Some of the renters have been in since it was built without a rent increase.

It can be argued that making that unit legal will increase the value of the property.

I guess our truer colors come out for some of us when talking about a strangers money and what they should have done...

He said that they purchased an asset with rents that have not increased in 5 years (can't remember exact amount).

I was able to work with them to get a 5% rent increase put in place within 2 months of closing.

My question is if it's always better to purchase properties in cheaper market where it takes less capital and the rent to price percentage is easier to get above 1% or if it's worth investing in a city like Denver where it's very hard to get the rent/price ratio over 1% but the cost of the real estate increases much quicker than it does in other less desirable places to live?

Overtime I imagine this will increase.

If you have the ability to do so, increase your earnest money deposit.  

You also have to take into consideration the color may not be attractive to the next tenant and that they did this without Landlord approval.

Cash on cash before rent increases with newly minted leases is about 4 to 7% going in.