I am in the process of purchasing an investment property, where I will live in one unit, and rent out the other two units.  The upper unit is on a month to month, but the rent is $150 below the average rent in the area, and the lower unit is being rented to a neighbors nephew without a lease, and for well below fair market rent.  I am definitely going to do my due diligence on all parties involved, and if all checks out, continue month to month with the upper tenant, and start a month to month on the lower, with an increase to fair market rent.  My question is really regarding the upper tenant who has been living there for the past three years.  Would it be prudent to raise rent by the $150 that it's below value, or keep as is for a six month period as a trial?  I feel that I should raise the rent to the fair market value as soon as I take ownership, but others have indicated that maybe I should leave his rent be for the time being.  I turn to BP nation as the voice of reason, and the experience factor that I am looking for.  Thanks in advance!

@Brian Buckley  Good question.  Having tenants that pay on time & don't cause problems is worth a lot more to me than just the rent collected.  I am guessing that you have a good rental market & could easily get new tenants if the ones you have moved out, just remember vacancies can be expensive.  So, I would give them some options, with 30-45 days notice.  Sign a year lease at a rate somewhere between what they are paying & full market rent, or go month to month at full market, either way get it on paper.  I highly recommend having each tenant sign a new lease with you, that way the contract obligations are expressly between you and the tenant, you want to avoid them doing the "well, our old landlord.... (did, said, allowed, let us, whatever).  

Hope that helps some.

A third alternative might be to write a new rental agreement and addendum with small monthly rent increases until you get to the desired rent. One lump rent increase might trigger an unwanted vacancy. Also I would check the laws in your state as there might be certain procedures to follow prior to being able to increase the rent more than say 10%+

You did not mention anything in your post about Security Deposits from the existing tenants. If they did provide deposits to the current owner, then you need to have some type of documentation confirming receipt, possession and qualifications for the return/forfeiture of the deposits to the tenants. Without leases/addendum clarifying these issues, you could find yourself in a sticky situation. Also, if Security Deposits were paid, make sure that all the parties agree on the amounts if it is in writing or not. 

@Brian Buckley  I would continue with month-to-month agreements, especially with tenants already in place that you did not have the opportunity to screen and select. You don't know them and they don't know you. Don't worry about the rent of the tenant that is paying only $150 below market at this point, as I agree with what @Jesse Waters  said about a tenant paying rent on time and not causing problems as being good. 

Your goal should be to use the first few months to get to know your tenants and for them to learn your management style. Starting with a rent raise is not a good way to start off the relationship. However, for the tenant who is way below market, he already knows his gravy train is about to end. I would raise his to that equal to the other tenant. Tenants will talk sometimes, so keep that in mind. Also, start them off on your rental agreement. 

Down the line, if both tenants are working out well and you have had a chance to see how the property is performing, adjust the rent as necessary. We purposely stay below market rent to keep good tenants and reduce turnover. Turnover is costly in terms of time and money and hassle. We are able to still meet our cash flow goals and maintain a favorable reputation in the community.

Also, use these first few months to work on the property and address any deferred maintenance issues. Tenants accept rent raises easier if they see some added value in what you have to offer them, so if you are planning some upgrades you can time rent raises to coincide with that.

First of all, a big thanks for everyones insight!  @Jesse Waters I agree that I should get everyone on an actual lease agreement, but as @Marcia Maynard said, I don't know them, and they don't know me, so I'm going for a month to month agreement, but drawn up with me, rather than the existing agreement the one tenant as.  @Silvio Brigliadoro, I think the increment idea is a good one, but I might initiate that after a six month trial with the month to month agreements in place.  @Greg Dyer, the security deposit is only applicable to the upper tenant, as he is the only one with any type of lease agreement.  He paid one months rent as a security deposit, but I will definitely have my attorney inquire as to the transfer from the current owners to my agreement.  

I plan on doing my due diligence regarding both parties, and establish month to month leases, with the lower unit being brought up to $150 below market value for that unit (equal to the upper tenant), which happens to be a two bedroom.  I agree that having good tenants who pay on time is invaluable, I just wasn't sure if this was common practice with professional landlords.  Any other advice or suggestions would be greatly appreciated, thanks!

I had a similar scenario. 

Bought a fourplex, two units rented way under market but they were living with a person selling heroin in the unit below. 

So... I met them, assured a turn around on the property. Spent three months making it very nice and keeping the rent the same. Then, I increased the rent to about $25-50 under market rents. 

I also did it nicely giving them a 60 days (legal requirement in my area) that I would bump it 50% of the total increase. then in 90 days it would come up to the full increase. 

They were cool with it and liked that I gave them lots of time to budget for the increase. 

win win. 

The units are both in good shape, and really don't need anything done in them, but I still plan on having a sit down with each tenant to address any issues or concerns they may have.  I think the increase spread out over a course of time is a great idea, and I see the value in being slightly below average rent.  I just want to start off my rental career on the right foot, with as little friction as possible.

I always have purchased properties that have at least some deferred maintenance. I put ona roof or replace windows or fix some nagging other issues. I explain to the tenants where I see market rent and the evidence of that. I spend a lot investing my time and energy on my tenants with sharing knowledge of the lease and improvements on the property.

My biggest question for you is how have you determined that their rent is below market rent? I just find it curious that you seem so confident that the one is $150 above market rent. I am interested in your methodology for coming to that conclusion. Bedroom number? Upper/lower, bathroom number, finish quality, layout design, appliances included, location (a block can make a huge difference.

In the end prove you will better their lives and improve their home and a moderate rental increase will not scare them off especially if you leave it a bit below market. 

$150 is a huge increase. I agree with other posters to raise it incrementally. If they are good tenants you want to keep them unless they are costing you money by being substantially under market. Like another poster said as well, make sure your rental amounts are truly market rent. Have a realtor check the MLS. Check CL, etc. Then take appropriate action if needed.

I'm basing my fair market rent price off of other rentals in that area, especially with the proximity the property is to the bay, as well as downtown area of the town.  It'll certainly be a learning experience, but one that I'm confident will pay dividends in the long run. 

To clarify my prior post, I did go over rents, as well as time on market for rentals with a licensed agent, but I also cross referenced craigslist to factor in rentals not listed on the MLS. I'll be sure to raise rent incrementally, if done at all ,within a years time to keep the long time tenant happy AND paying on time haha! Thanks everyone for the insight, any suggestions for a newbie such as myself are always welcomed!