Let's say I buy a 50 unit apartment complex. My mortgage is fixed. Expenses such as taxes and insurance will likely rise slowly over time.
Now if I raise the rent $50 per year on all 50 units (perfect scenario to demonstrate the concept) I'm pulling in an extra 30K per year. Now let's say I do that each year for six years. Now I'm making 180K a year MORE than before.
In this scenario, expenses have been budgeted for from the normal rent base, however, I could dip into some of this cash flow if needed.
I'm curious, if this is really true, why are more people NOT doing this? Seems to me THIS is the way to go. Heck I could replace my six figure IT salary in a few years and retire living the same lifestyle I live NOW. And I just get richer over time as rents rise and the mortgage is paid down.
Jack,
You're on the right track. You live in Seattle and I live in San Jose so I can envision a $50 rent increase without doing anything ALMOST perpetually. Of course, we're talking about the average of $50 rent increase. In good years, you can do $100-$200 rent increase while in bad years, you don't and may even have to cut rents.
Turnover gives you an opportunity to freshen up the unit and get several hundred dollars more in rent IMO. Units that were renting in 2012 for $1,600-$1,700 in 2012 are now renting for $2,200-2,300. So you have accomplished 12 years worth of $50 rent increase in 3 years in my market. That's the beauty of investing in expensive and high growth markets like ours. To sweeten the pot, for every dollar of NOI you generate, you earn twice as much equity on a 5 cap vs. a 10 cap. So low cap rate can be a great thing if you know how to play the game. Basically, you get paid twice the amount of money for your effort. How do you like the sound of this if your boss says "Hey Jack, you're doing a great job so I will double your salary." :>)
Here's the reality. People typically don't sell great performing assets. They sell their assets at a discount because there are some underlying issues. If you can identify those, cure them and reap the rewards.
Every market, every sector and every niche have people working in the trenches and looking for deals. How do you rise to the top and be the go to person that the agent/broker think of when they have a deal?
Good luck.
Jack,
Doesn't that kind of assume that the rental rates are depressed by that same $200 - $300? If they are then you are probably looking at a lot of expenses to get the place up to par. Just a thought. If you can add value to the property, then you are 100% Correct. Call my crazy but you should go read everything that @Ben Lebovch has ever written for BP, and his blog - this is his wheelhouse.
Let's say I buy a 50 unit apartment complex. My mortgage is fixed. Expenses such as taxes and insurance will likely rise slowly over time.
Now if I raise the rent $50 per year on all 50 units (perfect scenario to demonstrate the concept) I'm pulling in an extra 30K per year. Now let's say I do that each year for six years. Now I'm making 180K a year MORE than before.
In this scenario, expenses have been budgeted for from the normal rent base, however, I could dip into some of this cash flow if needed.
I'm curious, if this is really true, why are more people NOT doing this? Seems to me THIS is the way to go. Heck I could replace my six figure IT salary in a few years and retire living the same lifestyle I live NOW. And I just get richer over time as rents rise and the mortgage is paid down.
@Jack B
I understand what your saying, but your forgetting important factors. Increasing the rents gradually but with no added value in your 50 unit building will create turnover (over-time). You also have to consider in the perfect scenario the demographics and what type of tenants your catering towards, is your property in a desirable location? Is that location apart of a bigger redevelopment effort from the city/town or will be? If so then you can project an outlook of rental increase from say not just $50, but $50-$200 per unit annually as development brings in new demographics, this will also allow you to "update" building or buildings with your surroundings (new development) which will justify the increase in rents.
Smart investors don't just increase rents to do it because they can, there's a reason, which is done both from a artistic perspective (your vision) and a science perspective (hard data).
This may or may not answer your question as to why you don't see this as common practice. But there are property owners who play your provided scenario in real life, and I can't say I've seen them stick with that strategy for a long time without seeing the drawbacks of arbitrarily raising rents.
One of the many things to consider when you plot out scenarios. :-).
Bruce
Jack, this is the misconception my group had. We bought a couple c-class properties and the initial monies and time are outrageous. I know why "everyone" isn't doing this. However, in a couple of years all of my deferred maintenance issues are being dealt with and the properties are increasing in both rents and value. I'll be living this dream some day, but it isn't straight out of the gate and it is A LOT of work to get the right team in place. I'm a lot more hands on than I ever thought I'd be.
