Raising rent can be an importantpart of staying profitable as a real estate investor. Still, it comes with risks, such as tenant turnover and increased time commitment. While there is no one-size-fits-allanswer to the should I raise my rent question, you can best inform your actions by assessing your investing priorities, evaluating your relationships with your tenants, studying your local market, and more.
An expert is someone who has succeeded in making decisions and judgements simpler through knowing what to pay attention to and what to ignore.
Edward de Bono
Your tenants leases are about to expire.
Theres a for rent sign on the house down the street, and the owner is trying to rent it for an amount that exceeds your rent.
You would also like to raise rent, but the local economy is showing signs of weakness, and your current tenants are great.
What should you do? Raise rent and risk losing the tenants? Or maintain rents the way they are and risk missing out on income growth?
So, you scoured investment property forums, searched on Google for should I raise my rents, and reached out to your local palm reader for her opinion. You are still unsure what to do, and now youre down $50 bucks for those tarot cards. On the forums, one passionate group says, Raise the rents! and the other group says, No leave them where they are! And you walk away even more confused and puzzled.
The clock is ticking, the lease is about to expire. What should you do?
How This Guide Will Help You Save Money
Reader: Wait a second! Im here to learn how to make money, not save money. Can you provide me with answer to my rent dilemma?
Sadly, there isnt a one-size-fits-all policy for deciding to raise rents or not. It all depends on the persons unique situation. Instead of providing a definitive answer, its better if we empower ourselves to make our own decision. This article will discuss the numerous factors involved in raising rents. Usually people narrowly focus on the market rate for rents to determine whether one should raise themor not, but that shouldnt be your prime focus. There are numerous other components at play that should determine our final action.
Whenever we arrive at a crossroads in life, be it investing or personal, its always good to stop and reflect on what were trying to accomplish overall. Our values, usually written in a form of a business or hobby plan, will help us to determine the best course of action during uncertain times.
This guide will not provide you with a one-size-fits-all answer to your problem. Think of this guide as a decision making process to calculate the risk involved in making rent related decisions, so you dont lose a quality tenant due to a knee-jerk emotional decision.
The Goal of Raising Rent: Its Not What You Think
Narrowly framing the situation as an either-or dilemma, to raise rents or not, distorts the reality of the situation, which fans the flames of emotion and leads to a potentially bad decision. Making good decisions requires an understanding of all the alternatives so you can properly value the costs and risks involved in the final decision.
So lets reframe the question: What are my priorities for this property? Reframing the question creates alternative scenarios, which lead to better decisions because we can weigh the tradeoffs involved.
Potential PrioritiesMaximizing profitsMinimizing personal involvementMaintaining a low vacancy rateDecreasing tenant turnover costsStabilizing cash flow
Thislist is a starting point to determine your motivations behind aninvestment. Start brainstorming and think to yourself what are your true priorities.
Frank: Well, maximizing profits is important to me, but I dont know if its worth risking a higher vacancy rate and spending my weekend showing the property to new tenants.
Sue: Come to think of it, I really care about tenant stability and minimizing my time commitment. I have a demanding career, so I dont think raising the rents is the best decision at this juncture.
Pete: Actually, maximizing profits is something I would like to proceed with because I can handle the potential risk of tenant turnover and the added time involvement.
Related:How to Successfully Raise Rents Without Risking Costly Vacancies
The Power of Anchoring
When the tenant signed the original lease agreement, your negotiations for rent didnt end there. It just symbolized the closing of one chapter and the beginning of another in the ongoing negotiation for rent.
The original rental price has a powerful anchoring effect on subsequent negotiations. While we might think everyone is perfectly objective, we are emotionally-driven animals. We have strong sense of fairness running through our minds, and if the tenant perceives the rent increase to be unreasonable, they will be compelled to walk. No matter how underpriced the rents are, they will use their original rent as a reference point.
Your Relationship With Your Tenant
Another factor to consider is your current relationship with your tenant. Having a great tenant is compelling reason to leave rents at current levels or to minimize rent increases. If the tenant is excellent, is it worth the trouble to raise the rent at the risk of losing the tenant? Finding a good tenant can be a tough proposition in any market.
Signs of a Great TenantDoes the tenant pay always pay her rent on time?Does the tenant maintain the interior and exterior of the property?Have other tenants complained about this tenant (Noise complaints or property upkeep)?Does the tenant update you on potential issues related to the property?
Some investors minimize rent increases in a hot market, and if the tenant leaves, they list the property at a higher market rent so the new tenant doesnt feel heartburn of having massive rent increases after signing the lease.
Rent Increase Percentages and Tenant Reactions
In the SF Bay Area, rents are anything but affordable, while in other markets rents are affordable. In some markets, tenants expect regular rent increases of 10%+ as status quo, while other markets tenants would consider moving immediately. In general, Ive found that rent increase reactions cluster around three price bands.
