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Raising the Rent: The Ultimate Guide

The Ultimate Guide on Raising Rent

by  | BiggerPockets.com

 

SUMMARY: Raising rent can be an important part 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-all answer 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.

 

 

Your tenants’ leases are about to expire.

There’s 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 you’re 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! I’m here to learn how to make money, not save money. Can you provide me with answer to my rent dilemma?

Sadly, there isn’t a one-size-fits-all policy for deciding to raise rents or not. It all depends on the person’s unique situation. Instead of providing a definitive answer, it’s 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 them or not, but that shouldn’t 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, it’s always good to stop and reflect on what we’re 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 don’t lose a quality tenant due to a knee-jerk emotional decision.

The Goal of Raising Rent: It’s 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 let’s 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 Priorities

  • Maximizing profits
  • Minimizing personal involvement
  • Maintaining a low vacancy rate
  • Decreasing tenant turnover costs
  • Stabilizing cash flow

This list is a starting point to determine your motivations behind an investment. Start brainstorming and think to yourself what are your true priorities.

Frank: Well, maximizing profits is important to me, but I don’t know if it’s 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 don’t 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.

The Power of Anchoring

When the tenant signed the original lease agreement, your negotiations for rent didn’t 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 Tenant

  • Does 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 doesn’t 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, I’ve found that rent increase reactions cluster around three price bands.

Rent Increase Reactions (Rule of Thumb)

  • 1-5%: Expected increase, it’s 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 it’s time to start looking for a new place to live.” As a landlord, you must be aware of the hidden message you’re sending tenants by increasing their rents.

 

The Hidden Costs of Raising Rent

Before deciding to decrease or increase rents, you should determine the cost benefit analysis of your decisions.

Investor Pete has decided his property’s 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.

Pete’s 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 Costs

  • One-Month Vacancy: $650
  • Turnaround Costs: $500
  • Advertising: $50
  • Finder’s Fee for New Tenant (One Month’s Rent): $650
  • Total 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 it’s not a good idea for Pete to increase rents at this juncture. Maybe he should wait until the market strengthens.

RelatedIs Now a Good Time to Raise Rents?

Tenant’s Previous Earnings

An indicator of whether the tenant will be able to afford the rent increase will be the tenant’s earnings history. Open your tenant file and see what the tenant was earning when they qualified for the property. Now this isn’t 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 tenant’s gross monthly incomeavailable 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, it’s 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:

  • What’s the unemployment rate for your area?
  • What’s 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 aren’t determined by your gut feeling or by your desired return—they are determined by market forces. No matter how minor we perceive the rent increase to be, the tenant’s 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. You’ll 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 don’t have the luxury to drive through their property’s 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 don’t 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 property’s neighborhood, and make sure to create a database to track these properties. It doesn’t matter if your property is a duplex and the property for rent down the street is an apartment—tenants tend to lump different residential property types into the same category.

Now it’s 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. It’s 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 isn’t a scientific calculation, more of a ballpark measurement.

Things to Compensate for When Determining Market Rent

  • Does 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?
  • What’s the property’s 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 you’ve concluded that your rents are currently above market and that an additional increase wouldn’t 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 you’re 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 you’re lowering rent, the message is usually well-received by the tenant.

If you’re raising your tenant’s rent, it’s a different story. Even if you invoke the rhetorical power of Johnny Cochran via each keystroke on your laptop, it won’t change the fact you’re taking money out of your resident’s pocket. Now this isn’t something you should feel guilty about because, if you manage a quality property, you deserve to be well-compensated for your work.

While I can’t tell you how to perfectly construct this message, I can tell you a few do’s and don’ts:

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.

Don’t:

  • 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 wouldn’t raise it in the first place.

Oh, no! My Tenant Has Decided to Leave. Now What?

First of all, don’t panic! Confirm the reason why the tenant is leaving. If it’s related to your rent increase, try to negotiate with them.

Points of Negotiation

  • Gradually 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 don’t include a rental escalation clauses in their month to month or year long leases

If it’s 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:

  1. If the tenant lives in a expensive real estate market, the escalation clause provides the tenant with assurance their rent won’t increase more than the prearranged escalation rate.
  2. 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 can’t be based off of just one factor. You need to break the decision down into a series of parts to make sure you’re considering all aspects  that are influencing your final decision.

