My wife and I are relatively new landlords with 2 rental properties. They are both currently rented at slightly below market value to great tenants. We both work full time, so at this point having good tenants who pay on time and treat the property well is more important to us than squeezing out every dollar we can get. Even so, we don’t want to leave money on the table if we don’t have to. The lease on one of our properties is going to be up in a few months. We are going to ask the current tenants if they would like to renew the lease, and we are deciding if we should include a modest rent increase. I’d like to get the thoughts of some more experienced landlords on raising rents and how you approach the conversation with tenants. How do you balance wanting to keep great tenants with raising rents to reflect market increases?
That’s a great question…
I would say, it depends.
*What is your exit strategy and/or holding time?
*Are you looking to realize the highest equity build-up in the shortest amount of time?
*Are you looking to reduce/eliminate negative cash-flow asap?
*Are you looking for the highest, interim cash-flow, or fastest cash-flow achievement?
*Are you depending on appreciation, and/or forced appreciation?
*Are you depending on principal-reduction?
What does your market most likely promise in regards to the length of your investment?
While you answer those questions, you have about three general categories of investing in single family homes.
- Short term, 2) long-term, and 3) forever-term.
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Short term [1-5 year, active speculation play]: There is likely a negative cash-flow condition, for the entire term of the investment. Rent increases have nominal impact on the investment, and cash-flow isn’t the point.
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Long-term [5-10 year, appreciation play]: The cash flow over the entire term is neutral, but appreciation and principal reduction together, reflect the primary goals of the the investment.
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Forever-term [10+ years, cash-flow, equity-build-up]: Appreciation, principal-reduction, trade-potential, passive wealth creation, and retirement income are the primary objectives.
Among these three objectives, there is a sweet spot between camping on the rents, to the point of getting calls to change light bulbs, and frequent turnovers; to letting the rents become so under-market, that the tenants engage in major “remuddling” of your house, without your permission, and have no thought of moving. Both extremes attract/produce/cultivate an entitlement-minded client. Oddly.
Third-party property management tends to eliminate both extremes, as both are expensive to manage, and few management companies will put up with the headaches and baby-sitting these extreme situations represent.
All things being equal, the cost to maintain a “good” house in a timely manner is roughly the same, from house to house, regardless of the rents you charge. The differences result from timing of the maintenance and repairs. A full-on retail client will demand real-time repairs, and maintenance, and require above average management attention (baby-sitting), and are likely to be a nuisance client.
On the other hand, a tenant paying too little, won’t upset his apple cart with maintenance requests, and/or will do stuff himself, or most likely ignore repairs until they become critical.
Either way, these extremes costs more in overhead, and/or lost rents.
Keeping the rents at about 95% of retail, is probably the conventional sweet spot, for holding onto tenants, without sacrificing too much income. Of course, this assumes that the unit is maintained in “retail” condition, and not allowed to degrade.
Let’s examine what might happen if we camped on the rents, and held them at full retail, hell, or high water…
For example, we rented out a 3/2 house:
- The initial rent was $1,100/mo
- The market rent climbed to $1,150/mo, or 4.5%, over the last 12/mos.
- The rent was increased by 4.5% percent.
- The tenant gave notice to move.
- The tenant gave us $1,500 in deposits.
- The tenant treated our house like it was ours (if you get my drift).
- The costs to fix, clean the house was $1,500.
- The number of days to re-rent the house was 30.
- The total vacancy and credit loss was <$1,150>.
Total losses of <$1,150> divided by 12/mo is $95/mo. in vacancy losses.
So, to get that extra $50/mo, it cost us $1,150 in lost rents.
Over the next 12/mos we get $1,100 plus another $50/mo, or an additional $600/yr. We’re still down $750 from the last vacancy.
So …we raise the rents again.
The tenant moves.
It costs us another $1500 to fix and repair the house.
It takes another month to lease up the house at $1,200/mo.
We lose the first $1,200, plus the original $750 from last year, for a total loss of <$1,950.00>
Now, we’re down $1,950 over two years, trying to capture an extra $50/mo.