Rent Increase Reactions (Rule of Thumb)1-5%: Expected increase, its not worth moving unless my rents are severely above market rents.5-10%: I might consider moving, but if the property is well maintained, located in a nice area and has great amenities, I will probably stay put.10%+: Time to consider moving, unless I live in an area where all rents are increasing by 10% and moving would add significant time to my commute.
Now, everyone looks at increases differently, but once you start finding yourself in the 7-8% plus range, tenants start to think, Will these increases continue indefinitely? and Maybe its time to start looking for a new place to live. As a landlord, you must be aware of the hidden message youre sending tenants by increasing their rents.
The Hidden Costs of Raising Rent
A bird in the hand is worth two in the bush.
Proverbs of Ahiqar
Before deciding to decrease or increase rents, you should determine the cost benefit analysis of your decisions.
Investor Pete has decided his propertys monthly rent should be increased from $600 to $650 (8.3% increase), which would be a gain of $600 per year. Pete asked his property manager to research market rents in the area. The market rate for rents in his area is $500, but Pete is confident that his property is worth the rent premium because of the curb appeal of the unit and amenities.
Petes city is going through an economic downturn, and local vacancies have been on the rise. The property down the street has had a for rent sign on it for one month, and the asking rent is $550.
One thing Pete should think about is the risk of losing a tenant due to the rent increase and the costs involved in re-renting the unit.
Potential CostsOne-Month Vacancy: $650Turnaround Costs: $500Advertising: $50Finders Fee for New Tenant (One Months Rent): $650Total Cost: $1,850 (Pay Back Period: three years and one month)Pete is risking a potential loss of $1,850 for a yearly gain of $600. If Pete is wrong, it will take him at least three years and one month to recoup the costs involved for finding a new tenant. Also, if the lease expires during the winter or when school is in session the vacancy could be longer than one month.
Maybe its not a good idea for Pete to increase rents at this juncture. Maybe he should wait until the market strengthens.
Related:Is Now a Good Time to Raise Rents?
Tenants Previous Earnings
An indicator of whether the tenant will be able to afford the rent increase will be the tenants earnings history. Open your tenant file and see what the tenant was earning when they qualified for the property. Now this isnt scientific, but you can make a rough approximation of what their current salary should be a year hence of completing the application. You could either leave the salary as is or you can factor in an inflation adjustment.
I use the rent coverage ratio to measure the tenants gross monthly income available to pay the current rent. For my tenants, I require gross monthly income to be at least three times the monthly rent. If your rent increase causes the rent coverage ratio to fall below three, the tenant might leave or fail to pay their rent.
Assess the Local Economy
No matter how impressive the property, its still subject to market forces. Understanding the local economy will let you know what the market rates are for rents in your area.
Questions to determine the health of your local economy include:
Whats the unemployment rate for your area?Whats the average vacancy rate in your area? How long are listed properties remaining vacant?
You can find this information via multiple sources: Bureau of Labor Statistics, a quick Google search, your local real estate association, business journals, or local property managers.
Find Comparable Rentals in Your Area
Before you make a decision on rents, you must analyze the current market to determine the market rents for your area. The market rent is what people in your area are paying for rental housing. By determining market rents in the area, you can determine if your increase is within reason. Rental prices for your area arent determined by your gut feeling or by your desired returnthey are determined by market forces. No matter how minor we perceive the rent increase to be, the tenants opinion of the increase will be determined by its proximity to market rents.
There are many ways to determine market rents. Here are a few suggestions:
Walk around your neighborhood. This is the best way to determine the market rents for your area. Look at rentals in your area and try to arrange a preview of those properties.Speak to the locals. Ask them about how much a certain property was renting for in the area and whether they would be willing to rent the property.Speak to property managers. Ask them about the going rate for rents in your area.Speak to other investors. Youll learn about market rents, expand your network, and you never know if the investor might want to sell their property to you.Using Online Sources to Determine Market Rents
Out-of-state investors dont have the luxury to drive through their propertys neighborhood, so they will need to call local experts and review online sources to determine market rents. While online resources are easily accessible, they list rental prices that are aspirational, not the final leasing price (which can be lower than the listing price). Unfortunately most online sources dont have the capabilities to determine the final agreed upon rental price.
Sites to find rental comparables include:
You can use Rentjungle.com and Zilpy.com to determine rent trends in your area; however, none of these sites should be used as the single point of truth because each site has its own biases.
Comparables vs. Your Property
Sample size is everything. Try to find as many properties as possible within your propertys neighborhood, and make sure to create a database to track these properties. It doesnt matter if your property is a duplex and the property for rent down the street is an apartmenttenants tend to lump different residential property types into the same category.
Now its time to combine the data that you have collected to analyze how your property fairs against the competition.
