invited 3-5 candidates for each unit. But before inviting them, she asked them about their credit score and work situation. She wanted to make sure that their income is at least 3 times higher than the rent, and their credit score is 600 or above. She learned that people that have extremely low credit scores don’t often care about unpaid debts, and that if rent is more than 30-40% of their income, they are more likely to miss a payment due to unforeseen expenses. For the showing, she invited all of the potential tenants at the same time to save her time and create a sense of scarcity between the potential renters. She also left an application form with a nonrefundable fee for $40 to make sure that the people that filled out the application were committed. In the application form, she asked them to include their most recent credit report, three most recent bank statements, three most recent W-2s, and the phone numbers and dates rented for their two former landlords. She was determined to call and verify everything before making her decision. She also explained that she will demand 2 months of rent for a security deposit. Half the security deposit can be paid in 3 different installments. She explains that the security deposit will be fully refundable once they move out, less a $350 cleaning and paint fee and any other damages or past due rent. After reviewing all the applications, she decided on her top two choices and sent them all the documents and information, including a lease agreement, who is responsible for damages caused by negligence, who is responsible for bills, pet agreements,
working hours, noise appendix, 30 days' notice policy, and more. On the move-in date, she gave the new tenants a checklist to mark any damage that existed at the units, but because the units were brand new, no damage was found. They signed off on the checklist that everything appeared to be in good condition. Rebecca reminded her new tenants that although she lives next door, she will never go into their house without 24 hours' notice, and she will not bother them as long as none of the lease agreement terms were violated, as she expects them to respect her privacy as well. Also, as per the lease agreement, dedicated phone numbers will be operating between 10AM and 4PM Monday through Friday, and any requests should be made by calling during operating hours, leaving a voicemail, or sending an email. The tenants understood and shook hands with Rebecca. From that point on, the tenants paid on time between the 1st and the 3rd with one hiccup. The third month, the tenant from the JADU told Rebecca that he will be late with the following month’s rent. She told him that she understands that situations arise, but she will have to send him a formal letter that states that he breached the lease agreement and is subject to late fees per the agreement. Additionally, he received a formal warning that if the payment is not settled within the agreed upon time, she will have to start the eviction process. The tenants of the ADU defaulted as well, so they too received a formal letter for breaching the lease agreement with a formal warning. By sending them those warnings, Rebecca shortened the potential eviction process, but due to her expert handling of the situation and informed choice in tenants, the violations were never repeated. In addition to successfully managing her tenants, Rebecca was managing her books like a pro, monitoring her maintenance expenses, and putting aside money for repairs and unexpected expenses. She also put aside 6 months’ worth of loan payments and $10,000 for lawyer costs, just in
case she ever needs it. This wasn’t an issue since she had the 2 months of security deposits valued at $4,800 for each unit, plus after putting aside only 4 months of net rental income of $2,330 a month, she had the entire eviction fund secure. Now Rebecca
sleeps well at night, knowing that she has covered herself completely and can enjoy the extra $2,330 every month to spend or save as she pleases.
Now when you know how to manage your property it's time to take action. if you have a property make sure that for the next tenants you follow the steps to maximize your profits and peace of mind.
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