Good luck!
Cary
The multi-family advantage is a double edged sword. Short-term leases (1 year or less) that turn over in a down market may put downward pressure on rents...it's not always up.
Commercial properties with longer term leases may feel like the rents don't move often, but in a depressed market with good tenants that's a good thing. Also note that many new commercial leases have built in escalations the move the rent pretty regularly.
Chris
Great points above from @Matthew Forbes, @Cary P. and @Bruce G. as to not being able to raise rents perpetually with no value add. All of my commercial multi's have required a lot of work to get stabilized and to market rents.
I like multi's. Great economies of scale and very recession proof. One other point though is your 'fixed mortgage' @Jack B. Commercial loans usually have shorter terms and are adjustable/callable every 5 years. Mine have adjusted every 5 years for the last 13. Thankfully they adjusted down over time (starting at 7%, now at 5%) and weren't called, but I was taking on interest rate and call risk. Not trying to turn you away from apt investing, just pointing a couple things out. Cheers!
Thanks for the feedback all. I did mention that I budget the maintenance (including roofing, siding, repairs, etc.) from the regular rents and that in the event I needed to dip into that extra cash flow to do something to spruce the place up I would.
"In this scenario, expenses have been budgeted for from the normal rent base, however, I could dip into some of this cash flow if needed."
I know when I lived in a an apartment, I usually only saw rent increases (USUALLY) when they did something to improve the place. But when I lived in Seattle proper, my old apartment went from $850 a month to $1,400 a month in the span of 4 years or so. For me I was planning on sprucing up the place, but it doesn't cost much to make a small gym, or playground, etc. What I'm saying is, I plan on adding value for the rent increase, but it doesn't cost as much as the rent increase to add value.
Most of the places I've seen have decent interiors and acceptable exteriors. I was looking at one for 1.4 million recently but the 31 unit complex is right outside the gate to a military base, so that's likely going to be the demographic of renters there. I know that service members and certain members of the intelligence community are allowed to break their lease at the drop of a dime, so in the case of this complex, it's probably a bad buy. But you get the concept of what I'm saying as far as increasing returns to scale/economies of scale? When you find the right deal?
On the other hand Phil Pustejovsky (sp?) says it's better to have 2 paid off rentals that cash flow like crazy than have dozens of rentals mortgaged to the hilt. He said in the same video on youtube, that he used to think it was better to have multiple units leveraged to the max, but now he knows better.
I have yet to find out why he feels that way. What I can think of is that dozens of rentals = much more capital expenditures for updates, and much more work and time involved than two paid off rentals with more than enough cash flow to retire on. Still, it seems with a large enough complex with a PM, over time you still come out far ahead over a hand full of SFH rentals.
I need to do more research on this subject and look at it from all angles. For example, A year ago I was considering buying a car wash as a business. They seemed reasonably priced at 100K, with acceptable cash flow, especially for the money/time invested. But I waited, and I waited, and eventually after much research, it was driving by an old car wash near one of my rentals that I realized why these people were dumping these car washes: most people want to use automated car washes now. The seller didn't want to spend the money to do the updates. It dawned on me after driving by one such manual car wash that I later saw being updated to automatic (which is taking them forever).
I guess part of me always wonders, if it's such a great deal, why are you selling it? lol.
Dave Lindahl suggests in his book to always increase rents by $20 or so upon renewal. He calls it a "nuisance increase". It is big enough to make a difference to the owner's bottom line if the number of units is high. But it is small enough for a tenant to move out because of it.
Dave Lindahl suggests in his book to always increase rents by $20 or so upon renewal. He calls it a "nuisance increase". It is big enough to make a difference to the owner's bottom line if the number of units is high. But it is small enough for a tenant to move out because of it.
Did you mean it is small enough for a tenant NOT to move out because of it?
@Jack B., your assumption is correct that you can increase rents and can get more cash flow. I bought a 200+ unit deal and raised rents over a $100 per unit. However as @Bruce G., shares great points, you need to have a plan on making updates to the asset. If you continually increase rents but don't add value to the property, your tenants will leave. So you really need to understand your market, demographics and have a strategic plan that you can execute.