The process towards making the final decision to increase rents should incorporate the following:

  • Your goals
  • Relationship with the tenant
  • Cost of vacancy
  • Health of the economy
  • Market rents
  • Comparable properties
  • State, county, and city rental laws
  • How to communicate the increase
  • Potential 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).

The Benefits of Working with Steady Properties for Professional Property Management in Milton, WA


We are Steve and Jodi Williams, the owners of Steady Properties, a full service Milton property management company. We want to take this opportunity to introduce you to who we are and what we do. Our company has been in business since 2012, but together we have been in the rental game for over 15 years, starting with our own personal rentals. We found we had friends asking for advice, and we thought starting our own company was a great idea. So here we are, owning and operating Steady Properties. (more…)

January – (Avoiding Court)

Avoiding Court                  

No investor wants to receive a call from a property manager that legal action could be or is necessary. As your property management company, we spend a lot of time and energy trying to avoid this kind of call. Our efforts include updating our education, preventative maintenance, placing qualified tenants in your property, and handling the many details involved with your property in a timely manner. However, avoiding litigation requires teamwork. Property owners and managers can follow these ABCs to avoid legal action.

 

Always follow the law

Many important laws and rulings affect rental property today, such as Fair Housing, habitability, retaliation, lead-based paint, mold, etc. Every year even more legislation occurs due to litigation. We continually update our knowledge by attending industry events and reading important publications. We also make a conscientious effort to keep you, the investor, informed, by sending important notifications and providing informational articles in our newsletter. If a legal situation arises, we will make you aware of what is happening, what action is necessary, and explain why.

 

Why is it important that you know legislation or rulings that affect your property? It is crucial you know the penalties and costs that could affect your bottom line. You cannot plead “ignorance” of the law and place blame elsewhere. The court’s attitude is and always will be that you, the property owner, are responsible for knowing what governs your property. Knowledge empowers investors to make intelligent decisions.

 

Be Proactive

Taking a proactive approach will avoid the majority of legal issues. It is necessary for property owners and managers to follow Fair Housing laws and rules while marketing and renting property. Providing well-maintained properties to residents is another crucial area where the investor and property manager must work together to avoid future problems. It is always easier to think “preventative,” avoid difficult situations, and possibly incur financial losses.

 

Consider all options in seeking resolution

The fact is that no matter how much property owners/managers work on education, good tenancy, and preventative maintenance, problems can still occur with the tenancy or the property. Even good tenants can have unusual problems. Unexpected maintenance and external forces, such as a natural disaster can cause other difficulties and legal threats. No matter what happens, property managers and investors should work together and consider all options to resolve issues with the tenants and/or the property.

 

When an issue does arise, there are often alternatives to going to court. It is imperative that you evaluate the costs and results of proceeding with any legal tenant action. For example, the former tenant may dispute their security deposit deductions. Although their claims may not be justified, it can be more costly to refuse to compromise or make a concession and chance a court decision.

 

There are times that legal action is the only choice. If this happens, it is important to move as quickly as possible to prevent even further losses. As your property management company, we will do our best to avoid having to call you regarding a legal matter. We ask you to work with us to avoid litigation whenever possible.

December 15th, 2016 – Owners

What Do Your Tenants REALLY Want?

 

Everyone has heard horror stories about bad tenants. They make movies about them because melodramas sell at the box office. While there are bad tenants who cheat owners out of rent and can be destructive, the majority of renters are simply good people. What investors really want is good tenancy, as well as the best return on their investment. These are the very reasons why property owners should care about what good tenants want.

 

Fair Pricing

Most people are thrilled when they can get a great deal or an underpriced commodity, but the bottom line is that everyone wants a fair price for their expenditure. Therefore, it makes sense that tenants want fair market rent, not only when they rent but throughout their tenancy. Most tenants, when satisfied with their residency, will adjust to a reasonable rent increase. It’s when property owners raise the rent drastically or unfairly (i.e. retaliation), that it becomes a problem.

 

A Safe Environment

The best way property owners and managers can contribute to the safety of any community is by obtaining good tenants and by working with neighbors and law enforcement when necessary. However, in any neighborhood, investors need to provide a safe residence for their renters. . There are many ways to do this, such as adequate locks, working doors and windows, safe electrical, good plumbing, well-maintained flooring, etc. Fire safety in and around the property is extremely important. Tenants want to know that they can enjoy a safe and reasonable living environment.