I could go on, but unless we’re holding out for the “creamy tenants” with AAA credit that will stay put, and somehow pass up the steal deals offered by landlords who know that not all “retail paying” tenants are created equal, but will most likely end up being a scoundrel or a skip, we’ll find ourselves chasing pennies with dollars.
And that brings me to say that’s why I like renting to “C” grade tenants. These are the ones who’ll give me top dollar in rents, put up huge deposits, agree to two-plus years leases, provide cosigners on occasion, and have something to lose if they try to screw me. This is the sweet spot I like to operate in, and I get full-on retail rents.
The secret to the most successful “land-lording,” is making sure the tenant has something to lose. This can be hard to accomplish at either end of the spectrum. Just saying.
I think what you’re doing already, is a good strategy. Keep the tenant in place, with moderate rental adjustments, while at the same time making sure the unit is maintained in a marketable fashion. Otherwise, not maintaining a unit, and raising the rents, is like trying to have your cake, and eat it, too. No worky.
Thanks for the detailed reply. I’d say we fall into the forever-term category, and our primary goal is equity building and principal reduction. Extra cash flow would be great, but I’d trade extra cash flow for fewer headaches. It sounds like our current rent of slightly below retail is right where we want to be.
Your comment about “C” grade tenants is interesting. I’m assuming by “C” grade, you mean mediocre credit/references/income? When screening tenants we’ve gone with people with great credit and stable income. By going with C instead of A grade, I’m assuming you find people with worse credit are more likely to agree to higher rent and terms more favorable to the landlord?
Yes, the worse the credit, the more hurdles the applicants will jump, including paying higher rents (over retail), higher deposits, and longer terms.
Roughly speaking, a “C-grade” applicant might have “lates” on this credit; some charge-offs; and perhaps a judgement; and maybe an old eviction. However, we have to look at the history of problems, not what happened yesterday.
Crap happens even to good people. So, generally if the applicant seems to want to pay his bills, we try to help them qualify with fewer hoops. Otherwise, if there’s an eviction, a slew of charge-offs, and a poor residence history (which would put this applicant in the “D” territory), we will ask for a co-signer, and a deposit, up to four month’s worth of rent. This is unusual, but we’ve been offered that before, so it’s possible to get.
Notwithstanding, usually, someone with credit issues, has a problem prioritizing bills, if not holding on to a job. So, we want the huge deposit no matter, and then we expect to have to train the tenant to pay us on time with confiscatory penalties for paying late.
We frame the rental payment as being payable any 30 days prior to the first of the next month. That is, the rent can be paid up to 30 days before it’s due, but after the due date, there is a late fee of $250.
However, we discovered that once that fee becomes due, the tenant loses incentive to pay us anytime soon. So, we insist on a daily late fee of $25, as an ongoing incentive to pay us.
As an aside, we use the late fees as a negotiating tool. If the tenant is going to be late, and he calls us a few days in advance and attempts to make arrangement, we waive the fees and costs. That is, until he misses the arranged deadline, and then it reverts to the original agreement, and can get very, very expensive. Again the fees are a negotiation tool, if not leverage to get paid asap.
All said, after one or two months of paying late, and having to cough up an extra $500, it helps solve their “priority” issues. Again, it can take a couple of months to educate a new tenant that we want our money, before they eat.
Hi,
I think the best way to explain my strategy to this common yet rarely discussed situation is through a story:
A chemistry professor at a large college had some exchange students in the class. One day while the class was in the lab the Professor noticed one young man (exchange student) who kept rubbing his back, and stretching as if his back hurt. The professor asked the young man what was the matter. The student told him he had a bullet lodged in his back. He had been shot while fighting communists in his native country who were trying to overthrow his country’s government and install a new communist government.
In the midst of his story he looked at the professor and asked a strange question. He asked, ‘Do you know how to catch wild pigs?’ The professor thought it was a joke and asked for the punch line. The young man said this was no joke. 'You catch wild pigs by finding a suitable place in the woods and putting corn on the ground. The pigs find it and begin to come every day to eat the free corn. When they are used to coming every day, you put a fence down one side of the place where they are used to coming. When they get used to the fence, they begin to eat the corn again and you put up another side of the fence. They get used to that and start to eat again.
