How do you deal with tenants paying very low rent?

Question

Hi all,

I came across a very appealing 6-unit building in a great neighborhood and while looking at the current tenants' rent info, I noticed all units are paying incredibly low rent. The building is C-class but my idea would be to upgrade it to B or A. Now, the question I got is about these tenants, this may be a very basic question but how do you upgrade the rent to current market value? Do you need to kick people out at the end of their lease? What are the options?

I'd appreciate any help

Thank you!

John Warren · Answer

@Joan Pla this is always an issue when you are doing any kind of "value add" investing. I personally consider each situation differently. My very first property was a four unit in Lyons, IL, and I inherited four fantastic tenants. I was very nervous about raising rents, and I ended up doing one larger raise the first year, and then several smaller raises each year after that. My goal was to retain the tenants by keeping rents lower than market, but still getting their rents closer to market so that I wasn't losing tons of income.

Any land lord will tell you that turnover is your biggest expense. If you have good tenants, it may not make sense to push the rents as hard as you can.

Alternatively, I took over a nine unit property in Berwyn where we had some lousy tenants. We issued 30 day notices to 5 of the 9 units, and ended up having to evict 1 of the units. In this situation, I inherited a lot of bad tenants and acted accordingly. I do still have 4 of the units leased up to the tenants we inherited who were decent quality.

Pat L. · Answer

We inherited several long term tenants over the years & everyone was brought up to mkt rent. One in particular was paying $550/mo we bought them a new stove & upgraded the furnace as their heating costs were very high.

We raised it to $820/mo & not a squawk they even offered to pay $1200 cash if we would add central air to the new HVAC so we took them up on it.

Our 6-plex was gradually rehabbed & brought up to above mkt rents quickly with new tenants. We simply gave the C-grade tenants we inherited 30days.

Sam Shueh · Answer

Ideally you start renovate one unit at a time charge new tenants market price. The rest will get the message by vacating or willing to negotiate a higher rent. The difficulties are those with verbal lease or dated lease. That is what happened in San Francisco. Where seniors who have lived there for decades are being asked to leave since landlord is charging $10,000 per appointment.  You need to check local rent control ordinance.

Amit M. · Answer

LA has rent control. You can’t just end their leases. Maybe buyouts? You need to understand the local rent control laws very well before buying.

Simple answer why that bldg is a cheap!

John Warren · Answer

@Joan Pla I think a lot of this will depend on your market, but yes my experience has been good. Most of my tenants are very comfortable in what is essentially their "forever home". They won't move unless you jerk the rent too high too fast. This is where the soft skills come into play. For instance, in my Lyons building I have been moving them towards a market rent that is probably around $850 per month. All of them are now paying 730-750 per month. Some folks on here would tell you to raise rents all the way, but that would take money to turn the units, personal time to manage the rehab and releasing and it would gravely lower my returns for the year. Instead, I have made significant raises every year, and in year 4 or 5 everyone will be at market either way.

Nathan Schiess · Answer

Once you know what the market rent is in the area, I would call around to other landlords to see what their vacancy rate is and how long units usually sit vacant for. This way you will know what to expect when you move your rent up to the market rate. If their units are in similar condition to your units and their vacancy rates aren't too high, then you could raise rates without doing much work to the property at all and know that you could find new tenants to fill your vacancies.

If the rate that the tenants are currently paying is far below the market rent, then the added rent you would be collecting from the tenants that decide to stay could alleviate some of the pain you will feel from having 1 or 2 of the other units sitting vacant for a little bit.

Another simple solution is to not renew leases when they come due. The key to this is to know the terms of your lease. If the leases are month to month agreements then it would be incredibly easy to not renew their leases (one-by-one like @Sam Shueh recommended or all at the same time), rehab the units, and get them leased at the higher market rents.

To hedge some of your risk, I would see what the demand for these apartments would be after you rehab them. Post some ads with the higher price point and a description of what the property WILL look like. Use photos of an apartment that would be similar to what you would like yours to look like after the rehab is complete and see what kind of a response you get. If you get enough responses that you feel like there is a good demand for this kind of apartment and you could replace the tenants relatively quickly, then bump the rents all the way up to market rent and let tenants choose to stay or go.

In addition, the people who responded to your ad can be told that the unit has already been leased, but you will put them on a waiting list and contact them when the next one come available in a month or two. (The 4-hour Workweek strategy)

Joan Pla · Answer

@Amit M. thanks, that's what I was thinking, it had to do with the rent control.

Joan Pla · Answer

I know for fact that the rents some of the tenants are paying are even less than half the market average.. additionally, there is a high demand around the area AND I've seen the development plans for the years to come and it's very interesting, that's why I mentioned going from C to A-class (@Dennis M.)

@Pat L. Interesting points about upgrading some of the appliances, AC, etc... thanks!

@Tami R. I agree with the value of good tenants, there's always time to do the renovations.

@John Warren the gradual increase of rents seems to be the best way to go for me.

I appreciate everybody's inputs,  your comments are giving me a broader perspective. With all that said,  there is a key component that is important for me. It's the tenants themselves...I know business is business but my business decisions could/will have a strong impact on the tenant's personal lives that's why I want to understand different angles so to make sure whichever decision I make goes with my personal values.

How do you deal with tenants paying very low rent?

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