High End Apartment Building

Ways to Reduce Rental Property Liabilities

Updated January 1, 1 . AmFam Team

Limiting your business’ liability can protect your personal holdings and finances from loss. Because real estate investments can be risky, take a look at our important advice on the ways to reduce your rental property liabilities.

Small business owners face a real challenge in managing risks. And new landlords that have dedicated a large percentage of their personal savings towards real estate investments are no different. This new territory of owning a business and being its sole proprietor can come with a few financial realities in the form of hidden liabilities. That’s why we’ve put together this review that can help you understand how to reduce rental property liabilities.

How LLCs Protect Your Rental Property from Liabilities

When a successful legal action is taken against a limited liability company (LLC) and your group is held liable, collection of damages is limited to the assets of the company. Here are a few other important reasons to make your rental business an LLC:

LLCs protect your personal property. Safeguard your savings, and protect the property you own elsewhere with an LLC. Other personal assets, like your personal home or inherited money, are usually sheltered with the formation of an LLC.

Sheltering each property with its own LLC may be smart. Some landlords find that they’re able to further protect their real estate portfolio by creating an LLC for each property. That way, if one of your properties is found liable and held responsible due to unforeseen reasons, the rest of your properties are safe.

Limit Liabilities by Requiring Renters Insurance

Because the cost is nominal to the tenant you’ll find they may be willing to take on a renter’s policy. If something should happen, their belongings will be protected and your property stands to benefit as well. There are a number of other important reasons why requiring renters insurance of your tenants makes good business sense.

Your finances are better protected from tenant-caused damage. Tenants that are required to have renters insurance on board are more able to meet the financial obligations. If they damage your property they only need to pay the deductible.

Your tenant’s personal belongings are protected. If a theft should occur, your tenant can recover some of the cost to replace expensive stolen items.

Limit Liabilities by Keeping Common Areas Safe

With an obligation to protect your tenants, it’s your job to ensure that entries and hallways are safe and hazard-free. Here are some suggestions to limit liabilities by keeping common areas safe:

Maintain your property. Tripping hazards like uncollected parcels building up around mail collection areas can be a problem. Designate an out-of-the-way area for large package delivery and keep clutter down in high-traffic walkways. Good property management upkeep can really make a difference.

Revisit your pool, playground or other recreational areas. Take a look at your rental through the lens of a liability expert. If you find problems, take on the work if you’re up for it. Or if you need to, hire a go-to professional to get the job done.

Inspect stairwells. Be sure that your banisters are securely fastened in every stairwell. Verify all exit signage is operating properly and replace any burnt out light bulbs. Have maintenance personnel frequently inspect stairs exposed to the elements during winter months to salt and remove snow.

Check in on community and laundry rooms. Verify all lights are operating and that each space is well-lit. Clear out tripping hazards in highly-trafficked pathways in storage areas.

Install security Wi-Fi-enabled security cameras in common areas. If the unexpected should happen, and someone is injured on your property, having footage of the incident could be important. You’d be able to review how a problem occurred.

Limit In-unit Liabilities by Maintaining Your Property

Keeping your entire rental property well-maintained should be a high priority. Here are some suggestions to minimize in-unit liabilities on your property.

Require semi-annual inspections. Write up a clause in your lease agreement requiring the tenant to allow you access to the rental. When the time comes, inspect for issues. You’ll be able to look carefully at problems and liabilities that need your attention. You’ll also see how the tenant’s treating your place.

Check in with your tenant about their concerns. By asking them if they have any concerns, you may learn that the stove has been malfunctioning. If an occasional leak under the sink makes the floor slippery, you’ll learn about it then.

Limit Employee Liabilities With Training and Personal Protective Equipment (PPE)

As a business owner, you’re obligated to maintain as safe work environment for your employees. Here are a few ways you can limit employee liabilities with training and requiring PPE:

Offer training for new hires. When you bring on new employees, be sure to thoroughly train them on the tasks they’ll be required to perform. By investing time into training, you’ll help to rule out accidents and reduce turnover as well.