One thing you didn't mention, as NOI (net operating income) increases so does the value of the property. Assuming you were able to increase rents over the 6 years to increase NOI to $180k, and using a 10 cap, you increased the value of your property by $1.8 million (NOI/Cap Rate = Value). The cap rate is market specific so you need to get connected with a good broker, appraiser, etc.
After 15 months when I bought my 200+ unit deal for $6 million and taking occupancy from 86% to 98%, increasing rents $100 pu, spending almost $600k on adding value, I refi'd the asset in October 2015 for over $10 million.
Obviously not all deals are as sweet as this, but it can be done. DISCLAIMER though - this isn't easy by any means, it takes a lot of work to find the right deal in the right market, and to execute a plan and be ready for many surprises as they will happen!!
@Jack B., your assumption is correct that you can increase rents and can get more cash flow. I bought a 200+ unit deal and raised rents over a $100 per unit. However as @Bruce G., shares great points, you need to have a plan on making updates to the asset. If you continually increase rents but don't add value to the property, your tenants will leave. So you really need to understand your market, demographics and have a strategic plan that you can execute.
One thing you didn't mention, as NOI (net operating income) increases so does the value of the property. Assuming you were able to increase rents over the 6 years to increase NOI to $180k, and using a 10 cap, you increased the value of your property by $1.8 million (NOI/Cap Rate = Value). The cap rate is market specific so you need to get connected with a good broker, appraiser, etc.
After 15 months when I bought my 200+ unit deal for $6 million and taking occupancy from 86% to 98%, increasing rents $100 pu, spending almost $600k on adding value, I refi'd the asset in October 2015 for over $10 million.
Obviously not all deals are as sweet as this, but it can be done. DISCLAIMER though - this isn't easy by any means, it takes a lot of work to find the right deal in the right market, and to execute a plan and be ready for many surprises as they will happen!!
Now that is pretty impressive. Well done. I need to really look into this. I'm going to start small so I'm only speculating with money I can afford to lose if things go sideways, but these are the kind of deals that I'm talking about.
Dave Lindahl suggests in his book to always increase rents by $20 or so upon renewal. He calls it a "nuisance increase". It is big enough to make a difference to the owner's bottom line if the number of units is high. But it is small enough for a tenant to move out because of it.
Did you mean it is small enough for a tenant NOT to move out because of it?
Small enough NOT to move out
@Jack B. - good luck my friend. As you start your journey, (and I don't mean to toot my own horn), but feel free to check out my thread on how I quit my CPA job to buy and sell almost 1000 apartment units I also did a podcast with BP #135 that will give you more insight.
@Jack B. I have a tenant, he was really nice. I raised his rent 3%. He turned a complete 180 the next day. If you raise everyone's rent in a 50 unit building, keep doing it, and don't make upgrades, chances are you will get more than a few who turn into a major PITA.
@Jack B. I have a tenant, he was really nice. I raised his rent 3%. He turned a complete 180 the next day. If you raise everyone's rent in a 50 unit building, keep doing it, and don't make upgrades, chances are you will get more than a few who turn into a major PITA.
Thanks, yes I agree. It was not my intent to do it that way. I budget for maintenance out of normal rents not rent increases, though as I mentioned earlier, I would be willing to dip into the extra cash flow to spend where I need to spend, in the sense that I view such spending as a investment (that allows me to charge higher rents and adds value to the property). Still, it doesn't cost much to buy some gym equipment, add a playground, do free movie rentals and giveaways compared to the rents received.
@Jack B. - good luck my friend. As you start your journey, (and I don't mean to toot my own horn), but feel free to check out my thread on how I quit my CPA job to buy and sell almost 1000 apartment units I also did a podcast with BP #135 that will give you more insight.
I heard that podcast and great job! What you have done is very impressive.
Going back to the title of this post, I would argue one huge advantage of any real estate rental is the ability to increase rents. I got into this business because I saw these advantages:
1. I can finance a house and have my tenants make cover my payment.
2. I get extra monthly income beyond expense each month that I can put into other properties or paying down my mortgage.
3. I get depreciation advantages on my taxes.
4. Rents go up over time. I view this as an inflation adjusted income stream.
5. My property values increases over time, so I can make money when I sell.
Keep in mind that rent rate increases are dependent on the property quality and location. You may need to spend money to increase rents. If you are in a depressed area or find yourself in a recession, the rent rates could be flat or decrease. Property value only increases in the right area and with the right upkeep on the property. The concept of increasing rents being an advantage is true, but is dependent on many variables.
