Buying Multi-family and Increasing Rent?

Question

I've been looking at multi-families, and few ever get close to cash flowing with my specific circumstances, but there are some properties that could work... but only if the rents were increased. So I was wondering how you would go about increasing rent for units that are far below the average rent for the area.

Sacramento has no rent control, so theoretically you could bump the rent up to any amount as long as the tenant was month-to-month and gave 60 days notice.

If the tenant was on a lease, then you would have to essentially give 60 days notice, 60 days before the lease was to end.

So, if the rents are far below market, but the property is priced appropriately for the area based on comps, are you able to take any action as an investor to make it work?

Are you able to sign new lease agreements upon purchasing the property?

Are you able to receive the current lease agreements from the seller to get a feel for when the lease is ending?

Any anything wrong with increasing rents by 50% or more (beyond the moral dilemma with increasing rents for LONG term, established tenants, like a 90 year-old g-ma)?

Thanks!

Wes Blackwell · Answer

@Jesse Kailahi50% below market rents sounds too good to be true, and we all know the saying about things like that... it usually is. There might be more to the story depending on the property and where you're getting your information from.A lot of "for rent" listings on sites like Zillow, Craigslist, etc. aren't made by the homeowner, they're made by sites like Apartments.com or some new rental app looking for new clients, etc. I just had a friend here in Sacramento try looking for a place in Midtown and she told me half of the listings she contacted were complete B.S.But, if you simply wanted to test the higher rents, post an add on craigslist for renting the property at whatever price you want to test and see what kind of results you get. If you get a flood of calls then you'll know there is the demand. If no one calls you know that it was all a dream, you used to read Word Up! Magazine, Salt-n-Pepa and Heavy D up in the limousine.As far as leases go, you can usually get the information you need (how long is left on the lease) from the listing agent prior to even making an offer. The existing leases will have to be honored until they expire on their end date.An easier way to rehab all the units and move tenants around without seeming like Ebeneezer Scrooge would be to remodel the unit you move into, and then offer all the other tenants to essentially exchange units. For only a few dollars more they could rent your beautifully updated unit, and then you could move into theirs and start the rehab process all over again. Then at least you gave them the opportunity. And I probably second @Kenneth Reimer's advice about raising them a little more slowly than coming in and lopping everyone's head off with The Mighty Slumlord's Broadsword of Poverty (+50% to tenant rent, -50 karma per attack, +5% city homeless population).As far as the trailing 12, full rent roll, and expenses from previous owner... plan on it but don't count on it. 2-4 unit multifamily is often a mom-and-pop operation and the lease agreement could be something as simple as a hand shake. Tenants may pay in cash and then the money goes who knows where and doesn't go in the bank to give you proper documentation. Sometimes a property management company will be involved and you'll have all this stuff, but I'd say at least a quarter of the time you don't get anything. As a side note here's a bunch of great information about raising rents in the state of California:http://www.hrc-la.org/doc.asp?id=36

Kenneth Reimer · Answer

@Wes Blackwell Broadsword of Poverty, that's absolutely hysterical.@Jesse Kailahi As for paying for potential rent increases, that's normal. If rents are 70% under market and there is competition on the deal, the next guy is going to come in, pay for maybe 20% of the potential, and still make money. Remember, everything with money involved is essentially a formal auction.As for T12s and proformas, it depends. Wes mentioned that 2-4 units are typically mom and pops. They usually don't have the bandwidth to pay for fancy accounting software, so what you may get is an outdated excel spreadsheet full of incorrect references. This happens in larger complexes as well, believe it or not. Anyways, if they are available, you should be able to obtain them at any time. A pro forma typically sheds positive light on the building, so brokers/agents would be happy for you to look those over. T12s may paint the building in a different light if the current owners aren't running the building very well. Therefore, they may be more hesitant to show you as they will have priced the building based on how it should be run, as opposed to how it is being run.

Andrew Johnson · Answer

@Jesse Kailahi I always ask for the T12 before even bothering to view the property. The challenge is that sometimes the listing agent doesn't have it (which boggles my mind) or it takes time to get. But I deal with out of state purchases so I'm definitely reviewing a T12, building a pro-forma in Google Docs (there are tons of templates around as well as BPs calculator), and figuring out then if it's even worth a trip out. If my value based on a pro-forma I work up from their T12 is 1/2 what it's listed for, I'm probably not going to waste my time. I'll tag it, look for price reductions, and watch it age and then reassess. Like @Kenneth Reimer points out, the often show the property in a more positive light so you should risk-adjust them a little.

