Real Estate Deal Analysis & Advice

Raising Rent (& Risking Tenant Turnover) vs. Playing it Safe (& Missing Out on Rent): Which Wins Out?

Expertise: Mortgages & Creative Financing, Personal Development, Landlording & Rental Properties, Personal Finance, Real Estate News & Commentary, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management, Commercial Real Estate
175 Articles Written
business-questions

I used to say that not everything is as it seems in real estate. I don’t say that anymore because it simply doesn’t do justice to the truth as I know it. What I say now is, “Nothing is as it seems.”

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

As it relates to income-producing real estate, neither the income nor the expenses are what you think they are going to be, which in and of itself is the only constant. I know, that sounds weird — welcome to real estate!

The Secret to Success

The secret to achieving success in this sport is first coming to terms with the above reality — the only dynamic you can count on is that nothing is as it seems. Once you accept this, the path to success is a function of developing an ability to see that which is not obvious. Basically, it goes like this — now that I know that nothing is what it seems, how do I figure out the real truth?!

real-estate-boom

The Flow of Money

The flow of money in income property is at first glance obvious. You have income, and you have expenses. The income includes rents and fees, and the expenses include, well, you know what they include — you’ll find all of them in the BP Calculator.

What you may not know, however, is that there are forces at play that silently impact both the income and the expenses, which can dramatically impact our bottom line. These forces of evil are typically referred to as economic losses.

Related: How to Estimate Future CapEx Expenses on a Rental Property

One subset of these economic losses are all of the costs that are the result of tenant turnover. For example:

Loss to Lease

Let’s say you are renting a unit for $1,000. The tenant signs the lease for one year, and things go well. When renewal time comes, you send the tenant a notice that their rent will be increasing from $1,000 to $1,040. The next day, the tenant walks into your office and says that they are not comfortable paying more than $1,000, and if her rent goes up, she will need to look for another place to live.

Now you have a dilemma. You think that you can rent the unit for $1,040. But on the other hand, you realize that it’ll take a month to turnover and re-rent the unit. You’ll also need to clean the carpets, replace some blinds, and perhaps do some painting. So, it ain’t like re-renting this unit will cost nothing. The question is, will it cost more than keeping the tenant’s rent at $1,000?

And the answer is, in most cases, yes! In this case, lost month of rent is $1,040. Plus repairs, let’s say all in, you lose $1,500 on the turnover. On the other hand, not raising rents by $40/month will only cost $480 for the year.

Which loss is better — $1,500 or $480? Think on that for a minute. 🙂

How to Become a Millionaire

You Lose Either Way!

Yep, you sure do. Why? Because even if you chose the lesser of the two evils, it’s still costing you money (be it less money). After all, if the market for the unit is $1,040 but you keep your tenant at $1,000, you’ve signed up for a loss of $480 on your bottom line — say hello to LTL (loss to lease). And if you are going to be intellectually honest, you are going to show a 4% loss to LTL somewhere in your pro forma. This is why when I see people throw around 5%-10% vacancy, I just laugh!

Related: 3 Little Known Factors to Help Minimize Vacancy Rates

Tenant Retention

The moral of this story, in a roundabout kind of way, is that while not always, in many cases it is cheaper to keep a paying tenant in place, but doing so costs money. The lost revenue is but one aspect of this. You may also paint an accent wall or replace a few blinds for them. Happy and paying tenants, producing stable cash flow for us, is worth the effort and cost!

Conclusion

Very few costs in real estate are obvious. I read on the forums this week some dude say something like, “It’s all about the numbers; plug the numbers into a spreadsheet, and if they work, they work.”

Yeah — but you’ve got to know which numbers to plug into that spreadsheet.

Investors: How do you approach this dilemma (risking tenant turnover due to raised rent)? Do you agree with this assessment?

Leave your thoughts below, and let’s discuss.

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the
Read more
    Chris Jensen Property Manager from San Diego, CA
    Replied over 1 year ago
    We send out a 9% increase letter about 90 days before their lease is up for renewal. In the letter it says that if they sign another lease for a year, we will drop the increase to 3%. This has two results, number one , they come chasing after me to sign up for another year and I don’t have to chase them for signatures. Number 2, they feel like they got a great deal because they got the increase down from 9% to 3%. We rarely have move-outs due to price increases.
    Katie Rogers from Santa Barbara, California
    Replied over 1 year ago
    They do not feel like they got a great deal. They know the real increase is the 3%. It like like those fake “blow-out” sales furniture stores have. Landlords should not assume that tenants are stupid. Meanwhile, (until very recently) typical tenant wages had been stagnant. They were not getting annual raises to help cover the rent increase. Thus, in the US today half of tenants are now cost burdened, defined as paying more than 30% of their income to rent, and half of those tenants are paying more than 50% to rent.
    Vaughn K. from Seattle, WA
    Replied over 1 year ago
    The logical way to go about this IMO is to compare market rents, vs the pain/expense of moving to your tenants… And then act accordingly. I think the best way to do it is to slowly raise rents in small increments, but to always keep it below the point where it is worth moving, and to always be giving them a bit of a deal. If somebody knows they’re getting a deal they can’t replicate elsewhere, if they move out at all, it will be for other reasons. One can always backpedal too if a really great renter says “I just hit my wall, and I know this is reasonable, but I just can’t do this high.” It doesn’t make sense to keep a unit at the exact same rate for 10 years if rents have gone up 50%… But it may make sense to perpetually keep it $50 a month below market for 10 years.
    David M. Investor from Torrance, California
    Replied over 1 year ago
    I don’t see anyone considering the forced appreciation. That $480/yr rent bump results in an immediate $8,000 increase in the property’s value at a 6-cap – you typically won’t incur any additional expenses (other than a little for PM) so the value goes right to the bottom line. Combine that with the additional cash flow and it’s probably a good thing to increase the rent. This applies to 5+-units – different things to consider for a 1-4-unit property.
    Katie Rogers from Santa Barbara, California
    Replied over 1 year ago
    The thing about using rent to force appreciation is that the so-called increase in value may not be an increase a buyer will pay for, particularly if the rents are too high or there is significant deferred maintenance. There is a reason investors take a seller’s pro forma with a grain of salt.