What to do with my rental?

Question

My tenant's lease is up at the end of April, and like many other places in the country I'm looking around at the real estate market here in south Florida and seeing everything skyrocket. I've had this tenant in place for 5 years now, and he's been pretty decent overall. He pays rent on time, and doesn't cause problems, aside from a big red flag that he's been caught subletting the property without my knowledge/approval. He currently pays $1500/mo for a 2/2.5 townhouse. Stupidly, I haven't been raising the rent on him the last few years, because I thought that it would cost me more to clean/list the property again and have a vacancy month with no income. So now I find myself way below the market rent of $2000-$2300. I aim to fix that now.

I'm debating whether to raise his rent to $2k, or just not give him the option to renew the lease so I can find a new tenant at market rent. If I let him go, I would need to swap out the washer/dryer and repaint, as well as fix any other issues that I'm not aware of. I'm confident I could get the property turned over and rented for at least $2k within the month. I would be the listing agent as well, so I could save half of the commission there.

If I decide to keep him, I'm not sure how he would take the news of having his rent raised $500 all of a sudden, but I'm sure it's going to come as quite the shock. If I had only raised it $100/year, it wouldn't be such a big change, but here we are. I could also raise it by only $200-$300, but that would be leaving money on the table, which I'm not happy with either.

I also am considering selling the property in order to 1031 exchange into another rental or two. I paid $125k for the place (owe $80k now), and these units are now selling for $300k+. With my location in the community (on the water/lake), I'm sure I could be at the top of that selling price if I did some renovations prior to listing. I would need to do all 3 bathrooms, and probably put new floors in upstairs since the laminate is older. The kitchen and downstairs floors are in good shape.

Obviously, with selling there are a lot more variables to consider. I would need to get a rehab cost, and more importantly have a plan in place for what to do with the profit so I don't have to pay taxes. Turning my 1 rental into 2 rentals would be ideal, but in this local market I don't know if I could do that.

So what do I do? I want to give my tenant as much notice as possible. It's 2 months out from the end of the lease, so ideally I want to make a decision this week to give him the heads up.

Thanks so much for your replies.

Nathan Gesner · Answer

Dump the tenant. He's been making money off your property without your permission. Get rid of him and place a tenant that can easily afford the rent and abides by the agreement.

Joe Villeneuve · Answer

As soon as I read you were at almost 75% equity (gulp) I lost my breath.  Do you know how long you've been losing money?  Do you know how much you have lost?

Here's what you need to do:

1 - Start putting all of your time in finding replacement properties for this one using about $180-200k in cash for DP money.  That would mean a new total PV of...$900K - 1M,...not just the $300k you have now.2 - Before you raise the rent on your tenant, check to see what the limits are in your state.  There are limits.  You'll probably have to do it in increments.

Tim L. · Answer

Just to follow-up: I spoke with the tenant and he agreed to increase the rent to $2k.

Adam Schooley · Answer

@Tim L. I just went through this same scenerio a couple of years ago with my duplex in Ft Lauderdale. I had renters/friends renting one side that I didn't increase the rent for 5 years.  Meanwhile taxes and insurance went up every year especially when a property is not homesteaded.  When I told them I needed to increase the rent by $400 per month and that I would bring it up slowly they agreed and don't you know these so called friends went and bought a house within a couple of months.  I was able to rent the unit right away so it wasn't a big deal.  I ended up selling my duplex because I had a ton of equity in it which I regret doing now!  I haven't been able to replace that duplex with anything near as nice. I should have done the HELOC and used it for my next deal.  A 1031 is a great idea but you have a very limited time and it might force you into a deal you might not be happy with. I would not sell it. Hold for long term wealth, pull equity out to buy your next rental property. Just my two cents. Good luck!

Estela Almeida · Answer

Raise the rent - once he starts looking what he will have to pay for a similar property (and how hard it is to find something), he might decide to stay.

