Tuesday, March 31, 2009

When Do I Raise Rents? (The 2% Rule)

The quick answer to the question "When do I raise rents?" is that this should be done whenever the market allows. If you have a tenant in your house, it is now an investment and you should treat this like all investments, trying to achieve the best return at the lowest cost. There are two components to investment performance which must be managed, income and expense.

Right now about 20% of our clients are refusing our recommendations to raise rents. I don't understand how an owner will easily turn down $300.00/year in additional income, then anguish and get upset over a $100.00 repair. I have often said home ownership creates emotional decisions when the decisions should be financial, please try to avoid this trap.

So, how do you know if the market will allow? Ask us! We are experts in determining the correct amount of rent to ask when a tenant first moves in and also in determining the amount of rent you can increase at the time of the expiration of the initial lease period. We want your asset to have the best overall performance, it will cause you to continue to use us as your investment manager. We also want you to make enough money from rent so you agree when we recommend appropriate maintenance and upgrade expenses.

I will not reveal all of our secrets on how we make the determination of how much to increase the rent, but part of the equation is the "cost of the pain to move". If you have a tenant already living in a home, and the tenant can get the exact same home for the same price right down the street then you can increase the rent. A tenant will almost never move over a $25.00/month increase.You can then use this $300.00 extra per year to provide a higher level of maintenance, increasing your value in the home and providing a better product for the tenant. A variable measure/rule to use for rent increase at renewal is 2% of the rent. In my last post I talked about the 1% rule (annual maintenance costs compared to the value of the home), so let's call this the "2% rule" - always raise the rent 2% at renewal.

One of the things I often do after a rent increase is send the tenant a thank you note with a gift certificate, which the tenant can use in whatever manner they see fit. If you want this done, just ask your property manager, they will send a gift card to your tenant with a personal note. I usually send a $50.00 gift card when I do this.

I also use the additional rent funds to send an HVAC specialist to perform a system maintenance which will keep the system in better repair, and reduce energy consumption for the tenant. This is a win/win situation, the tenant benefits from lower energy costs and the HVAC unit's life is extended, lowering my overall costs. Your tenant will appreciate this care you provide for the home and remember this when it comes time to renew their lease.

So when we suggest you raise the rent, follow our expert advice. Then you have a choice, you can spend the extra money on yourself, enjoying the fruits of your investment, or you can reinvest, either into this home or any other investments you may have. But, never turn us down when we recommend a rent increase, this is money you can never get back.



Anonymous said...

wow...from this blog it would seem that the value of a renter means nothing that one would be so willing to raise the rent when that person has cared for and maintained the quality of the home during the lease time period. you're right...the "pain of moving" is definitely a deterent for a renter. however to nickle and dime a good tenant over $25 bucks a month, in this economy CAN make or break a family...that's just selfish. but i guess it's all about the dollar and not about the individual. what i find disappointing is that the property management company cares more about the investment than the families they put in their homes. makes you wonder as a renter where the security is in being a good tenant. if so be the case, than no matter how you treat the home, you could be $25 away from being out on the street. very disheartening.

Unknown said...

wow is right...

Thanks for taking the time to express your thoughts. Your concerns are valid and tenants who are "good" tenants are valued by our clients.

There are many things which go into evaluating when to raise rents, but an important issue to remember is the business of supplying a rental home to the public is still a business. Our clients provide this service in order to make a profit and in doing so they are taking risks with their families personal finance and they expect/need/demand an appropriate financial reward in return for this risk.

Tenants do not have the same risk as the landlord. If a specific tenant cares for the house better than the average tenant this information is relayed to our client when they make the decision on raising the rent. The fact remains that in most of the markets where Prime Properties operates a tenant can lease a home for less than they can buy it, based on the amount of money the provide at move in. The tenant does not have the responsibility (expense) to maintain the home or the expensive items which age and fail. The tenant can also move without the expense of a $9,000 realtor fee (a "typical" fee on a $150,000 home).

