Planning For Rent DECREASE?

Question

Do you account for rent decrease when evaluating whether or not to purchase a rental?

If so, how do you estimate the decrease?

If not, what assures you that the rent will not dive so low that you are no longer cash flowing?

Account Closed · Answer

Rent prices don't normally have anything to do with the rising and falling of property values.  It's really a totally separate beast.

When the market completely tanked in Silicon Valley around 2007ish, rents also tanked for a short time.  For us, the problem when the crash first happened, was because many people lost their jobs and had to move back "home" or in with family until they could find another job.

This left us with about 20% vacancy almost overnight.  What we did, though, is we marketed to a new type of tenant.  The owner's building was next to a university.  He didn't want to rent to students.  But, I suggested we target graduate students.  The university was not hurting for students.  This change in marketing to a new type of tenant worked for us.  They were happy to pay top market for an apartment within walking distance to the university.

That said, I did have a tenant present a case at the beginning of the crash, who printed out Craigslist ads showing rents had decreased, and requested a decrease in their rent.  We split the difference with them in what they were asking and what their current rent was.  So, for one tenant, we did decrease rent.

We did also lose a few tenants who took advantage of the market crash and they left because they bought homes.

I would only foresee rents decreasing for your investment - if the market was to crash, though, or if a big employer or university (your tenant pool's "employer") disappeared or cut back their force severely.

But, what happened in Silicon Valley is that even with the market crash, and the 6 - 8 month decline in rents - is that then the foreclosed-upon owners were now looking for rents, and rents not only came back to where they were, but soared way beyond what could have been imagined.

So, unless your rental is in a town where the only employer may go belly-up (a one-factory town), you probably won't have to worry about it.  And if there is any other possible tenant out there you can target (like students for us), you should be fine.

Carson Sweezy · Answer

Account Closed alluded to, if housing prices decline, and rent becomes more expensive than to own, which it is in a lot of areas, then won't rent amount decline? If I was cash flowing $200 a month, but rent drops $200 over time, then I'm breaking even.

Maybe I am trying to plan for something that is impossible to predict. Just trying to evaluate all possible scenarios.

Account Closed · Answer

@Carson Sweezy

Thanks for the clarification!  We have been buying real estate since 2005 and have never seen a rent decrease.  We have stayed steady for several years, but never have we seen a decline.  And we are 100% occupied currently.  Good luck!

Account Closed · Answer

@Carson Sweezy Interesting question.  If you are asking how do I know the rent amounts a potential seller is telling me is accurate, that is a very valid question.  I typically drive the neighborhoods and call several FOR RENT signs to see what they offer (BR,BA, Square footage, utilities paid, etc) and see how it compares to what the seller is stating he gets.

The other way is to ask for the current leases and verify that is what he has locked in.

Finally, you could knock on the tenants doors and tell them you are considering buying the building and trying to verify what they pay for rent.  If they balk at sharing the info, I tell them I am asking to make sure I don't end up charging them more by mistake.  It works!

Good luck!

Bryan N. · Answer

When analyzing a property I put the rent reduction into the numbers before buying.  If the property will rent all day long at $1,275 a month, I factor $1,200 a month.  If that number works I buy.  If it doesn't, I move on.

Carson Sweezy · Answer

I think what Michael was referring to was finding comparable properties that are for rent, and asking them how much they are renting for.

I would like to hear more about your strategy though, John. Are you suggesting that by requiring an estoppel, that if rent is not what the seller admits it to be, their is a breach in the contract?

Jeff Greenberg · Answer

I think the more important issue is how much of a rev decrease can the deal withstand.  Even though we only buy in improving markets there is always risks with the local or national economy.  Make sure that the deal has enough play and you have enough reserves.

@michael dowd (@ not working) most of the seller I have dealt with would have kicked me off of the property with a shotgun if I let anyone know I might be buying the place.  You can accomplish the same thing by secret shopping the leasing office.  You also will get to the actual leases during the DD period. Faking the leases would be considered fraud.  If you really don't trust the sellers you could require estoppel letters.

John Thedford · Answer

Odd question! What would make you assume a rent decrease? Is the current rent well over market rate? Is the current ASKING price too high and the property is vacant? Do you see a market shift to lower rents for your area? I always plan on getting market rents and usually plan on small increases (kind of like cost of living increases) on a yearly basis. If the economy sours, lots of people lose jobs, vacancies increase, etc then at the time I will work with the current market situation and adjust accordingly. Hopefully, that won't happen anytime soon (or at all).  As for assurances that the market won't dive lower than OE, etc...nothing is guaranteed.