Review PPE best practices. When employees will be required to wear protective gear, be sure you make time to teach them how to use the equipment correctly.

Put together an operations manual for your rental property. Build a document that discusses all the various tasks employees may be expected to perform. Write out safety measures that need to be taken and required PPE for common tasks and maintenance requests.

The Benefits of Commercial Umbrella Liability Insurance

Rental property owners are attractive targets for lawsuits because the risks related to investment properties are so numerous. You can help mitigate your financial risk and help to further protect your finances. Take a look at the benefits of commercial liability insurance:

Slips and falls can be covered. Tenant injuries resulting from landlord negligence can result in serious cash awards. And these rewards can skyrocket if the injuries impact the tenant’s ability to earn a living.

Defamation lawsuits against your business can be covered. Connectivity into online communities can present risks and liability blind spots for real estate investment property owners. Even a small misstep on social media can be considered liable.

Employee-caused car accidents and damages can be covered. If you or your employees are out on official business and are involved in an accident, your commercial umbrella liability policy can be used to cover the costs for injuries and damages.

American Family Insurance’s Loss & Risk Control Resources

We believe that your business should be a safe and prosperous place for yourself, your tenants and your employees. We’re helping our policyholders reduce the risks and losses by providing informative, instructive safety and risk management information. And this is information you can use to help identify risks and reduce liabilities.

By understanding your vulnerabilities and protecting your business with carefully-insured policies, you’ll find real peace of mind. And you’ll know that your investments are more secure. While reviewing your property’s risks, make a phone call to your American Family Insurance agent (Opens in a new tab) and request a thorough business insurance review. You’ll get an affordable insurance coverage that can give you the security you need to pursue your financial goals.

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    Start with the “One Percent Rule”

    Answer a simple question: Will your monthly rent for the space equal at least one percent of the purchase price? If your answer is yes, then your place may be able to turn a profit in the years ahead. Congrats, you’re off to a good start. Be sure that the rental’s priced competitively for spaces of similar design. Here are few other factors to consider:

    Understand the formula

    If the total purchase price of the property is $200,000, rent should be no less than $2,000 per month or one percent of the total cost. Likewise, a $600,000 purchase price for a multi-unit rental property should meet or exceed $6,000 per month in total monthly rent earnings.

    Get the purchase price right

    When factoring in the purchase price, remember to include closing costs, property taxes and insurance. One way to better estimate these costs is to use an online closing costs calculator which can approximate appraisal fees, home inspection fees, application fees, prepaid interest among a host of other out-of-pocket expenses that can up your purchase price, sometimes by thousands.

    Factor in repair costs now

    Because real estate investing as a landlord requires the space to be “habitable” upon tenant occupancy, you may need to make certain repairs or upgrades before renting the property. As a result, you’ll want to add the total cost of these repairs into the purchase price.

    Consider the “Class” of the Neighborhood

    Neighborhood classifications help buyers understand the potential return on investment in a given area. If you’re new to being a landlord, you’ve got to pay close attention to what the neighborhood’s telling you.

    One good way to check out an area — specifically if it’s an investment that requires some traveling — is to use Google map’s street view. Is trash left out on the front lawn? Do neighbors maintain their property? What can the cars parked on the street tell you about the demographic? Here are details on the four distinct neighborhood classes real estate agents use to classify a region:

    Class A neighborhoods

    High income neighborhoods, combined with a home that is move-in ready will usually get an A class rating. Because homes are expensive in these neighborhoods, and their higher than average tax burden, real estate investors usually won’t buy a home there because the one percent rule fails the test. Tenants in these areas tend to be very reliable, high-quality renters.

    Class B neighborhoods

    Typically populated by those earning a moderate-to-high income, B class neighborhoods are frequently considered a good investment for landlords and fertile ground for tenants seeking rentals. Purchasing “as is” properties that can be cheaply updated and rented above the one percent factor is typically possible here with minimal risk. These areas will usually experience increased turnover and vacancy rates.