The landord does have expenses which increase over time, including maintenance and taxes. Most landlords are lucky if rent increases cover the increasing costs. So how can a landlord offer this service and still make a profit, the answer lies in the fact that a landlord will gernerally put more money into a home than a typical homeoowner and also that current tax law which allowsa business owner to deduct their expenses. If either of these items were to change then rents would be required to increase even more.

Home ownership is not for everyone, as many want the reduced expense and the freedom and flexibility which comes from renting. If you buy a home and live there less than 5 years it is, depending on the market, almost always going to cost more to buy a home than to rent a home. Example, if you bought a house in Phoenix two years ago, you would be very happy be paying an extra $25.00 more in monthly rent rather than be looking at a home on which you owe $200,000 and is now only worth $120,000. Paying $25.00 more per month beats being $80,000 in debt! The tenant do not have the risk of this happening, but the landlord does.

I am glad you responded to the blog, this dialogue is one which should happen more often. The basic assumption that "renting a home is bad for the renter" is often wrong. Many people would be in a better financial postion if they had rented instead of buying.

Drew Kolb said...

I would like to add a few comments to Kevin's response. There are a couple of things from a tenant's point of view that should also be considered. Good tenants are a big part of the owner's equation for both sides of the owner's goal to maximize the performance of his investments. Tenants effect both sides of the equation of maximizing income and minimizing expenses.

There are a few economic issues you are not considering in your response that the tenant is not considered important. There is more to deciding why to increase rents, than just to increase rent. The first is inflation. A 2% increase in rent, in most years, does not cover this cost. You see this type of increase in your personal expenses as well. Second, the increase also helps cover the owner's repair costs that also, typically increase each year due to the increase in cost of contractor services and the cost of materials used. The proper up keep of the home continues to provide you with a quality home at a competitive price in the market place. This is a “value” that you consider each time you have looked for a home to lease. There is an intangible value to you as a tenant when you chose between two homes that are priced the same, when one is presented with obvious lack of maintenance and one home is offered that is well maintained. If the home was not maintained during your lease, you would not see the value in staying another year and would consider moving and incur all the expenses of moving.

Just as the owner’s costs are typically increasing each year, your personal expenses are rising also, not just in rents. Things like cell phone service, utilities, cable, internet, etc. Some of those increases in costs by these service providers will be passed along to you, just as owners pass along the same type costs to tenants in rent increases. We do care about the tenants that occupy our client’s homes. We want to be sure to help the owner povide a quality home, be sure that it stays well maintained, and is offered at a fair market price. This attracts quality tenants that will stay longer and continue to enjoy and care for the home.

Bronson Reyna said...

I would also like to thank our tenants who take the time to examine the blogs and post comments and concerns. As a property manager, I represent the landlord, and I am often asked by tenants, "Why is the rent being raised?" I too would like to take a moment to share the reasoning behind many landlords' decisions to increase rents.

Your landlord's decision to raise the rent amount is often used as a strategy to move tenants slowly up to market rate. If you look around your area at similar rentals, you will probably notice that many of them are likely priced higher than yours. Often, homeowners will move tenants in at a lower introductory rate to avoid extended vacancy time. Most people do not like moving, so by the time your 1-year renewal roles around and the rent is slightly raised, it should be comparable to similar rentals. It only makes sense for you to stay in the home and pay the small increase rather than relocate which will likely cost much more money and headache. When the rental market is strong, like it is now, a renter's chances of moving and finding another similar rental at an equal or lower monthly rate is slim. Landlords take this approach to insure worthy and long-term residents. In addition, the rental market is cyclical just like any other market. "What goes up, must come down." It is important for landlords to keep pace with rents when the leasing market is strong so that they can survive leaner times when rents fall and vacancy rates rise.

As Kevin pointed out above, it is also important to take the economy into account. Landlords might be more inclined to raise rents when operating costs have risen. If the homeowner is experiencing increased property taxes or insurance, it only makes sense for them to raise the rent to make up for these increases. The age of the home should also be taken into consideration. As a home ages, it will require increased maintenance and upkeep. It is important that the homeowner has funds available to make repairs when your air conditioner or water heater fail. Most tenants may not realize it, but they are actually benefitting from the increase in rent by helping the homeowner to be able to expedite repairs necessary for the tenant's health and comfort.

