Purchase Price is Market But Rent is 10 Years Behind

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Purchase Price is Market But Rent is 10 Years Behind

Adah N.
Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes

Would you buy a 2-4 unit property that needs 85% increase in rent to match market rate and purchase price?

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Nathan GesnerBusiness Member
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Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
5y

I try to buy it based on what rents currently are, not what they could be. If the rents are 85% below market, it's unlikely the seller would base sales price on that because it's obviously worth more. I would probably try to meet somewhere in the middle by justifying a lower purchase price based on the amount of money lost with current rent rates.

If rent income should be $3000 a month but it's only $500 a month, that's a loss of $2,500 a month. Spread over a year, that's a loss of $30,000. So maybe you approach the seller and tell them the building is worth $200,000 but you'll lose $30,000 the first year before you can get rents up to market. Offer $170,000 to compensate you for the projected losses and the work it will take to bring them up to market.

It's the same thing you would do with a bad roof. A home in great condition is worth $200,000 but you notice this one needs a new roof and it will cost $15,000 to have it replaced. So you offer $185,000 to compensate you for the cost of the new roof.

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  • Steven Marttinen
    Rental Property Investor · Jordan, MN · Member since 2021 · 24 posts · 16 votes
    5y

    @Adah None

    I wouldn't.

    0Reply
  • Patti RobertsonBusiness Member
    Property Manager · Virginia Beach, VA · Member since 2016 · 2k+ posts · 2k+ votes
    5y

    I buy in a market that dies t have rent control, so I base my decision on the building and market rent, not what the current tenants are paying. Low current rents make for a good buying opportunity. Tenants are temporary. 

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    10Reply
  • Sean McKee
    Rental Property Investor · Chicago, IL · Member since 2017 · 269 posts · 189 votes
    5y

    @Adah N. I actually just purchased a building like that.  It needed a lot of TLC.  Which explained the low rents.  I don't see why not, as long as your market analysis confirms the rent increase, you've taken account the repairs, and your willing deal with the current tenants. You'd be surprised how far some people allow rents to lag the market. The owners usually don't want to make the repairs and are willing to accept significantly below market rents.

    3Reply
  • Nathan GesnerBusiness Member
    Moderator
    Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
    5y

    I try to buy it based on what rents currently are, not what they could be. If the rents are 85% below market, it's unlikely the seller would base sales price on that because it's obviously worth more. I would probably try to meet somewhere in the middle by justifying a lower purchase price based on the amount of money lost with current rent rates.

    If rent income should be $3000 a month but it's only $500 a month, that's a loss of $2,500 a month. Spread over a year, that's a loss of $30,000. So maybe you approach the seller and tell them the building is worth $200,000 but you'll lose $30,000 the first year before you can get rents up to market. Offer $170,000 to compensate you for the projected losses and the work it will take to bring them up to market.

    It's the same thing you would do with a bad roof. A home in great condition is worth $200,000 but you notice this one needs a new roof and it will cost $15,000 to have it replaced. So you offer $185,000 to compensate you for the cost of the new roof.

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  • Eric James
    Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
    5y

    The fact that current rents are low doesn't make you any money. What makes you money is the rent you could charge being high relative to what you would pay to buy the property. 

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    5y

    There needs to be some upside for you.  Otherwise, just go buy a property at market price with market rents.

    4Reply
  • Scott M.
    Real Estate Broker · Rochester Hills, MI · Member since 2009 · 2k+ posts · 2k+ votes
    5y

    Honestly, not enough info here to answer.  Are the tenants under rent control?  Are 50 year rock solid leases in place?  Anything in place that would prevent you from giving notice in the short term so you can re occupy with tenants are current rates?

    Also, no mention of the condition of the place.  Generally when rents are way below market rates the condition of the property is as well.  Lots of deferred maintenance.  

    Just not enough info on the leases or the ability to turn the units (income side) or the the condition of the units themselves (expense side).  