You can add the information into a basic spreadsheet, such as this one, to get a better idea of how the market is determining value.
While understanding the market rents for the area is important, these averages exclude the unique features that your property may offer. Make sure to add or subtract the value of the amenities included in the rental. Its hard to precisely determine the true value of amenities, but you can approximate the value by finding comparables.
If you see two properties in the same area that have approximately the same square footage, but one unit has one bedroom and the other has two bedrooms, you can approximate the value of an extra bedroom by the difference in prices between both rentals. It isnt a scientific calculation, more of a ballpark measurement.
Things to Compensate for When Determining Market RentDoes the property have curb appeal? Are people living there because they want to or because they have to?How many bedrooms and bathrooms?Size of the backyard?Whats the propertys walk score?What utilities are paid for by the tenant?Does the property include garage parking?Does the property allow pets?Is the property furnished?
By aggregating the data and refining it based upon your understanding of the market, you will be able to determine the market rent for your property.
If youve concluded that your rents are currently above market and that an additional increase wouldnt be worth the hassle, then you may even consider decreasing the rents depending on the state of the local economy. Sometimes it is better to get ahead of a softening economy, and lower your rents to prevent a vacancy.
Important: A Message from Lawyer Cat
Remember, each state, city, and county has its own rules and regulations regarding rent increases and communicating rental price changes. Please read the rules or consult a human lawyer.
According to the State of California, If you have a month-to-month (or shorter) periodic rental agreement, the landlord must give you at least 30 days advance written notice of a rent increase.The landlord must give you at least 30 days advance notice if the rent increase is 10 percent (or less) of the rent charged at any time during the 12 months before the rent increase takes effect.The landlord must give you at least 60 days advance notice if the rent increase is greater than 10 percent of the rent charged at any time during the 12 months before the rent increase takes effect.
Last note from Lawyer Cat: If youre raising rent because your tenant filed a complaint against you or are raising rents for any reason that looks retaliatory, STOP! Rent retaliation is illegal. Stop being a slumlord, and be a true landlord.
Thanks, Lawyer Cat. Now back to my story.
Communicating the Rent Increase
If youre lowering rent, the message is usually well-received by the tenant.
If youre raising your tenants rent, its a different story. Even if you invoke the rhetorical power of Johnny Cochran via each keystroke on your laptop, it wont change the fact youre taking money out of your residents pocket. Now this isnt something you should feel guilty about because, if you manage a quality property, you deserve to be well-compensated for your work.
While I cant tell you how to perfectly construct this message, I can tell you a few dos and donts:
Do:Communicate clearly and succinctly.Feel free to express your appreciation for their stay at your property.State the new rent amount and when the new rent changes will take effect.Dont:Make your rent increase letter/email as long as War And Peace.Communicate the increase in person. Sending the increase via email or letter allows the tenant to digest the information before responding. Apologize for increasing the rent. If you were truly sorry, you wouldnt raise it in the first place.Oh, no! My Tenant Has Decided to Leave. Now What?
First of all, dont panic! Confirm the reason why the tenant is leaving. If its related to your rent increase, try to negotiate with them.
Points of NegotiationGradually phase in the rent increase or minimize the rent increase for a longer lease agreement.If requested by the tenant, consider adding an amenity (air conditioning, garbage disposal, etc.). So long as the amenity provides a reasonable return on investment, consider making the investment in order to keep the tenant and secure the rent increase.Rent Escalation Clauses
A rent escalation clause is a provision included in the lease agreement allowing the landlord to increase the rent to a pre-arranged rate based upon a fixed percentage or the consumer price index (CPI). Typically rent escalation clauses are used for multi year commercial lease agreements. Most rental properties dont include a rental escalation clauses in their month to month or year long leases
If its a multi-year lease, you can consider pegging the increase to the consumer price index CPI for your area.
The rent escalation clause serves two purposes:
If the tenant lives in a expensive real estate market, the escalation clause provides the tenant with assurance their rent wont increase more than the prearranged escalation rate. The manager knows they can avoid the difficult rent increase conversation and their rents will increase with inflation.Conclusion
The decision to raise your rents cant be based off of just one factor. You need to break the decision down into a series of parts to make sure youre considering all aspects that are influencing your final decision.
The process towards making the final decision to increase rents should incorporate the following:
Your goalsRelationship with the tenantCost of vacancyHealth of the economy Market rentsComparable propertiesState, county, and city rental lawsHow to communicate the increasePotential rent negotiations
Finally, keep in mind that you are taking a calculated risk by raising the rents: trying to get the most rent from your property at the risk of losing a good tenant (and spending time or losing money to replace that tenant).
Were republishing this article to help out our newer readers.
Do you have any tips for raising rents? Or do you have any questions?
Leave your comments below to discuss!
https://www.biggerpockets.com/renewsblog/2016/03/17/raising-rent-ultimate-guide/