In summary, there are many variables that influence landlords' decisions to raise the rent. The current rental market and operating costs of the property are just two examples of fluctuating criteria that influence the need to demand higher rents. I hope this explanation also helps to shed some light on your landlord's decision.

Ronyta... said...

I would like to comment on raising the rent....

I believe renters should expect some sort of rent increase - I'm not sure that I agree this is to be done annually. However, the assumption is the rent increase is to cover things like maintenance upkeep...I've been renting a home for 4 yrs and treat it as if it were my own.

However, when the home you reside in/rent is going up on the rent and the repairs are not being done, where is the justification in that? I don't think it pays to be a good tenant...obviously.

But I love renting, and as one of the people who responded said...moving is just a dreadful thought.

Nonetheless, I will be forced to move if the repairs are not addressed and I believe in this market...the owner and prime properties will loose more than me if I move...just my opinion.

Unknown said...

Dear Ronyta,

Please contact your property manager and give them this same information that you put in your post. If you do not know who they are or how to reach them you can email me direct at kmartin@oneprop.net. If you email me, please include your property address, I will work with your property manager and your landlord to see if we can get the repairs done.

Anonymous said...

I find this topic very interesting considering I was just watching CNN and they recommend that renters should request a reduction in rent due to the bad economy. I can agree with CNN when you have only one person working in a household and every dime counts. Although it is a hassle to move a renter has to figure out if that extra $25-$30 per month is feasible in this economy. Property owners should probably take into consideration that there are many more available homes for rent nowadays and at lower prices. In addition to that how long will it take you to replace a tenant who has been paying on timely monthly and that takes care of their investment as though it is their own. Like all other investments right now would you rather not have a tenant and lose more money or would you rather have a steady return on your investment and wait on the economy to improve? There is always a risk with an investment. Just a thought when there are so many choices out here now.

Unknown said...

Every Real Estate market is different. Our role is to use our experience to help a Landlord realize the most income at the lowest cost. If a market will allow a landlord to increase rents it will help offset the landlords increasing expenses and insure there are adequete funds for proper maintenance and repairs. It may also mean a landlord uses the funds to acquire more properties, making more rentals available and increasing competition and keeping rents down. If your landlord increases your rent you need to decide if you are still receiving good value for what you pay. Your points about the cost of a vacant home are valid, but I make no secret that I will recommend to a landlord an increase in rent if the market conditions show it will increase their profitability. Your landlord took a financial risk when they bought a house and made it into a rental, and they continue with that risk each day they have it, and they take this risk in anticipation of a reward. People rent homes because they want the freedom from risk associated with home ownership and also for the freedon to move if their personal life changes due to a change in job or their family situation. I have been a renter and a landlord, and I never held it against a landlord who raised my rent on a home, I accepted their decision and I either stayed or moved based on my needs.

Right now the situation in the apartment markets are different than single family homes. Apartments are experiencing higher vacancy rate and a tenant in an apartment is more likely to be in a situation where a reduced rent might be appropriate.

CNN does not have the time in their 30-60 second blurbs to go into this type of detail. Other television shows like 60 Minutes or CBS Sunday Morning look at these types of stories more in depth and can actually provide more information. Most landlords and their tenants spend about 10 minutes a month deciding if a current landlord/tenant relationship is the right one for them. At ONEprop we have over 50 people who spend all their working hours trying to understand the markets and what makes sense for our Landlords and their tenants. I am proud of the work done by these people and proud to represent the Landlords we do. Our Landlords take good care of the homes, making appropriate repairs and providing good value to people who want to rent a home. The homes are not all palaces, but not everyone wants, needs or can afford a palace. In most of our markets a 3 BR home will actually rent for less than a 3 BR apartment and usually rent for the same or less than a comparable house payment (assuming 3% down payment). The security deposit is usually less than the minimum down payment required to purchase a home. All in all, still a good value for all and the tenant does not have to pay the $2,000 bill when the AC fails.