Question About Raising Rent

[Cole Oliver]

Hello! I am curious to get feedback from everyone about this situation I have found myself in. I am currently under contract on a property that has 2 duplexes (4 units) and shop buildings on it. The seller of the property built them back in the 90's and paid in cash for them. 

When running my numbers I got the current rates that he is charging, and they are 30-40% less than the fair market rent value in my area. He has two 3B 2.5B units rented out for $1,050 and $1,100, and 2B 2B units rented for $975 and $1,000 each month.

Based on my experience in my market the 3B 2.5B units should be renting for $1800-2000/mo and the 2B 2B units should go for $1300-1500/mo.

Tenants are currently on a month to month lease so raising rents won't be a problem, but how much would you raise it to?

Our contract states that I will give the current tenants 60 days notice from the day of closing that rents will be raising, but would it be too much of a jump to raise rents to $1600 for 3B units, and $1300 for 2B units? I figured I would give current tenants a better rate for a year, but if they decide to move then I'll market at the top rent rate. What are your thoughts?

[Theresa Harris]

What is the condition of the units?  Increasing the rent that much will trigger vacancies.  If you are prepared for that and have the funds to do repairs and renos to get them to market value, then try it.  In the long run, you'll be further ahead, but in the short term you will be putting in a lot of money and not getting anything back.

Giving them 1 year's notice that rents will increase and letting them know they can move out at anytime with 30 day's notice will give them time to find a new place.

I'm also assuming you aren't in an area where there are caps on rent increases.

[Moises Ortuno]

My first question would be where is the property located? 

Although it may not be located in CA, it is still advisable to investigate if there are any rent control laws applicable to the county or state, as Theresa mentioned.

[Cole Oliver]

The units are in a small tourist town in SW Missouri and are in great shape. A little dated perhaps but they are located in one of the best places in town and otherwise very attractive. There are much smaller homes in worse parts of town renting for $1600+ currently.

There is not a cap on how much I can raise rent here in SW Missouri, and my thought process was to keep the rent a few hundred dollars under the market rate so that if they decided to look around, they’d realize they can’t find anything comparable with the new increased price and stay anyways. If one or two tenants decide to leave that’d be okay, but I wouldn’t want all 4 at once. 
Also, there is a shortage of housing and a very high demand for rentals due in part to being a tourist town, but also because of an influx in people on coming from the west coast. 

[Bill Brandt]

Easier to just non-renew them. Anything less than market is like you giving strangers a cash gift every month. You can’t complain about 20% under market and then target 10% under market. Anyone buying from you would say this fool was 10% under market, I’m raising rents. Even at jus 8% under market you’re better off with a months vacancy and then getting market rate. 

You are telling other strangers you won’t let them pay $2,000/mo because other strangers are paying $1,000 or $1,500 if you go up half way. Think about how dumb that sounds and raise rents to market. What are they going to do? Go through the hassle of moving so they can go pay $2,000 (market rent) somewhere else? 

[Cole Oliver]

That is interesting. However, there are tenants that have lived in at least one of the units that have been there for over 20 years. I felt like it would be better to take a couple hundred dollars less for the first year to try and keep them because they had been great tenants for the their current landlord. Would you still non-renew them?

[Gregory Schwartz]

Vacancy and turns are expensive. You have to weigh the cost of a non-renew against the potential income you could make. 

IE if a unit is vacant for one month (at $1600 per month rent) and the turn cost is $2000 then you're out $3600. If the rent increase potential is $200 it will take a year and a half just to cover that expense. 

The art is to increase the rent without running off GOOD tenants (very important, if the tenants aren't ideal tenants then non-renewing becomes the default option). Personally, I keep my rent increases to 5-10% while not pushing them all the way up to market rent. The idea is that they might be upset about the increase but will realize they are still getting a good deal when they search around and find out similar units are renting for $50-100 more than their renewal rate. 

I'll go as far as to tell my tenants, "hey your new rate is $1200 per month but honestly I plan on advertising it for $1500 if you plan on non-renewing." This makes it clear that they're getting a good deal. And Im happy because Im not out $3600 :) 

Hope this helps

[John Morgan]

I’ve bought 16 houses that came with tenants paying way under market rent. I raise rent 10-20% in the first year. I just raised rent on one I’ve had for almost 3 years. In 3 years, her rent has gone up 67%. I remodeled her bathroom, upgraded her kitchen a little and added central air and other things. But I tell my new tenants that rent will be coming up quite a bit because my expenses are much higher than the previous landlord because I have a mortgage on it. They all understand and want to stay. I also tell them I’ll fix anything and everything that the previous landlord didn’t. They really appreciate it and know I’ll still keep them quite a bit under market rent. It’s a win/win for the tenants and me.

[Cole Oliver]

Really like that Feedback Greg and John. I have the issue of a high mortgage and taxes and insurance. Currently the property brings in $4,775/mo but they have the potential to bring in around $8,000/mo if rented correctly. My estimated monthly expenses including taxes and insurance will be somewhere around $6,300 so I will no doubt have to raise rent significantly to pay the bills but I am thinking about raising them to bring in at least $7,000/mo for now and then make more subtle rent increases over the next year or two unless I have a turnover. 

I really like the idea of letting tenants know how much their unit will be marketed for if they don't renew their lease to help them realize the deal they will be getting.

[Robert Rixer]

I've had this before with in-place rents at $800 and market rents at $1200. Raised rents on existing tenants to $1150, a little below market. Some got mad and threatened to leave but when they had a look at the market they decided $1150 was still a good deal. Those that couldn't afford it, left but those tenants would not have been viable long term tenants anyway.

[Ned J.]

You need to raise it to pretty close to market- within 5-8% is usually my target. Enough to get you close but mitigate a turnover if possible.

My biggest advice is be brutally honest when you assess market rate. Some old run down never renovated unit is NOT the same a a newer nicer unit with the same bedrooms, baths and square footage. I see a lot of people seem to think an old beat up unit is going to compete with a nicer until that is 1% higher on rent. 

[Matthew Morrow]

Quote from @Cole Oliver:

Hello! I am curious to get feedback from everyone about this situation I have found myself in. I am currently under contract on a property that has 2 duplexes (4 units) and shop buildings on it. The seller of the property built them back in the 90's and paid in cash for them. 

When running my numbers I got the current rates that he is charging, and they are 30-40% less than the fair market rent value in my area. He has two 3B 2.5B units rented out for $1,050 and $1,100, and 2B 2B units rented for $975 and $1,000 each month.

Based on my experience in my market the 3B 2.5B units should be renting for $1800-2000/mo and the 2B 2B units should go for $1300-1500/mo.

Tenants are currently on a month to month lease so raising rents won't be a problem, but how much would you raise it to?

Our contract states that I will give the current tenants 60 days notice from the day of closing that rents will be raising, but would it be too much of a jump to raise rents to $1600 for 3B units, and $1300 for 2B units? I figured I would give current tenants a better rate for a year, but if they decide to move then I'll market at the top rent rate. What are your thoughts?

It sounds like you have a solid plan for maximizing the property's potential rental income. Raising the rents gradually to $1600 for 3B units and $1300 for 2B units seems reasonable, especially considering the significant gap between the current rents and the fair market rates in your area. Offering current tenants a better rate for a year is a thoughtful approach that may encourage them to stay while still allowing you to increase your overall revenue. Just ensure that your increases comply with local rental laws and regulations.