Jack,
You're on the right track. You live in Seattle and I live in San Jose so I can envision a $50 rent increase without doing anything ALMOST perpetually. Of course, we're talking about the average of $50 rent increase. In good years, you can do $100-$200 rent increase while in bad years, you don't and may even have to cut rents.
Turnover gives you an opportunity to freshen up the unit and get several hundred dollars more in rent IMO. Units that were renting in 2012 for $1,600-$1,700 in 2012 are now renting for $2,200-2,300. So you have accomplished 12 years worth of $50 rent increase in 3 years in my market. That's the beauty of investing in expensive and high growth markets like ours. To sweeten the pot, for every dollar of NOI you generate, you earn twice as much equity on a 5 cap vs. a 10 cap. So low cap rate can be a great thing if you know how to play the game. Basically, you get paid twice the amount of money for your effort. How do you like the sound of this if your boss says "Hey Jack, you're doing a great job so I will double your salary." :>)
Here's the reality. People typically don't sell great performing assets. They sell their assets at a discount because there are some underlying issues. If you can identify those, cure them and reap the rewards.
Every market, every sector and every niche have people working in the trenches and looking for deals. How do you rise to the top and be the go to person that the agent/broker think of when they have a deal?
Good luck.
@Account Closed
It must be a left coast thing, you sound a lot like landlords I know in Vancouver ... just keep raising rents $50 - $100 each year in perpetuity.
A $50/year rent increase is wonderful - something most of us on the other coast might only see a couple of years per decade - but it's only feasible so long as the underlaying economy and family income continue to increase at a similar rate, otherwise you will eventually price yourself into the high-end of the market and hit your own ceiling.
@Account Closed
It must be a left coast thing, you sound a lot like landlords I know in Vancouver ... just keep raising rents $50 - $100 each year in perpetuity.
A $50/year rent increase is wonderful - something most of us on the other coast might only see a couple of years per decade - but it's only feasible so long as the underlaying economy and family income continue to increase at a similar rate, otherwise you will eventually price yourself into the high-end of the market and hit your own ceiling.
In my area, my property taxes went up on one property by more than 1K in just one year. It raised my mortgage payment by $100 a month. To date I have not passed that cost on to tenants (all of my expenses at my properties increased due to insurance and taxes last year) only for strategic reasons (turnover, work/grad school/other things) so that I don't spend time I really don't have right now dealing with tenant turnover. But when the time is right, like this summer, I will likely be raising rents across the board. Otherwise I'm just giving people discounted housing at my expense and there is no profit in it.
But I guess it depends on your market. In small towns, you are not as likely to be able to get away with rent increases, but in bigger cities with rapidly rising costs, if anyone thinks landlords are eating the costs of rising expenses and providing rent cheaper than their expenses, think again. They either raise the rent or they sell. No on stays doing this when they are losing money by letting people live in the house below cost.
SMILING; After 18yrs on my 6-units, I can say every point raised is true!
My loan was, believe it or not, fixed 30 arm adjustable twice a year - - and that never became an issue.
Like @Cary P., I started with class-c & deferred maintenance. This actually gave grounds for SMALL increases. Like @Jack B., the operational expenses were from the original due diligence, so improvements were via the CapExp and the existing cash flow. After all, the DSCR used to get the loan demonstrated the property to be 'self sustaining'.
As a remote landlord, vacancies are a nemesis and move-outs disdained to say the least. This impacts marketing and my rents vs fmr. When I raise rents, I make it trivial to avoid giving cause for moving (never exceeded 10%).
IMO, profits come from first controlling expenses (but not on the cheap), then from marketing the value / amenities to justify the rents to the new tenants.
eg: marketing amenities: units come with a one car, lockable garage and it frequently gets used as a storage unit. Easily worth $100/mo, but that's my marketing advantage and it sells the apt / justifies the rent.
Not soliciting, but the unit is for sale and I've had an offer 1/day for a week and last is all cash at full listed price and it aint cheap. Must be doing something right.