Offer tenants the choice between 2 leases?

Question

I'm closing on my first investment property this Friday in Lancaster, PA.  It's a duplex with long-term tenants who are getting a steal paying way below market value.  I'm sure the tenants are torn between paying more or moving out, but I have to raise rent to make the deal work.  Does anyone have feedback on the idea of presenting the tenants with a choice between two leases?  One option would be to stay month-to-month, but jump immediately to my goal monthly rate (a 40% increase of their current rate) and the other option would be signing a 6-month lease at an interim rate (about a 20% increase), with the understanding that after 6 month the rent goes up again to my goal rate.  In my mind, the options soften the blow and don't scare the tenants away as easily.  Worst case scenario is that they both say no and move out, but is this a weird idea?  Thanks for any feedback.

Michael E. · Answer

There was a BP podcast with a guy that had a system that I think would work great for you. I don't remember the episode number but he called it "The binder". Basically it was a binder with printouts from rentometer.com showing the average rents in the immediate area. After showing the binder to tenants he would ask them what they thought was a fair amount for rent. This leads to the tenants "asking" for the rent to be just under the average. I've looked for the podcast but can't find it, although I'm sure a smarter and more experienced BP member would know.

Good luck and congratulations on your first deal!

Greg M. · Answer

Just rip the band-aid off. The only thing the soft rate increase does is prolong your losses. The tenant can/will pay market rent or they can't/won't. I'll lose money for 6 months so you can move later is a suckers move.

If the unit is 40% under market and you want to keep them as tenants, raise the rent 30%. It's still under market for them and an incentive to stay and it makes you a lot more money. The tenants aren't stupid. They know that's a good deal and will likely stay if they can afford it.

Scott M. · Answer

Is this unit in top market rate condition?  Or is it, like the monthly rent, below market rate?  If you told me my rent was going up  40% but the unit was not in similar condition to those asking for 40% more I would leave.

Have an honest conversation with yourself about the condition of the unit before you talk to the tenant.  If the unit is in dire needs of upgrades cosmetic and otherwise then you can't expect a tenant to pay for market rent when your unit isn't close.  If this is the case, you can tell the tenant what you are going to do to bring it up to market rent by X and then rent will be Y etc...

Also, be sure you have the funds and crews ready to handle the turn before you spring any increase on them, and be sure they are not in the middle of a term lease.

You said this is your first investment property, you have yet to learn the value of long term tenants.  doesn't mean you can't raise rent mind you, but long term tenants bring value to the table on their own.

John Underwood · Answer

I would not offer a 40% rent increase. I would do a more modest increase and the a bump.again in 12 months.

Cheaper in the long run to keep current tenants than be greedy today and run every one off.

Nathan Gesner · Answer

Bad advice. If they are 40% below market, it's unlikely they can afford market rate. Even if they accept it, you run the risk of starting off with a bad relationship that will bite you later.

Get rid of them and start fresh with new renters.

No offense to the BP podcast guest, but building a binder with comparable rentals and then asking your tenants what they're willing to pay is a complete waste of time. Does the local grocery store spend time justifying their price for a T-bone steak? You study the market, you determine what it's worth, and you offer it to the public at that price. People can accept it or they look somewhere else. You don't need to spend hours trying to sell a rent increase to existing renters when demand is so high.

Jason Stoltzfus · Answer

Long-term rentals are in short supply in Lancaster. If you needed to place new tenants, I'm confident you could do so quickly. I listed my place last year in Lancaster and had a tenant in weeks. I've had the same experience in Columbia, which is nearby and a similar market. I think that's been the general trend.

I have no experience in this particular situation so I can't offer you advice on what to do.

Where in Lancaster is your rental?

Todd Rasmussen · Answer

@Brian McHugh

I don't think a six month reprieve is a reprieve in the tenants eyes. Just a second blow after the first. Give them a single increase and you can show grace with the days until it goes into effect instead.

Dustin Somers · Answer

@Michael E.  I remember this episode it was a great approach to this exact issue.  I personally have not done this because my properties are in CA and we have strict rent control laws.  However i do offer my tenants 3 lease options when it’s time to renew a lease.

Option 1. Month to month at the max rent increase permitted

Option 2. A 6 month lease at a moderate increase

Option 3. A new 12 month lease at the lowest increase i am willing to take.

These are all wins for me and they give the tenant several option so they don’t feel like i am being unfair

Michael E. · Answer

Wow, a lot of people are quick to pay turn-over costs. I found the episode, it is Show #448.

First, I'm not trying to say that anyone is wrong in what they have said. Personally, I don't think the tenant should be automatically blamed for the previous landlord not raising the rents. Having said that, I would think the biggest question is, are they good tenants? Maybe run them through your screening process. If they meet your standards (income supports new rent amount) and are/have been good tenants, how much is it worth to keep them? If on the other hand, they don't even come close to passing your screening then cut and dry would probably be the best option.

Offer tenants the choice between 2 leases?

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