How to raise rent when unit is well below market value

Question

My fiancee and I are buying a duplex in Brunswick, Maine that has a great location. Walking distance to multiple local restaurants, Bowdoin College, public library, park, grocery store, etc. My fiancee and I will be living in the downstairs unit. The tenants that live in the upstairs unit are supposedly very nice, do not complain and keep the unit in great shape. The upstairs unit is a 5 bedroom, 1 bath that is currently renting for $1,150 with heat included (old house so separating heat will be a project) which is far under any comps in the area (between$1,500 and $1,900). My hopes would be to rent it for $1500 with heat included, but I can't see the tenants staying if I increase the rent by $350 a month.

We are looking for suggestions on how to handle this. Do we take the cut in rent because they are good tenants or just risk them leaving and hope it gets filled at $1500?

Thank you in advance!

We are looking for suggestions on how to handle this. Do we take the cut in rent because they are good tenants or just risk them leaving and hope it gets filled at $1500?

Thank you in advance!

Will Fraser · Answer

Hi @Jourdain Francine!  Welcome to the Bigger Pockets forums and congratulations on the sweet house-hack situation you guys are walking into!

Here is how I handle this in my business:  if I really do enjoy the tenants and want to keep them around, then I'll present something like this to them:

" Hey tenant, here's a document that shows what the market rent rate is for your unit.  $1,500!  Isn't that nuts!  I know you've been here at $1,150 a month and I enjoy the interactions we get to have so I want to propose the following options as potential wins for you.  While I can't know what exactly constitutes a win for you, I thought the best way to find that would be to present options:

- Month to month least at the full market value = $1,500/month.

- 12-month lease at $1,400/month

- 30+ month least at $1,250

While I know this puts your rent increasing, I want to illustrate what I'm doing to be a blessing to you.  Worst case scenario you live in this place that (I hope) you love for the fair market rent, with maximum flexibility (MTM).  Otherwise you can have a slight increase and still be getting a $250 discount EVERY.SINGLE.MONTH.  Add to this that you can lock this in for as long as you'd like with no annual increase (which, BTW, would typically be at least 5% each year)!

What I love about this is, as long as they are truly people I want to keep around, I'm creating a menu of options that are all fine for me.  That allows them to clarify what they truly value .. . if they want to stay they they can lock in a rate that works for you for a "long time".  If they value the flexibility then you are compensated with the fair market rent and they may very well end up staying . . . a long time.

Nathan Gesner · Answer

I agree with others that you need to be more accurate in your assessment. Is it worth $1,500 or $1,900? That's a big difference and you need to know.

Once you settle on the value, notify the tenants that you intend to increase the rent to that amount. If they want to try and stay, you should make them apply and pass your screening to ensure it's affordable. The biggest factor is that they make 3x the rent, which is probably unlikely if they are that far below market.

I disagree with @Will Fraser about giving them a break. A $250 reduction in rent is $3,000 a year. If you feel that generous, you should give it to people that are starving to death in Africa or a battered-women's shelter instead of a tenant that wants a nicer house than they can actually afford. When you rent below market, the tenant treats it below market. Many Landlords mistakenly think tenants will appreciate the discount and behave better but the opposite is true in most cases.

Let them know what it's worth. Make them qualify like anyone else. If they can't/won't, you can both move on.

Marc Winter · Answer

@Jourdain Francine, first congratulations on your investment!

Introduce yourselves as the new owners, let them know you'd like them to stay on, and will discuss a rent increase in the spring.  Get through the winter so you don't have a vacancy and see how much your heating bills are in real-time, and you'll see if they are prompt payers, and respect other people's right to quiet enjoyment.

I'd start discussing increases around middle of March, and feel them out and educate them as far as what would be market rent. By that time you'll have some heating bills and other proofs of expenses to help them understand your position.  See what kind of numbers will work for them and yet be acceptable for you.

Anthony Wick · Answer

@Jourdain Francine . Find out what the market rate rent should be, and set it at that, as soon as you can. I would send them a written notice asap. $1,500 to $1,900 is quite the range. Find out what you can actually get. It is not your place to subsidize their rent. No, you do not give them a discount. They will almost assuredly leave. That is ok. It's also ok if they don't like you because of this. Very doubtful you ever get tenants for life. Do NOT negotiate with them. They will want to negotiate on everything moving forward. It is your property, you set the terms (nicely, of course. But firm). Imagine losing $400-500 a month because "they're nice people". Ugh. $6k a year, $30k in 5 years, $60k in 10 years. And that's before any investment returns on that lost profit. Yes, they're going to leave. Now that you know that, go get that rent up to market rates and start making the profit you intended to.

John Warren · Answer

@Jourdain Francine I have gone through this experience recently, and I recently told my wife that going forward I will almost always clear buildings out if I have major renovations in mind (hvac). Dealing with inherited tenants can be dramatic, and you have all these tough moral/ethical dilemmas. If you clear everyone out for renovations, you get to jump to market rate with tenants you have placed right away. I REALLY prefer this route if you can afford the up front vacancy.

Isaac S. · Answer

Also, in this situation where you have few units, you need to consider the turnaround time/lost rent, and fixing/cleaning it up to be move in ready.

I would probably give them a 10% bump, that's about a third of the $350, explain that cost of heating and the new assessed taxes are mostly to blame for this. So, now you are $1265 with good tenants and no turnover costs. Do not sign them on long lease, only 12 months, and then raise it another 10% in 12 months, that puts you at $1391 in 24 months....they are still getting a pretty hefty discount from market rates and when you factor in 1-2 months lost rent and $500-2000 in turnover cost, you end up at about the same return as loosing them and finding a $1500 tenant now combined with the aforementioned expenses.

However, if you could realistically get $1600-1700+ and keep a tight leash on your turnover time and costs(no major remodel, basic paint and maintenance)  and only 2 months max vacancy, you should probably bite the bullet turnover the unit. The compounded return after you cover the lost rent and turnover expense, will be very worth the pain now for a much better cash flow in 8-12 months.

Good luck and happy new year!

Nik Corbaxhi · Answer

@Jourdain Francine, congrats on your purchase! $350 seems to be a lot to leave on the table for just being nice tenants. Is there any way you can ask the seller for any history? At least you can attempt to get some info as far as how long they have been there, etc.

If similar properties are going for $1500-$1900, I would definitely have a conversation with them. I believe it is all on how you approach the situation. I would have an open and honest conversation about the facts. Be prepared to provide them with some examples of comps, only if they ask for how you came up with $1500/month. Also, not sure if they are on a contract or not, but I would make the changes starting at the end of the current contract. If on a month to month, try to give them a break and tell them that you will keep rent the same until March or April. Trying to get people to move in during the winter months is a bit harder. Hopefully, they will see the value and you will be able to persuade them to stay.

Another tactic is to say you will raise the rent to 1600 with the heat included. After their expected dissatisfaction, tell them they are great tenants and that you are willing to slash the price to $1500 for them.

Looking at the facts though, you can't loose much. Work with the timing and if they decide they will move on, while you give them notice to vacate post it and start showing it to other new tenants.

How to raise rent when unit is well below market value

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