Landlording & Rental Properties

Your Long-Term Rental Will Probably Perform Better Than Expected: Here’s Why

Expertise: Real Estate Investing Basics, Landlording & Rental Properties, Real Estate News & Commentary, Mortgages & Creative Financing, Real Estate Wholesaling, Personal Development, Flipping Houses, Business Management
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Most people who read this article are probably already sold on the notion of buying and holding real estate. There are numerous blogs written (many by me) about the benefits of owning real estate. From the cash flow that can be generated and the appreciation that can be realized to the use of leverage to increase returns and the tax benefits, there are many factors typically found in your average pro forma that can easily justify the long term investment in real estate.

Related: How to Increase Investment Value by Increasing Rental Income

Rent Increases

However, I see many real estate pro formas that leave out another huge benefit to owning rental real estate. It’s the fact that rents increase over time. Not only do they increase, but rents are currently increasing faster than most investors realize.

Zillow’s Chief Economist was quoted as saying:

Over the past fourteen years, rents have grown at twice the pace of income due to weak income growth, burgeoning rental demand, and insufficient growth in the supply of rental housing. This has created real opportunities for rental housing owners and investors, but has also been a bitter pill to swallow for tenants, particularly those on an entry-level salary and those would-be buyers struggling to save for a down payment on a home of their own … Next year, we expect rents to rise even faster than home values, meaning that another increase in total rent paid similar to that seen this year isn’t out of the question. In fact, it’s probable.

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According to the latest Bureau of Labor Statistics report, the rent index increased 3.4% in 2014. Zillow’s report mentions median rents increasing 2.9% last year. So let’s assume rents are increasing nationally at a rate of approximately 3% per year. In theory, that means your rental house getting $1,000 a month could increase to $1,030 in one year! If rents continued to increase at a pace anywhere near this high, the returns on your rental property would jump significantly over a just a few short years.

Related: Offering Rent Specials to Tenants Can Be a Costly Mistake: Here’s Why

The Importance of Knowing Trends in Your Market

I will concede the fact that 3% is a national number, and every market is different. However, some markets are actually experiencing rent increases that are even higher than this. It’s important to research the market you are buying in and understand the rental trends. While you will probably not see precise jumps in rent every year (i.e. an exact 3% increase every year), as you hold property over time, you should see opportunities to increase rents (sometimes on existing tenants and other times during turnover). I know in my market, it’s not uncommon for us to bump rent prices up in $25 and $50 increments as the market allows.

As an investor looking at potential long-term investment properties, are you building some sort of rental increase into your pro forma? I would venture to say that most investors do not. Perhaps there is a tendency to calculate returns as conservatively as possible, and there isn’t anything necessarily wrong with that. But in my opinion, if the data points to a certain predictable increase (whether in rent appreciation or price appreciation), why not factor that into your buying criteria and future return calculation?

How about you? Have you seen opportunities to consistently raise rents on your investment properties?

Leave a comment below!

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

    David G
    Replied almost 5 years ago
    Hey Ken, I’ve planned on increases to my rents when I bought my rentals, and most of them have gone up even faster than I thought. Another thing I think will lead to higher rent is the decrease in gas prices putting more money in tenants pockets and making rental properties farther away from areas where people work more desirable. I tend to look for nicer properties in commuter areas and I think lower gas prices are set to work very well for me because of this. The beautiful thing about inflation is the rents will go up in time while my mortgage will always stay the same. Great article. It would be nice to hear how many other investors make decisions based on the hopes that rents are likely to increase and sometimes getting the return you are looking for just means hanging in there for a little while.
    Ricky Williams from Prosper, Texas
    Replied almost 5 years ago
    The other thing to keep in mind when running pro-formas is that even if you don’t plan to raise rent, that the property tax district and the insurance companies sure plan to increase what they charge you. I have found that I have to increase rent at rates higher than I’d like just to keep up with the increases in property taxes and insurance. In the DFW market especially, the appraisal districts have been very aggressive at increasing tax values.
    Tamara R. Investor from Vienna, Virginia
    Replied almost 5 years ago
    This. My mom paid off 46 year old house 16 years ago, but she told me the real estate taxes are now higher then her mortgage ever was. Something to consider……
    Deanna Opgenort Rental Property Investor from San Diego, CA
    Replied almost 5 years ago
    For all that people complain about California as an investment area, TAXES are the one area that we have most other states beat (also why it is SO important to push back if the local tax assessor tries to overstep the initial assessment, and why a rehab/long-term hold can be better than a turnkey…in CA). Prop 13 means our property taxes are in relation to the price when PURCHASED. Barring a gut & rehab the taxes continue to be based on the initial purchase price (with adjustment for inflation). Given that VALUES can increase by 100% in a few years in a crazy market, prop 13 is the only thing that has saved the homes of innumerable older folks here. It also, happily for me, benefits us long-term hold folks, as I can predict my tax bill for as long as I own the house.
    Wendy Noble Investor from Sunnyside, New York
    Replied almost 5 years ago
    I like to just sit back and enjoy the ride. Mutual funds and the stock market fluctuate too much for my liking. Rents just keep creeping up without me having to do very much at all.
    Susan Gillespie Investor from Saint Paul, Minnesota
    Replied almost 5 years ago
    Yes, rents increase, but so do taxes, services, utilities and other expenses. Higher income can help offset higher expense. I wouldn’t plan for one without the other.
    Niko
    Replied almost 5 years ago
    Exactly people! How do we hedge against the taxes, insurance and utility increase? Rents can only go up so much? This is why buy and hold does not make sense. Your cash flow will eventually go down every year. I have yet to find a guru who has laid out an effective strategy any help?
    Ricky Williams from Prosper, Texas
    Replied almost 5 years ago
    I’m afraid you extrapolated my point on taxes and insurance more than I intended. The point I made is that taxes and insurance go up. So does rent and maintenance. Mortgage payment stays the same or (eventually) goes away. The nirvana long-term buyers seek is when the mortgage goes away and about half of the rent is free cashflow.
    Kyle Hipp Investor from Appleton, Wisconsin
    Replied almost 5 years ago
    Most of the homes I purchase are energy hogs. I make energy efficient improvements to lower utility costs and make the homes more comfortable. This increases rentability and keeps tenants longer in my experience. The cost savings are pretty substantial.
    Greg Rand Investor from Mooresville, North Carolina
    Replied almost 5 years ago
    I appreciate that Ken started this post by highlighting the three drivers of return – cash flow, appreciation and the impact of leverage on returns. Too often I hear things like, “It’s all about cash flow. Appreciation is a bonus.” But it’s about both. Single family rentals are the only asset class in the world where you can generate an easy 7-9% annual return when you combine cash flow and appreciation with a stable and predicable investment. Leverage it at 70% LTV and it goes into the low double digits. So a 5% cap rate is actually a 12% investment. If more people knew that, the stock market would drain.
    Al Williamson Rental Property Investor from Sacramento, CA
    Replied almost 5 years ago
    Ken, good insight. It’s long term holding really get fun once the principle reduction is greater than the monthly interest. I just love that.