    0Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    5y

    If you buy this, I assume you will be bringing it up to speed as far as being able to ask top rent? Or are you just going to continue to slumlord? Or somewhere in the middle?

    Most importantly, you need to have enough money set aside to cover your holding costs for a few months while you renovate the units.

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Patti Robertson

    Thanks Patti, that sounds like a good plan. The market rent certainly supports the purchase price. However, not sure about the building.

    How do you communicate to someone their rent will have to go up 80+% to come close to market rate? In small chunks or one big bite? Does that thought make you want to think twice about buying?

    0Reply
  • Account Closed
    Investor · Boston, MA · Member since 2018 · 61 posts · 46 votes
    5y

    To me at least it's certainly a red flag. Consider the condition of the property-the current seller is losing out on a huge opportunity cost by not raising the rents-has he kept the property up to date or has he been neglecting upkeep? Worst case it needs a lot of work but it's selling at market rate-in which case the minute you try to bring the units up to market, the tenants will (probably rightly) leave to find a place in better condition for the same market rent-now you have to place a whole building of new tenants.


    Best scenario is he has been keeping it up to date and keeping the rents low anyway-in which case you have to double the rent and, while the tenants are unlikely to leave, they won't be happy.

    Either way, it causes trouble. It's fine to buy trouble properties, but you better be getting a good deal to compensate you for that trouble. If your paying as much for a trouble property as you are for a market property, it's overpriced. 

    1Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Sean McKee

    Thanks Sean. I think the biggest cause of lag in current rent is no rent increase over the years. Based on photos it needs flooring, appliances and paint to command market rent. Of course big ticket items like roof and HVAC may need to be changed but I don’t think those affect market rent as long as they are currently functional. The purchase price is however market rate.

    Have you had to communicate the big rent increase on the new purchase? How did it go? Will you renovate with tenants in place?

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Nathan G.

    Tenants are actually on month to month. Which seems to be the new trend.

    My biggest hang up is the need to raise rent by so much. As is, it needs about 60% increase. It needs about 80+% if upgrade a little to meet market as well as purchase price it. Unfortunately purchase price is already at market due to too much demand.

    How much is too much of a rent increase? State and city laws are not an issue.

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Bruce Woodruff

    Lol! No not planing to be a slumlord, I don’t think the current owner is though. He says rent is so low because they are great tenants and he has not raised rents in years. I will find out soon enough.

    1Reply
  • Stephen Brown
    Real Estate Broker · Huntsville, AL · Member since 2019 · 1k+ posts · 872 votes
    5y

    I'm in a similar situation and I believe I am going to pass on the property because in my journey right now I need all the cash I can so I can scale faster. If I spend it to upgrade and get more rents in a year or so... yes it's good in the long run... BUT I have opportunities currently with other properties that already cash flow. So think about it like that. Can you afford to take a big hit now given your current goals?

    1Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    5y

    What are current rents? If they're $1500, then a $100 increase is ok...but not if they're at $600

    0Reply
  • Patti RobertsonBusiness Member
    Property Manager · Virginia Beach, VA · Member since 2016 · 2k+ posts · 2k+ votes
    5y

    @Adah N. - 

    "How do you communicate to someone their rent will have to go up 80+% to come close to market rate?"  

    What I do is inspect each unit and have all the tenants complete an application upon purchase to find our what their household income.  Once you know how the tenants are taking care of the units and what their financial position is, make a decision unit by unit.  If the tenants are capable of paying market rents, put them on a rent increase schedule to get them to market rents.  If they can't, give them notice one at a time, with the worst housekeeper being the first to go, and replace them one at a time.  This will preserve your cashflow as you build your rent roll.

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    4Reply
  • Nathan GesnerBusiness Member
    Moderator
    Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
    5y
    Originally posted by @Adah N.:

    @Patti Robertsono

    How do you communicate to someone their rent will have to go up 80+% to come close to market rate? In small chunks or one big bite? Does that thought make you want to think twice about buying? 

