Should/Can I raise rents right after purchasing this 4 unit?

Question

I'm looking at a 4 unit property now and the rents are low.  Two of the renters have been there for 20 years and the rents have never been raised!

Can I only raise rents with the renewal of a lease?

Can I force the tenants to sign a new one with raised rates?

When raising rents, would you recommend I do it slowly over a few years?

The current rents and where I want to raise them is as follows:

Unit 1: 785/1075

Unit 2: 675/825

Unit 3: 725/825

Unit 4: 550/825

To get max rents, slightly higher than my goals above, I'll have to do some cosmetic upgrades to 3 of the units when the tenants move out.

The numbers I'm getting when running with the current rents are giving me just over a 5% COC return.  After the rent raising goals, it jumps to 13%.  With the 5% COC and needing to update the units when the 3 tenants move out, I'll have to pour a bit more money into it each time.  This is a concern for me as the down payment on this property stretches us thin with our savings.  What would you suggest there?

Sorry for all the questions!  This would be my first property and I'm trying to be as thorough as possible in my numbers and plan of action.

Jon Holdman · Answer

There is some sort of lease in effect for all tenants.  Perhaps a long term written lease, perhaps a month to month lease, perhaps nothing written in which case you're under your states default terms.  As part of the purchase process you should get copies of the leases.  Even better would be to also get estopple letters signed by the tenants.  This is a letter outlining the lease terms.  It helps avoid a "yeah, the lease says rent is $500 but we have a verbal agreement for $350".

After your purchase, you're still bound by those leases.  You can raise rents and otherwise change terms only when the lease ends.  If they're month to month, you can give notice and change terms in accordance with the lease and local laws.  I highly, highly recommend a new landlord spend a few hundred bucks with a local landlord/tenant attorney to learn about local laws and customs.

If you make a big jump in rents its likely the tenant will leave, depending on your local market.  Be sure your expected rents are in line with your competition and that your comparable or a big under similar units.  Be careful not to overimprove your units thinking "mine's extra nice so I can get higher rent".  You just want to be similar to other properties in the same area.

You might get away with going from $725 to $825 in one step, if that's clearly the market rent. But if there are comparable units for $800 your tenant may make the jump. Going from $550 to $825 is almost guaranteed to create a vacancy. That may be OK, if that gives you the chance to fix up the unit and re-rent it for the higher rate. If you lose a month's rent at $550 but then get a tenant at $825 you make that up in two months.

Thomas S. · Answer

The problem with low rents in a multi is that it seriously lowers the value of your property. Bringing rents to market not only increases your cash flow it also increases the value of your property. In your case you are looking at increasing your rents by $665/month in total. That is far too much value to be ignoring. Go for it.

I would increase each property directly to market one at a time to stager any vacancies and costs. You may be presently surprised that some may not move even at market when they discover they have no where to go that is less expensive.  Bottom line you clean house, increase your rents and property value to the point that you may be able to refinance and pull enough to pay for everything.

If you are not utilising your recourses to achieve maximum returns you are not operating a efficient business.

Jack P. · Answer

Great advice from @Jon Holdman and @Cara Lonsdale.  I have a couple of tenants who have been in place for over a decade, and I haven't raised their rents, but the difference is not nearly as dramatic as yours.  In my case, its more advantageous to keep the tenants happy rather than risk them leaving, because as soon as they do, I'm on the hook for a $10k rehab.

As far as how to fund a rehab, there are a few options.

If you are in the local area (or at least within a few hours drive), take advantage of sweat equity and low-interest credit.  Home Depot offers up to 2 years at 0% interest on their credit card for many purchases.  I just put a roof on one of my rentals, and am financing it over that term (also for a much lower price than the local contractor).  Keep in mind that they'll do almost everything...flooring, cabinets, HVAC, etc.

A lot of credit cards offer an introductory rate, some as low as 0% for 18 months.  If you are coordinating the rehab yourself, use vendors that accept credit cards.

Bottom line, you can finance a rehab on straight credit cards at terms much more favorable than a HELOC or personal loan.  Use cash only when you have to.  Just make sure to pay the balance before the promotional rate expires, otherwise you get hit with astronomical interest rates.

Cara Lonsdale · Answer

Leases run with the land.  If they have a lease in place, you can't touch it until renewal time.

If they are on a month to month, you have the ability to change the rental rate.  You have to give at least a 30 day notice, and in many areas, it is 60 days notice of the new rental rate.  So, check your area.

In terms of how fast to hike it, it really depends on what your end goal is.  Do you want these tenants out?  Hike it to the full extent of what you are looking to get.  They will leave.

The trick to raising rents on tenants you want to keep is to make it high enough for you, but low enough for them that it isn't worth a move.  If you target JUST under market rent, they will tolerate it because it is a discount from where they could move to, but higher than they pay now.

It's all about balance.

Michael McManus · Answer

@Thomas S. Makes sense.  Much appreciated!

Should/Can I raise rents right after purchasing this 4 unit?

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