Raising rent on inherited tenants??

Question

Hi everyone,

I'm working on a up/down duplex deal. Both 3/1. It has a value add of making a 2/1 or efficiency in the basement. Anyway the owner has got bigger irons in the fire and has just lost interest in smaller properties. He hasn't raised rents In years and has left half of the duplex empty for about a year. The median rate for a 3/1 apartment in this area is $200 above what he is charging. I would like to raise it $100. C+ B- property. I don't want to shock the existing renter and scare him away. How should I go about this?

Erik W. · Answer

@Wally Klosner, market rent, by definition, should be the rate at which renters and willing and able to absorb the inventory within 60-90 days, assuming you are marketing properly.  What are your fears?

1) Insufficient cash reserves to handle 60-90 days vacant?

2) Your measure of market rent is inaccurate?

3) Something else?

There's a balance between irrational fear and irrational exuberance when raising rents.  Our job as investors is to find out the facts and act accordingly.  Too many land lords are afraid of raising rents, but when I probe for the reasons I find often they either don't know their market well enough or haven't built up the necessary cash reserves all investors should have.  Or they are just afraid for no real reason other than "the tenants might move."  So what if they move?  Even tenants paying cheap rent could decide to move tomorrow, if their needs change.  Cheaper rent doesn't guarantee you long term tenants.  Tenants move when tenants decide to move.  Plus, a reasonable vacancy followed by a higher rent isn't as bad as one might think.

Think of it like this: $750 rent bumped to $950 ($200 extra) means you can "eat" about 1.6 months of vacancy per year and still come out even financially compared to bumping only $100.  Also, in most cases, higher rents attract better quality tenants, which is an often unmentioned benefit of catering to a higher income clientele.  As much as we'd all like to think a dollar of rent is a dollar of rent, the truth is a $950 / month rental attracts renters that are often more stable and less likely to tear up your property.  There is also less of a sense of entitlement among tenants who pay fair market value, whereas those who are getting a bargain seldom remember to be grateful or appreciative toward you for subsidizing their living expenses by giving them cheap rent.  That has been my experience over the past 15 years, anyway.

Bottom line: I am not advising you to act irrationally either way.  I would like you to examine your fears, find out if they are valid, and then act accordingly.  I hope this helps and best of luck!

Ronan Donnelly · Answer

Hi @Wally Klosner, it is great to find a property with below market rents since increasing them will allow you to create equity in the property. Ultimately, the faster you get to market rents, the faster you increase the value of the building which you can then use to refinance and get your capital back.

Your key concern is to minimize the loss of rent if one tenant leaves and you have to find a replacement. Here are some ways that you might want to think about that risk

1) What does supply/demand look like in your area and how long do you think it would take to get a market rate tenant

2) Set expectations with the existing tenants that you would prefer them to stay and therefore you will be implementing a small increase but that they will still be below market and will therefore save $x per year over a comparable rental

3) highlight any additional value that you will bring in return for the higher rent e.g. more responsive management, rehabs, additional amenities etc.

4) Assess whether the tenant is one that you are interested in keeping e.g. do they pay their rent on time and do they look after the unit

Good luck!

Erik W. · Answer

You didn't say how much the rent is today, so it's hard to know how big of a percentage increase this is.  Example, a $100 raise of a $1,000 rent is a much lesser shock (10%), vs. a $100 raise on a $400 rent (25%).

If it were me, I say rip the band aid off.  Let them know you've bought the place and rents are going to market within 3 months (or whatever), which will give them plenty of time to find another place or to see how reasonable your rent rate is and pay it.   There's no reason for them to move to a different unit of the same type, because market rent is market rent.  They won't gain any savings unless they downsize.  They've had a nice, long time to enjoy paying less than market.  They can be grateful for that.

Don't be afraid to raise rents.  The loss whatever a month's rent is for turnover will be recouped within a few months or a year when you are at market rate.  Even if you bump it $100, that's still $1,200 per year lost.  Adds up fast!  We're in tax refund season now: time to get new tenants while they have money to pay the moving and move-in costs!

Mike Cumbie · Answer

Hi @Wally Klosner

I'd work on getting the second side rented and the value add rented before I started kicking the only paying tenant around. There are spaces to fill and I would concentrate on that first. Much better to have low rent on one and no rent on one than no rent on 2.

Just my 2 cents and good luck!

Michael Ealy · Answer

I totally agree with Erik's answer.

If you've done your due diligence and found out the rent is undermarket by $200, then you should be willing to increase the rents by $200. Yes you can stagger it to avoid "sticker shock" but you can justify the rent increase by improving the apartment (new paint, new flooring, new appliances, landscaping, etc). When they see how beautiful the unit is they will be more than willing to pay the higher rent.

And Erik is right in saying higher rent will attract better quality tenants anyway. So yes, you can have all units empty as a consequence of increasing the rents but once you fill them with better tenants, those tenants will stay longer and not trash your apartments.

Let me give you an example. We bought a 96-unit building, 20% occupied and people told us you can never get rents higher than $500-$550/month in that area. Well, we got the Tapestry report showing that the median income in the area is $44,000/yr. So we know that they can afford a higher rent BUT WE NEED TO GIVE THEM A BETTER PRODUCT than what they were used to. Our philosophy is to deliver  a "B" looking unit for "C" areas so they feel the higher rent is worth it.

The result -we proved the naysayers wrong and simultaneously increased the occupancy to 94% and the rent (we got an average of $679/unit/month a 29% rent increase!). We sold it 2.5 years later and made $1.5 MILLION profit because we INCREASED THE RENTS TO MARKET (but justified it with great looking apartments).

Wally Klosner · Answer

@Ronan Donnelly very helpful thank you very much.

Cory Lucas · Answer

@Erik Whiting good info, good share. Thanks

Wally Klosner · Answer

@Peter Nikic thanks for the response. This site is awesome. I'm going to take everybody's advise and combine it to come up with the solution.

Wally Klosner · Answer

@Marlen Weber thanks

Wally Klosner · Answer

@Michael Ealy thanks Soo much guys!!! This site and the helpful people on it are pretty sweet.

Raising rent on inherited tenants??

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