Whether you’re investing in residential, office, or industrial real estate, one of the most important things you or your property manager will do will be selecting your tenants. The quality of your tenant can have a tremendous impact on your properties value. Consider owning a building where you’re able to attract Chase Bank as a tenant.

For purposes of this article, let’s focus on residential property, multifamily or single family rentals.

Importance of Tenant Quality

The quality of your tenants will impact the quality and risk associate with the cash flow of your investments. It will make or break your investment. If your tenants are stable and long-term, and pay on time, your life will be great. If your tenants miss rent payments, put holes in your walls, then stop paying all together, you or your property manager will find yourselves in eviction court fighting an attorney who’s collecting what would have been your rent payments. One of these occurrences could cost five thousand dollars or more.

Here’s an example:

One investor I knew owned a 30 unit apartment in Oakland. After three months of consistent payments, one of his tenants stopped paying. He delivered him a 3 day notice to pay or quite then proceeded to eviction court. The tenant broke all of the electrical outlets in the apartment then counter sued and claimed he stopped paying rent because the unit was ‘uninhabitable”. Long story short, it took this guy 6 months to evict the tenant. Even after the tenant moved out, he sued my investor friend again. This experience had such a negative impact on my investor friend that he ended up selling the building and getting out of the business all together.

Don’t let this happen to you.

Tenant Selection Starts With Property Selection

Start by acquiring property that your tenants will demand. Even before tenant selection comes into play, you should have an idea of the types of tenants you would like to provide housing for and acquire the housing that will attract those tenants. Even if you are the best salesman alive, if you acquire an ugly property in a bad neighborhood without the features in demand in that rental market you will be unable to attract decent tenants. Are your residents going to be students? If so, what types of housing and features do students in that market demand? WIFI, study rooms, group activities?

How do I know who will make a good tenant?

When it comes to the stock market, “past performance is no guarantee of future results”, however it is a pretty good indicator, particularly when it comes to tenant selection. What I’ve learned is that it is a good assumption that people will not change, so you must assume when it comes to selecting a tenant that their past will be their future as your tenant. If they have a criminal history, it is likely that they will commit crimes while occupying your property.

Check the following:

Credit: Indicator of their willingness to pay their debts / financial responsibility
Income Level: Indicator of their ability to pay the rent
Income Stability: How long have they held their current job with their employer? Long and steady employment is a good sign that they have established ties in the community. A short employment record may indicate a “flighty” tenant without established ties and little reason
Rental History: Indicator of whether or not they operate responsibly and take good care of their residence.
Criminal History: Indicator of character. Are they a responsible adult? Do they abideby societal norms?

What is a good tenant?

Good tenants can afford to be choosy. They have sufficient income and good credit and can choose among many different properties to rent. They alert you quickly when there are problems with the property. They work with you and are reasonable when it comes to finding solutions. They know how to take care of a home, but they are not overly demanding (avoid those types). They want it to stay in good condition and they treat it like it is there own.

Overall, after ten years of investing in residential real estate in various markets, I’ve found the best indicator of tenant quality is responsibility. I look for proof of financial responsibility, proof of being a responsible community member (ask for and check character references), proof of managing pets responsibly (are they fixed, shots, etc.?). If they are not able to demonstrate this responsibility, I will not approve them. I understand my target tenants well and I’ve done a good job acquiring properties that meet their needs, so the next applicant will likely be the great tenant I’ve been looking for.

Alegria Capital Management is a real estate investment management company that manages funds invested in quality residential real estate in high-growth markets nationwide.