Real Estate – Raising the Rent

Real Estate - Raising the Rent - For Rent

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

 
 
Income
Totals
Monthly Rent Income
$1,400.00
Less: Management Fees
$(140.00)
Net Rental Income
$1,260.00
Expenses
Mortgage (P&I)
$1,049.63
Escrow (Taxes, Insurance, and PMI)
$305.64
Homeowner's Association
$120.00
Repairs/Maintenance Allowance
$100.00
Total Expenses
$1,575.27
Net Income (Deficit)
$(315.27)

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

If you enjoyed this post, subscribe below to get to receive new posts by email.

Comments

  1. W2R,

    When I first started renting, I thought I was going to be in the boat of raising every year. However now, I really like my tenants and my cash flow is pretty good. Additionally, my condo has finally stopped raising the HOA every year and taxes are fairly flat. So at this point if I raise, it is to make more money. They are comfortable and seem to really like the place, so I expect them to stick around for at least another year. With that, I don’t think I’ll raise unless my taxes go up a lot.

    -RBD

    • At this point, I am more than likely going to go that route moving forward. Unless I am changing a tenant, or market conditions change drastically, there is no need for me to up the rent needlessly. Of course, always subject to change! :)

      Thanks for stopping by RBD!

  2. This is a really, really touchy subject, and when I was doing my research I would find forums and threads that were 100 pages long… people debating back and forth on what’s best.

    You’ll probably never find the correct answer, or consensus, since everyone’s situation is different.

    What I’ve gathered, from personal experience and from networking with other investors, is that most new landlords are better served not raising rents annually. This takes into account for a cash flowing property, but the reason is when your first starting out, any missed payment is very likely a 100% vacancy situation. When your’re new, that’s a downright scary situation to face! I haven’t raised rents on any tenants yet, and the results have been great (so far). The first tenant has been in the property for over a year now, and doesn’t really bother me much for anything (knock on wood). She even renewed a 2 year lease!

    For the right tenant, it can work out well. It’s kind of a give and take, respect thing. For tenant #1, she recently had a garage door problem. I took care of it, but when rent was due the following month, she deposited an extra $60. At first I was confused… but later realized she put in the extra funds to pay for the repairs herself. Who does that?!? I was blown away by that action (although I did refund her back), so for this tenant, there’s a good reason why I don’t want to raise rents. I collect back in other ways… mostly through 0% vacancy.

    My plan is to get to 10 properties or so, and in the beginning the cash flow doesn’t have to be spectacular. I just need 0% vacancy, most importantly. Over time, when the portfolio grows, taking a vacancy hit won’t be so bad. It’s kind of like owning 40 stocks and seeing 1 company go belly up. At that time, I would probably start increasing rents more regularly.

    Your situation is different though. Your property is cash flow negative, so that changes things greatly. In this case, I think your’re doing the right thing raising rent. You aren’t going overboard with the raise, but you’re also helping yourself chip away and get back to breaking even. 1.8% really isn’t that much, so you may be able to even get away with this annual increase without having to worry about tenant backlash.

    Best of luck!

    • Wow, thank you for the great comment FI Fighter!

      I completely agree that newer landlords will struggle with missing the rent (I’ve had vacancy before and it isn’t fun). Ultimately though the decision to bump it slightly isn’t intrusive, but also signals that you are comfortable continuing to raise the rent. Most of the goodwill issues could possibly be mitigated with responsive landlord-tenant interactions and consistent treatment the timing and payment of repairs and maintenance issues.

      Love the analogy to stocks, where the more properties you have, the less a vacancy hit will be, therefore the more aggressive your pricing can be. However, the higher the rent on a property, the bigger the pain a vacancy can be. With one of your SF properties, although unlikely, if it were to sit vacant for a month while you tried to get maximize your rent, the vacancy cost would far exceed the incremental rent income in my opinion. Thus the question would be, is it better to consistently charge just under market rent and maintain that 100% occupancy? In my mind, more than likely. Ultimately it is just a personal management decision as each people have different risk tolerances.

      Again, thank you for the great comment, and of course, thanks for the share and stopping by!

  3. FIF’s comment was awesome!

    Personally I don’t think your negative cash flow situation is as bad as it seems. You are building equity each month right? Over time it will eventually break even (still building equity) and even be cash flow positive (and still building equity).

    I don’t own real estate, but I do find discussions like this fascinating.

    • Agreed CI! His comment was fantastic!

      It really isn’t as bad as it was prior to the refinance. Still isn’t ideal, as you’d like to be making bigger deposits than you do expenses, but it isn’t the end of the world.

      Thanks for stopping by, and like yourself, I find these topics very fascinating.

  4. When The Wife and I were younger she rented an apt for $1300 a month. We almost walked over the audacity to raise it $25 a month. Was the $300 really going to make the landlord? When I told my father, who has been a landlord for 30 or so years, the story he just laughed and said the guy never had a bad tenant yet. $300, $600 or even a grand or so a year isn’t worth the headache of a pissed off tenant

    • Thanks for stopping by Evan. I agree a marginal increase in rent is probably not worth the potential for unhappy tenants. No one likes to feel nickel and dimed, and will probably be less likely to be forgiving in case of any other mishaps.

Trackbacks

  1. […] Real Estate – Raising the Rent by Write Your Own Reality […]

Leave a Reply