Caleb Brown · Answer

Raise the rent, the tenant will stay or leave. You can pull a HELOC to utilize the equity to scale into more deals. If you wanted to get aggressive I'd 1031 and find a MF or a couple STR. Florida is hot so I'd think in 1-2 years it'll keep going up. Weigh out the Pro's and Con's along with numbers then decide and take action. Good buy :)

Mackenzie Grate · Answer

This is always a tough one. I guess my main question would be, what is your end goal and how much time do you have right now to commit to it? If your end goal is to scale and you have extra time and energy to do the rehab, list the property and scout for a new like-kind property for the 1031 exchange, go for it. To me, it doesn't matter whether the market is way up, or if it down when you do that. You are still going to be looking for a property of equal or greater value to put your money into...

If you don't have a lot of time and energy, I'd let him know of the rent increase now and give him the option to renew the lease or not. I don't love the idea that your tenant has been violating your lease by subletting it out. That is concerning as there could be extra damage to the unit that you don't know about. So it is important that you have this conversation sooner, rather than later, and inspect the unit to assess any additional costs. If the tenant decides not to renew, then you will have a clearer idea of how much you will have to put into it. If the damage is more excessive than you thought, it might be worth it to fix it up and list it, and trade up.

Just a few thoughts. No matter what though, I recommend you raise the rent and get in the habit of raising it regularly. People are afraid that if they do that "good tenants" will leave. In my experience, as long as it's a fair amount, and not excessive, quality tenants tend to stay if they are happy with how the property has been managed. It takes a lot of effort to find a new location and move, especially in this competitive market.

Good luck! Sending good vibes your way with this tough decision. I know you will figure it out though :)

Andrew Frowiss · Answer

Hi @Tim L. Thanks for posting! I have a few thoughts on your situation.

I'm not a fan of extremes so instead of increasing the rent by $500, I recommend seeing what he is open to paying for an increase. If you can increase the rent by $200 or $300 this year and keep him in the house you can put off the makeready a little longer. I always figure rehabs are going to cost more than what you expect, and you should weigh that against the cost of the rents you would otherwise lose if you only increased the rent by $200 or so. Would you lose more on the rehab or in rents?

If you do a 1031 exchange you would need to consider renting it with the Tenant or without. I expect Sellers to net more when their properties are vacant so the new Owners can occupy them. That being said you could still do both of these avenues. Increase the rent, and if you still feel bad about how your investment is going later on, you can always just sell.

When are you looking to retire? I ask this question because it leads to another set of questions. Are you interested in building wealth right now? Or are you looking to retire and need cash flow?

I tell my clients who are trying to build wealth to invest in areas with high appreciation. Austin TX is a high appreciating market, but not much of a cash flow city anymore. Buy a property (or two) in an area like this and hold it for a few years. Build up your equity and when you are ready to start raking in the cash flow, 1031 your funds into a market with lower appreciation/purchase prices, and higher cash flow.

Good luck on your future endeavors!

Tim L. · Answer

Great responses team! I'm leaning towards just raising the rent to market rate, if he stays, fine. If he leaves, also fine. Then I can look into a HELOC in order to get some cash out to get the next deal going. I truly appreciate the help, everyone!

Dave Foster · Answer

@Tim L., The raise the rent now crowd are right.  So are the "how will he react" crowd.  But what if you gave him some options to see what his mood/flexibility was.  Let him know that you're weighing your options and have to raise rent if you keep it.  But might sell.  Maybe he would like to buy it?  I know he would be flattered that you at least thought of him.  And that offer might offset any resentment when you do go ahead and raise rent.  Who knows maybe he can buy it.  And you save some realtor fees.

You do have a ton of equity that could be put to work for you.  And townhomes typically come with HOAs that very often drag properties down when a market corrects.  You could easily make a much higher ROI with a sale, 1031, and put into an asset that at least didn't come with the ticking bomb of an HOA.

What to do with my rental?

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