    When A renter is significantly behind on rent, I do not recommend raising the rent and trying to keep them. Even small raises in increments are more likely to do harm than good. Periodic raises will result in confusion, animosity, and they will eventually reach a level that is unaffordable and the tenant may get behind on rent or decide to vacate anyway. Why waste your time or continue losing money to keep someone that can't afford it?

    it sounds like your tenants are on months to month leases, so just give them notice to vacate and be done with it. Clean the units up, then rent them at market rates to tenants You have selected.

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  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Mike Dymski

    Unfortunately investors are going crazy bidding up investment properties in my market and artificially driving up rents.

    Even with market rate rent and purchase price, the returns are not great in my market.

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Scott M.

    Thanks Scott.

    No rent control, lease is month to month. Units look fine overall and should command 60% more with the usual tenant turnover cleaning, painting . Roof looks fine, HVAC is from the ice age but works. Will need an inspection to get the other details.

    The biggest problem is how much increase is too much at a time. I get 10%-30%, anything more seems excessive. Best to ask them to leave but they will not get anything close to what they are paying. Rent is really from 10 years ago for that part of town.

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Nathan G.

    I see how it would cause animosity or tense owner/resident relationship.

    I agree it may be best to just give notice.

    0Reply
  • Adah N.
    OP
    Investor · Atlanta, GA · Member since 2020 · 294 posts · 142 votes
    5y

    @Tyler Lee

    I think he has been keeping up with needed repairs and maintenance.

    You know what I just realized, this whole notion of not raising rent because landlord wants to be a “good” landlord and wants to “keep” tenants can actually be bad for good tenants.

    Best to raise rent to keep up with market or a little under market but give incentives or update/upgrade property to a little better than market grade.

    1Reply
  • Gary L Wallman
    Rental Property Investor · Beavercreek OH · Member since 2018 · 422 posts · 970 votes
    5y
    Originally posted by @Adah N.:

    Would you buy a 2-4 unit property that needs 85% increase in rent to match market rate and purchase price?

     Absolutely. Have done it several times and love it, so long as you base your purchase price on the current rent role. Nowhere to go but up.

    Generally, I wait a while to increase the rents. Then I educate my tenants on current market conditions, but raise rents below the market. Most understand and appreciate the lower than market rents while they still have them. Within 2 or 3 years I'm near market rates.

    If folks can't afford and move out, I renovate, then move to 100% market immediately.

    Respectfully,

    Gary

    0Reply
  • Jill F.
    Investor · Akron, OH · Member since 2016 · 2k+ posts · 4k+ votes
    5y
    I won't buy with tenants if I can't cashflow at the current rent, which is probably going to be the case if the rents are way, way below market and you purchase at or near market price. I might ask for the building empty and discount my rent based on how much reno is required.
    0Reply
  • Chris John
    Member since 2020 · 671 posts · 937 votes
    5y
    Reading this from California is weird.  You guys can have tenants leave?  Man, I forgot what that used to be like... 

    I've passed on so many deals like this in my area of California recently, it's not even funny.  

    "At that price and with market rents, this thing will be a winner!  Oh, wait...  Current rents are 50% below what they should be.  I can't get the tenants to leave and it will take me 6 years to get to today's current rents with rent control.  Who knows what 6 year's market rents might be?  I may never get to market rents.  Better call Florida, I guess..."

    I get that appreciation and debt retirement are where the big money is, but I'd still like some cash flow to grease the wheels during the tough months when everything goes south.  I wonder if I'll regret moving my attention out of state when 2031 rolls around or be happy I did it.  Should be interesting...
    0Reply
  • Martin Shaw
    Investor · Memphis, TN · Member since 2019 · 24 posts · 2 votes
    5y

    @Adah None

    Yes but be prepared to probably be tenantless for a while if you make the increase at once. Which is fine because you’ll want new tenants anyway cause there is nothing you can do to justify a 85% increase in the eyes of the current tenants.

    0Reply
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