Mostly Month to Month tenants in a Multifamily - Big red flag ?

[David C.]

(Sorry for all the M's in the title)

Fellow BP-ers,

An OM crossed my desk which seemed promising, a 9 unit multifamily which had decent cashflow and the numbers would work at a slightly lower offering price.  However one thing stuck out like a sore thumb - 5 of the 9 units were on Month to Month leases.  

Interestingly though, two of these month to month tenants have been there for 6 years, and two have been there for 2-3 years.  I did note that these month to month tenants had been paying less rent than the long termers who have yearly leases for similar units.  As such, I am thinking that if the rent is raised to the proper rate on the month to month tenants(to align with the others), they may take off and destroy the cash flow.

That being said, I would put the question to you, of those who own multifamily properties, would this raise a red flag for you and what are your thoughts?

Dave

[Ken Dunn]

I would say that having existing tenants on a month to month lease is NOT a red flag. In fact, it would be a good thing when you purchase a rental property, be it single or multi-family. As @Jonathan Greene pointed out, it is much easier to evict for upgrading units to re-rent at a higher rate.

Like most landlords, I have a one year Lease agreement. I also manage my rentals. If I am not sure I want to keep a tenant after the one year is up, I often let the Lease automatically default to month to month (at month 13) so I have greater flexibility. Of course, they also have flexibility to move out on shorter notice.

If I KNOW I want them out after 1 year (too much drama, not getting along with neighbors, etc) and they have not violated the terms of the Lease, I simple do not renew the Lease when it expires in month 12 and give them proper advance notice.

If they refuse to move out, they are “Hold Over Tenants” and can be evicted.

If they are great tenants, sign a renewal for 12 months (but be sure to include a rent increase, even a small amount, so they come to expect it every year).

I try not to have my Leases expire in the months of Nov through February. If they do, I can let it automatically default to month to month and wait until March or later to renew. That way, I avoid trying to find a new tenant during the holidays and Texas winter months.

By having 5 of the 9 tenants on month to month, you have the flexibility of raising rent on just one or a few of the 5 tenants at a time. I would not do all 5 at the same time since you do not know if some or all will move out and wreak havoc on cash flow.

If you are going to remodel and then raise rents, you can space out the projects / tenant move out dates to suite your cash flow and rehab budget.

You mentioned that the numbers work at a slightly lower offering price. What happens if some/most of the rents increase by $25 to $50 each? Is there potential to raise rents even more due to deferred maintenance / lazy landlord not adjusting rents to market rates?

I recommend taking a good look at each of the units and compare their condition/amenities to comps close by to get an accurate rental rate.

For example: I purchased two 4-plex properties in N. Texas last January, just as Covid was taking hold. The buildings are next to each other. There was a lot of deferred maintenance with 4 units vacant and 4 units with rents too low and 8 months left on their leases. The previous landlord got leases signed in preparation to sell, but he did little else. He was about 78 years old and owned them for at least 20 years, paid off, free and clear.

I was investor #4 to walk the units. I guess the first 3 just saw too much work/repairs/headaches or did not realize the potential to raise rents in a big way. They may not have thought to negotiate a large discount on the purchase price by documenting/hiring property inspector/taking own photographs and presenting findings to listing agent and owner who had not walked the property in over 3 years.

The 4 units that were rented were, $600, $700, $700 and $800, with both of the $700 units being 3 bed 1.5 bath at approx 1,100 sq ft. The two others were 2 bed 1.5 bath at approx 925 sq ft.

Once the existing leases were up in Sept 2020, I raised rents by $200 each on two and $225 each on the other two for an extra $850 per month in cash flow. Since the original tenants were still in these 4 units, I did not rehab, just regular preventative maintenance. I recently bumped them again in Sept 2021 by $25 - $30.

In Jan/Feb 2020, I renovated the other 4 vacant units and quickly rented them in Feb/March for $900 to $925 each. 

I am about to renovate one of the 3 bedrooms (original inherited tenant just moved out) and expect to rent it for $1,150 to $1,250 (depending on how much my wife allows for renovation budget). Rough estimate is about $9,000 remodel.

I plan to hold these properties for the long haul, at least 15 to 20 years, unless I do a 1031 exchange into something bigger/better. 

Hope this gives you some helpful ideas.

Best regards,

Ken

@Jonathan Greene