Dealing with an unintentional rental is no fun. Let me be the first to say that a negative cash flow is never an ideal situation, no matter how much the short-term tax benefits or principal pay-off reverse the financial pain. That being said, when I refinanced this past spring, my monthly cash flow improved significantly, saving me over $350 per month. These savings, coupled with the aforementioned tax benefits and principal pay-off, at least brought a positive spin to this sad rental situation. But the value of rental properties are really in the cash flow and increasing the rent is really an integral part growing your returns with rentals.
When to Raise the Rent?
There are two schools of thought when it comes to raising the rent on your rental properties. The first is to raise your rent on an annual basis for your long-term tenants, in addition to raising the rent with each new tenant. It seems to me that the advantage to raising your rent this frequently is pretty straightforward. Common sense would seem to indicate that the more you raise the rent, the higher your returns, right? Well, yes, in theory, this should be the case. Like an adjustable mortgage, where the banks benefit with a more frequent rate adjustment period should interest rates rise, you can benefit by continuing to maximize your rental income each and every year.
However, not everything in the world is as straightforward as just raising the rent as often as you’d like. With that in mind, the second school of thought is to only raise the rent with each new tenant. Now why would you want to do something as crazy as that? Raising the rent on your current tenant introduces the potential for negative feelings within your tenant which might have adverse consequences for your landlord/tenant relationship. Look, being viewed as a fair, responsive, and even generous landlord is an asset when managing your tenants.
Happy tenants mean constant rent checks. But by possibly souring that relationship, the potential loss of goodwill doesn’t seem worth it. But does this change if you live in an area with low vacancy rates, and your place is in an otherwise marketable position? I say no, the risk is still there.
Ultimately, there is a chance your tenant will see you as a money-grubbing slum lord just looking to line your pockets with gold. Which we all are… well perhaps not in those terms, but we rent to make money, not friends. So by putting yourself in a position where your tenants might leave because of a rent hike, you then open yourself up for the most expense part of being a landlord, turning over a rental and possibly vacancy days. No expense is as large of a risk with a rental as vacancy. No tenant equals no money. Perhaps being a friend is the right path?
Oh come on, the cost can’t be that big, right? Just think of it this way; if you are renting a house out for $1,500 per month, and you decide to raise the rent by $100 per month, you’ve gained $1,200 over the course of the year. Fantastic, a 6.67% raise! Although, if the tenant ends up leaving you are blessed with turnover expenses (painting/cleaning/repairs/etc.) and a possible vacancy, essentially taking that $1,200 of extra income and flushing it down the drain. Better to have kept that tenant in there at $1,500 and skipped the rent increase in this particular situation.
So what did I do? I ignored the potential negative response of raising the rent on existing tenants and went ahead and raised the rent on my mine.
Let’s take a moment so we can all think about how much of an idiot I am. I’ll wait.
Okay, I joke, I don’t think I’m an idiot (although it is possible), but instead just a money-grubbing slum lord trying to squeeze a nickel out of a penny. I did indeed raise the rent, but only by a whopping 1.8% from $1,375 to $1,400. Why implement this token rent increase when the risk of losing the tenant is higher after such an increase? My
reasons excuses are simple: My tenant has no desire to move, loves the house, and was/is renting below market rate. Did I risk losing my tenant over $25 a month or $300 a year? Absolutely. Will I be doing this again next year? Not a chance. He didn’t move this time, but the next time he might.
Updated Rental Property Financials
So what are the updated numbers on a monthly basis for my unintentional rental? Well, they still aren’t pretty, but it could be worse!
Townhouse Rental Financials
|Monthly Rent Income|
|Less: Management Fees|
|Net Rental Income|
|Escrow (Taxes, Insurance, and PMI)|
|Net Income (Deficit)|
Ultimately this small raise decreased my monthly negative cash flow by $22.50. While not significant, everything adds up! I should point out that while the financials above show a net loss of $315.27 per month, $100 of this is a repairs allowance which is not realized until expenses actually occur. Like I said at the beginning of the post, my rental property is performing just above the break-even point when netting the actual cash flow loss with the new principal repayment amount, which is in excess of $300 per month. Of course this does not get into any tax benefits which would increase the limited positives of owning the property.
So the question is this, if you were or are a property owner, when would you raise the rent, and why? Is it best to rent just under market value to ensure 100% occupancy, or do you push to make the most money every month with every tenant you have?
Flickr: Charleston’s TheDigitel