Raising rent on inherited tenants vs rehab & raise rates

[Nate Ginsberg]

Hey friends!

My wife and I will be house hacking a duplex - our first deal! - and the tenants in the other unit have been there 10 years!! Since the seller bought the house, actually. The seller never raised rents during that period, so the tenants are paying $1150/mo, which is ~$350 below market. According to the seller they have been model tenants.

As my wife and I have debated this, she’s pushing for us to screen and keep the tenants slightly below market (assuming they pass the screening). She would have us keep the rent ~$150 below market initially, to help make sure the tenants stay. I said we should boot them, give them cash for keys if necessary, renovate their unit to open up the floor plan and rent for ~$100 above market rent since. For reference the house is a B property in a B neighborhood in central Mass, the units are side-by-side and each has 3 bed, 2 bath, plus about 800 sqft attic and 800 sqft basement space.

Using her way we potentially have zero vacancy and zero reno costs but are giving away $1200-1800/yr income. My way we probably incur $15k reno costs and 2-3mo vacancy, but make $2400-3000/yr more in rent. Using the current rental rate to estimate vacancy cost, our cash on cash return for the reno should be ~13-16%.

Which would you do?? I appreciate any advice the community can share!!

[Matthew Dennehy]

At a minimum you always want to screen holdover tenants and have them sign your lease. You can’t do this if they’re on a current lease, but leading up to its expiration you certainly can.

One consideration you might have is the condition of their unit. If it isn’t up to current housing code or there are significant defects, then you want to address those up front, which might require the rehab.

Also, if you have extra cash burning a hole in your pocket and no other place to invest it, it might be wise to rehab for a better return.

Otherwise, letting them stay might be a much easier route. Just make sure to bring rents up initially to where you need them to be, it won’t get easier by waiting longer for that.