    Class C neighborhoods

    Because the risk is a little higher in neighborhoods that land in the C class category, the opportunity to see a high rate of return on fixer-upper places is good if you buy a For Sale by Owner property, or one not listed on the MLS (multi-listing service for real estate sales). Populated with blue collar workers with relatively low-to-average income, C class areas typically have higher crime rates and under-performing schools. Landlords should expect less-than-optimal tenants and periods of vacancy.

    Class D neighborhoods

    Areas riddled with crime, properties damaged upon a tenant’s exit and high costs for property upkeep can be anticipated in D class neighborhoods. Buyers usually consider these types of purchases high risk. It should be noted that many property management companies are reluctant to accept properties to service in these areas because the risks associated with the area. Investors tend to seek properties in more stable neighborhoods.

    Use the Capitalization Rate as a Predictor of Value

    Another key way of understanding the rate of return on an investment is the capitalization rate or “cap rate” for short.

    What is a cap rate?

    A cap rate determines a profit ratio that a property can generate. It’s best used as a quick way to compare investment opportunities to determine which one is the better value. Start by dividing the total of one year’s rent by the current market value of the home which should include costs and upgrades required to get the space habitable — you can’t rent the place if it’s not livable, right? The resulting percentage is your cap rate. The higher the rate, the better your annual profit margin.

    How to Calculate the Cap Rate for an Investment Property

    Although the cap rate’s a useful tool to quickly analyze the relative value of comparable real estate opportunities, it’s used as a rough guide to qualify properties for consideration, given the state of today’s current market climate. First, estimate your property’s overall purchase price:

    Figure the acquisition value

    Simply put, this is the total purchase price. It should include all upgrade costs, closing costs, taxes, business insurance, fees, points, etc. Let’s assume a property you’re considering has a total purchase value of $200,000.

    Calculate one year’s rent

    If you’re collecting $2,000 per month, you’ll have twelve payments at the end of the year, or $24,000. This figure is your gross annual income.

    Account for half a month’s vacancy

    Because turnover typically requires some painting and repairs, it’s fair to consider that half a percent (two weeks’ worth of rent) of your total annual income will be deducted to cover the mortgage payments. Assume that your new tenant will cover the remaining pro-rated rent for the other half of that month. Once the vacancy amount is deducted, the result is your gross operating income.

    • Gross annual rental income: $24,000
    • Less the cost of vacancy: -$1,000
    • Gross operating income: $23,000

    Factor in operational costs

    These costs will include money required to keep the property habitable, like paying for trash collection, making repairs, fees from property management, and landlord insurance. Let’s put that cost under fifty percent of the gross operating income, or $9,300. Some years it will be more, some less.

    • Gross operating income: $23,000
    • Less operating costs: $9,300
    • Net operating income (NOI): $13,700

    Divide the NOI by the total value of the property:

    ---------------------  =  0.0685 or 6.85 % - That's your cap rate.

    The capitalization rate for this investment is 6.85 percent annually. If another property under consideration returns a higher cap rate like 8.23 percent for instance, you may want to explore opportunity with the higher annual yield in order to maximize your profit potential.

    What is considered a good cap rate?

    Generally, a cap rate between 8% and 12% is considered good. However, an optimal cap rate is really going to depend on several factors including location, risk and current rental income. For example, in high-demand like big cities, a cap rate of 4% may be considered good.

    Reach Out to Your Agent Today

    With so many different ways to look at profitability when determining where to invest in rental property, it’s important you do your homework before you decide to buy. And while you’re making that big decision, remember to contact your American Family Insurance agent and discuss your upcoming purchase. When it comes time to close the deal, you’ll have peace of mind that your property’s insured carefully.

    This article is for informational purposes only and includes information widely available through different sources.

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