You continue until you have all four sides of the fence up with a gate in the last side. The pigs, who are used to the free corn, start to come through the gate to eat; you slam the gate on them and catch the whole herd. Suddenly the wild pigs have lost their freedom. They run around and around inside the fence, but they are caught.
Soon they go back to eating the free corn. They are so used to it that they have forgotten how to forage in the woods for themselves, so they accept their captivity.
The pigs are your tenants. Every quarter you should send them gift cards in the mail thanking them for being so awesome. They will appreciate your gesture and the Law of Reciprocity will encourage them to “thank you” back with certificates of appreciation aka an increase in their rent.
Truly, this should be part of your tenant renention plan.
I hope this helps!
Kelly!
That is such a great analogy!!!
Somehow, I failed to put two-and-two together regarding you and your bandit sign webpage. Never mind your username! LOL
You are the most attention-getting marketer for bandit signs ever. I laughed so hard with your sales pitch, that I’ve shared it several places, just to give an example of great marketing to anyone who wanted to see it done right.
Great post.
I have to agree that having a good dependable tenant paying slightly less than market rent is better than trying to get market rent from a deadbeat. Raising rent is like walking on spring ice. When you start hearing it crack you quickly back up.
I like the idea of giving them a gift card to a local restaurant for being such a great tenant. Ask them if there are any repairs or issues that need to be addressed. Because guess what? Tenants like having landlords that care just as much as landlords appreciate tenants that care.
During the discussion, mention that you have just completed a survey of similar rental properties and determined that the rent you are charging is below market. You do not want to loose them as a tenant, but you do not want to loose money either. Say that you are charging $1,200 but the market rent is $1,300. Why not offer the split the difference and only increase the rent $50. In this way, your tenant doesn’t feel taken advantage of and you will most likely keep your tenant.
Another option is to offer a longer term fixed lease. Offer a 3 year lease fixed at $1,300.
Unless you’re offering some overwhelming benefit/protection, it’s enormously difficult to lock a tenant into a three year lease, in my experience.
If the rents are going up fast…
If you’re dealing with a credit risk…
If there’s a shortage of places to rent…
Then maybe.
Gift cards, coupons for rug shampooing, window cleaning, are all good, if you’re trying to keep tenants. One thought …offer the coupons with a lease renewal.
BTW, tenant’s feel taken advantage of no matter what the increase in rent happens to be.
I mean have you ever been notified of a rent increase and not immediately thought about moving? Me neither.
I tried to work it every way possible, from blunt force trauma increases to retail; gradual rate increases; and ‘here’s your options’ approach.
I think the best practice is regular annual, predictable adjustments that don’t threaten to blow the tenant’s budget.
My typical tenants typically gross about $50k. So, a simple $50/mo increase still represents a $600 annual dent in the tenant’s bank account, or about 1% of their gross.
A $100/mo increase is $1,200… That’s a 2.5% hit on a the client’s gross income, not to mention net income.
Failing to pay attention, and account for these types of details sets you and the tenant up for failure. I mean, we rented to the tenants based on the current income in relation to the current market rent. If the market rents skyrocket, and our client’s income doesn’t, how do we respond? Camp on the retail rents, and rub our hands together, and celebrate our fortune? I have done this, so don’t judge me.
That’s when it’s really necessary to predictably and gradually adjust the rents to whatever level we need to, and maintain continuity with that customer. The renters already know what the rents should be. They talk with other renters, who are paying more (or less), and they’ll squeal like stuck pigs, at first, even if the adjustments look like bargains after their blood pressure returns to normal.
That’s my take.
P.S. Of course, I like to find and rent to the customers who are grateful that I’m renting to them at all, and will gladly pay over-retail, and give me extended leases, co-signers, and huge deposits.
Thanks for the honesty. You do make some good points. I will have to agree that regular scheduled and predictable rent increases are the way to go. No surprises. I have tried writing in a CPI clause into the leases (especially commercial ones). Though the increase (usually 3.5% +/- annually) are often less than rental rate appreciation, it does bring some increase.