Jesse Kailahi · Answer

@Andrew Johnson Sorry, noob question.. do you have to be in contract to obtain a T12 or Proforma for a 2-4 multi, and if so, how do you even approach the analysis without one? Does running the numbers through a spreadsheet or BP calculator amount to an unofficial Proforma?@Kenneth Reimer Thanks Kenny! 50% of market is pushing it a little.. Perhaps with a full rehab and above average/designer remodeling. But I've lived in 5 different apartments/homes in the area (mere blocks away) over the past 10 years, and from personal experience, having friends in the neighborhood (literally 2 blocks away), and researching current rents... 70% of market seems like a very conservative estimate for what these units are producing. But from looking at the price tag, it really seems like the seller is trying to get a buyer to pay for the potential in rent increase, not the current rents. List: 670k, 2/1: 3, 1/1: 1, rents: 750, 750, 700, unknown. Craigslist rents for 2/1: 1295-1695, friends paying $1100-1400 for 2/1 several blocks away.@Wes Blackwell "The Mighty Slumlord's Broadsword of Poverty (+50% to tenant rent, -50 karma per attack, +5% city homeless population)" LMAO

Kenneth Reimer · Answer

@Jesse Kailahi Great thoughts Jesse. 50% of market sounds too good to be true. I would double-check the area rents, ensure that the numbers are legitimate, and then make sure that the tenant doesn't have any type of deal with the landlord to exchange labor for rent. Many times, you'll see unwritten agreements between the landlord and tenant to barter work for rent. If you find that the market rents are that much higher, understand that you will definitely have a spike in turnover if you boost them up that quickly. If it really is 90 year-old grandma living in the unit that you just "put on the streets" by raising her rent too high, you could have a news truck at your property which would be a whole nightmare that you don't want to deal with. Yes, you can give options to sign new lease agreements with the tenants that are month to month, and you can also raise their rent with proper notice. Yes, you should absolutely be able to receive lease agreements, trailing twelve, and a full rent roll. These are all documents that should be part of your due diligence. All in all, what you will find most investors do in this type of situation, is slowly raise the rents after closing. Natural attrition allows the investor to cash flow the property while doing renovations on unit turns. This will allow you to keep your stream of cash coming in, limit turnover, and not put a bad taste in the mouths of your stable, existing tenants.Hope this helps!Kenny Reimer

Andrew Johnson · Answer

Jesse Kailahi Not to be nitpicky but I usually value multifamily properties based on a pro-forma from a T12 to determine a cap rate. If the units are renting for 1/2 of the market rate is the cap rate competitive at the purchase price? Or do you have to add value through rehab to get market rents which will then make the property pencil out? The reason I ask is that if rehab is the only way to get the value maybe you consider cash-for-keys so you can rehab quicker, re-rent at market rates quicker, and cash-flow quicker. If it pencils out at the current price and current rents you could take a one-by-one approach and raise rents at lease end effectively emptying the unit for your rehab to start.

Jesse Kailahi · Answer

@Gene Vityugov I understand the shock, but honestly the intention would be to bring the rents up to market and rehab the units that go vacant during that process. The current rents (according to the MLS data that I have) are HALF of market! I guess I would have to see the renter's agreements and decide whether to carry the mortgage for the duration of the existing leases.Also, it would be an owner occupied, so that's one unit that can get a facelift and it may even cash flow with only a single unit rented at market if I decide to move after the minimum duration.

Gordon Cuffe · Answer

you can always ask for copies of leases when you are in contract with a seller. You can ask for any rent amount that you think you can get. No rent controls in Sacramento county

Gene Mattos · Answer

The renter's lease does not expire because you buy the property, so no. Asking the seller to raise rents for you is going to be a non-starter.Yes, and you definitely should.It depends on the tenants. Usually 50% increase is quite a shock and would cause the tenant to look elsewhere, although if you're charging market rate, they would be disappointed in the results. I would avoid such a high increase unless you're trying to turn over the units and place new tenants.