 

Fair Treatment

Like fair pricing, people want fair treatment. Below are common areas where many investors fail.

  • Tenants want what property owners and/or managers promise them. They have the same expectations if they report maintenance calls. When there is failure to follow-through on promises and nothing happens, it creates bad landlord/tenant relations.
  • Tenants do not want rude surprises. Generally, this means they do not want property owners or managers to show up unannounced at the property. They want everyone to abide by the federal and/or state housing laws on the right-to-enter. While the tenant does not own the property, this is their home and they want owners and managers to respect this.
  • Tenants want a fair return of their security deposit. There are times when tenants should lose all or part of their security deposit. However, property owners need to have reasonable expectations regarding deductions because there is going to be normal wear and tear in any property.
  • Tenants want a reasonable guarantee they will not lose their home during the agreed upon period of occupancy. There are circumstances that do arise where property owners have to sell a property or lose it due to financial circumstances. If this happens, property owners need to do their best to extend fair treatment to their tenants during this process.

 

You know how this song goes, R – E – S – P – E – C – T, find out what it means to me.Good tenants want respect and appreciation from property owners and their managers, just as they expect on-time rental payments and proper care of the residence from their tenants. When property owners provide fair pricing, a safe environment, and fair treatment to their tenants, they give them what they really want. In turn, investors are setting up the best possible scenario for a successful tenancy.

Deciding on Pets

cat_and_dog_cartoon_image-913

Most owners shudder when you mention pets. To be perfectly honest, this is an understandable reaction since there are times when tenants allow their pets to cause considerable damage or liability. However, when facing the issue of pets, property managers and/or landlords often need to use a logical approach. Saying “no” to a pet right away can often lead to illegal pets or possibly missing the best tenant.

The Application

Whether or not a landlord allows a pet, it is always advisable to have an area for disclosing pets in an application-to-rent. It is important to obtain as much information on the prospective tenant, particularly if you want to determine whether they do have or do not have pets. If another landlord reveals that the applicant has a pet, this becomes solid ground for refusing the applicant.

Consider Pets Negotiable

If you are saying no to all animals, consider saying, “pets negotiable.” The problem in stating a definite “no” is the prospective tenant may be the right person for the property. When you say “negotiable,” it allows the landlord to select a tenant who has an appropriate pet or just decline the applicant. Well-qualified applicants generally extend the care for their pets to caring for the property. It would be better to have them list their pets, examine the information, and then make an informed decision.

Do Pets Work in The Property? 

This is a logical step to consider. Obviously, a townhouse with a postage stamp backyard generally is not suitable for a German Shepherd, Springer Spaniel, or a Great Dane. The perspective tenants may tell you their pet never makes a mess, has never caused damage, they walk it every day, always pick up any animal droppings, and it is accustomed to living in a one-bedroom apartment for years. Common sense must prevail when renting the property to someone with a pet or pets. Look at the property objectively and discuss the issues with our management company on what pets are suitable for the property before putting it on the market.

Avoid Some Animals 

There are pets to avoid and mostly this comes down to “dangerous and destructive.” Some people relegate this to a Pit Bull, Rottweiler, Doberman, large or small snakes, rats, etc. However, anyanimal that is vicious or dangerous, large or small, can be a problem. Good tenant screening often takes care of this problem. It is a good idea to have a list of “unwanted” pets that are completely unacceptable. Insurance companies often carry a “dangerous pet” list and you can check with your provider on what animals they have listed and could cause problems with claims.

It is also important that to determine what defines a pet and if it meets the requirements of the zoning laws for the property. There are areas that allow farm animals, but this is not normally the case – this will eliminate people who may want to raise chickens, a cow, sheep, horses, etc.

Service Animals are NOT Pets

Always remember that if a person is handicapped and they have an authorized service animal, they are NOT pets. You can screen handicapped persons just like any other applicant, but you cannotturn them down just because they have a service animal. Generally, most service animals are fully trained and well behaved. It must be the rental history, not the service animal, that determines whether to accept or deny the applicant.

Additionally, under Federal Fair Housing, you cannot charge any amount of deposit for a service animal. It is illegal and landlords can incur serious fines and damages if they charge the handicapped for a “pet.”

The Bottom Line

When you are in doubt concerning pets, use common sense and proceed with caution. Discuss your questions and concerns with us and we can assist you on the subject of pets. Then, if you still feel you want to say “no” to a pet, you can.