How much is too much rent increase?

Question

Looking at purchasing a tri-plex and one of the tenants has been at the property since 1998. (WOW!) his original lease was for $450 his current rent is $490 he has 3 bedrooms plus use of the full basement for storage (he has a lot of junk)and his workshop down there. He does cut the grass as a plus but for a 3 bedroom a fair rent in the area is $750 not including the basement use. How much can you reasonably raise the rent in a new lease agreement. I am afraid if I make it too high he will leave (which could be a good thing) but also will have to remodel the whole unit. This is a cash deal so the other rents will cover the expenses with a positive cash flow just was not ready or have cash reserves to remodel the unit right now. Any ideas or thoughts would be apricated.

Gary David · Answer

Good Point Joe

A lot to think about Thanks for the feedback

Sam L. · Answer

If he's month to give him 3 months notice that you're increasing the rent to $750. Seeing as he has decades worth of stuff there, call his bluff. Chances are he's not going to want to move all his stuff. Discuss with him that his rents are way below market.

Worse case scenario is he moves out and you have to spend some money turning it over (which it probably needs anyway).

Joe Splitrock · Answer

@Gary David keep in mind $750 is market rent for a property that has been updated. You may need to spend several thousand to get to market rent. Still consider that you are currently you are $260 under market rent. That is well over $3000 a year, so a new tenant could make up the rehab costs within a couple years. You are probably better off getting a new tenant in there.

I don't see any issue raising rents $50-75 a month. That still puts his rents far under market. It is unheard of to have such a little increase over 20 years. He has saved thousands of dollars in rent increases and his income has likely gone up considerably over that time. It is better to have one large increase and get it over with. If he leaves, it is better to have him leave now. Going forward, make sure to push annual rent increases.

Todd Rasmussen · Answer

@Gary David

When we had this situation, we gave the tenant a year notice that we were going to start raising the rent to market. We gave him a discount of the rental rate equal to the vacancy allowance, but within three years had raised it to that mark. He's still there paying the new rent. I think we did a $100 increase and a $50 increase to get it to where we needed it.

Gary David · Answer

@Michael Garofalo

Point taken thanks for your thoughts

Michael Garofalo · Answer

No problem. I have found that $25 is the gold standard when it comes to raising rents YoY. $50 on $490 is over 10%, so proportionally that is somewhat substantial.

Again, if it were me I would not increase it all, at least for the first year. Let's say you increase to $50, that would equate to $600 in added revenue over the course of the entire year. If he doesn't like that and decides to leave, and if the unit sits vacant for more than 1.5 months, financially that rent increase makes no sense. In my humble opinion, you probably will not be able to find a qualified replacement tenant at $540/month given it's condition in such a short time frame. And if he has as much junk as you say he does, then showing it to prospective tenants before he moves out probably will not yield you with the demographic you are seeking.

Gary David · Answer

@Michael Garofalo

Thanks for the input what are your thoughts on a $50 increase for a new lease do you think it would drive them out as well?

I will check the state laws as well

Thanks

Gary

Michael Garofalo · Answer

Hey @Gary David,

As a general rule of thumb, you should get familiar with your local and state laws re: rent increases. Even if someone has been there for a long time, some states do still have rent control measures in place. You need to honor the existing lease terms. Once that lease expires, then you would be able to increase rent in accordance with local and state laws.

Personally, I would not raise rent on a tenant who has a history of paying that has been there that long, if I did not have the cash reserves on hand for a full-scale renovation. If I were you, I'd let this tenant live there for another year, and collect rent from him at the current amount until you have enough cash saved up to afford the vacancy and unit renovations. If you increase rent and drive him out now, the unit sitting vacant would be a problem and if it is outdated, you won't find anyone to pay the fair market value of $750.

Once you are financially ready to renovate, I would still give this tenant ample advanced notice. If he's been there since 1998, the humane thing to do is to let him know what is coming so that he has enough time to make alternative arrangements. Yes this is a business but coming in guns blazing on day 1 saying you are going to raise the rent drive them out will likely not end well in your favor.

A final word of caution: please make sure if you go through with buying this you do have cash reserves for unexpected repairs/capex. If you don't have any sort of nest egg, you may want to question this purchase or identify alternative forms of financing so you have a buffer in case things don't go as planned from a cash flow perpsective.