How far below market do you keep a good long term tenant's rent?
Investor · Santa Barbara, CA · Member since 2014 · 96 posts · 23 votes
I have kept rent very low on one of my units because it needed work. I'm getting work done now and would like to bring it closer to market. I'd love feedback on the following:
Tenant has been great for 15 years. His rent is now $270 below what nearly identical units are paying. In this area, same square footage, amenities, etc. is upward of $1900/month.
Is $270 too big a gap? If so, how much would you raise? Would you increase one increment, or over time?
If I wanted to keep the tenant, I'd spread it out over at least 3 years, if I didn't care if they moved or not, 2 years, if I rather they moved anyway - all at once.
Personally, for a long term tenant that has been easy to deal with, and has taken care of the house, I'm OK with rent sliding below market over time.
I have a tenant now that is in her 4th year, and last year was the first time I raised her rent. She keeps the house immaculate and has never been a bother. She's at least $150 under market, maybe $250, but I'm OK with it because she has been such a super tenant. She is set to increase again next year, about 3%, but she'll still be under market.
When she moves I'll bring the place up to market, but until then, I'll enjoy no vacancies, a well kept house and a model tenant. For a tenant of that caliber, being a little under market is fine by me - we both win.
How I look at it is, how much is that tenant really worth to you?
As you know, $270 a month is a total of $3,240 a year. There is also a significant opportunity cost here as well as that money lost is not available for reinvestment. For example, that money in a Vanguard Index Fund and in 10 years you haven't lost $32,400 but $50,691 (using a reasonable 8% annual rate of return). If the property is a multi-unit that roughly costs $32,400 in resale value if you were to sell, now we're talking over $83,000 lost due to low rents!
However, it also depends on your motivation/needs. If you're comfortable leaving all that money on the table, there is nothing "wrong" with that. Lastly, if you think the above numbers are worth the "Hassle-Avoidance", then that is fair to you, just be aware of the true cost (and lost investment opportunity) of that tenant.
For a good below-market tenant, we raise the rent by ~5% per year to get it closer to market (as long as rents are raising lower than that).
@Brendon Woirhaye Thanks, Brendon. That seems like a reasonable rule of thumb.
@Kurt K. Thanks for your detailed response. I appreciate your perspective on the numbers. I don't intend to keep the $270 gap, but I want to be fair to a very good tenant. I also don't feel comfortable jacking up the rent right before the holidays -- not so much because I'm worried about the response, but because it just doesn't feel right. My real question was more about how much is too much of an increase, or what is a reasonable discount. I'm not sure what you mean about hassle-avoidance. I'm not concerned the tenant will move if the increase is fair and handled well, so I'm not really worried about the hassle of a turnover. Even if the tenant does leave, which is always a possibility, turnovers just come with the territory. Not fun, but a fact of life. Thanks again for your input. I appreciate your longview approach.
@Account Closed , if you assume a conservative cap rate of 10%, that $270/mo discount is reducing your property's value by $30,000 (270*12/10%). Even more at a lower cap rate. I think you should raise it to market at your next opportunity. It would be unfortunate if he left, but it's a small price to pay to get your property up to market.
I disagree.
CAP rates are of marginal truth or consequence for a SFR. That aside, the value of your property is only relevant if you wish to sell or refinance. If you are operating as a rental, cash-flow is king.
In the OP's original post, she stated market rent as just north of 1900/mth and her long term tenant was ~$270/mth below market. To make the math easy, lets say her tenant is paying $1600.00/mth. She could hike the rent to market and compel a good tenant of 15 years to leave. Now she has 1 or 2 months vacancy while she turns over the unit and finds a new tenant and, along with it, lost revenue of $3200.00. When she does re-rent at market, it will take 11-months to recover the lost revenue.
Alternatively, she could meet with the tenant and layout a game plan to slowly raise the rent closer to market - but still keep it slightly below market - again let's say $100 below to keep the math simple. two years she raises the rent by $200/mth ... $50 now and $25/quarter over the following 18 months. Here you have a win/win for both the landlord (ultimately an additional $2400/yr) and for the tenant who is still below market and not compelled to move.
You're absolutely right about the property value. On the other hand, I don't think I'll be bringing the rent up to the exact market rate for a long term tenant. I will still offer something of a discount. Per a lot of the advice here and my gut feelings, I think I'll end up doing a gradual increase and then be consistent with increases in the future. Thanks so much for taking the time to consider my issue.
@Kurt K. Thanks for your detailed response. I appreciate your perspective on the numbers. I don't intend to keep the $270 gap, but I want to be fair to a very good tenant. I also don't feel comfortable jacking up the rent right before the holidays -- not so much because I'm worried about the response, but because it just doesn't feel right. My real question was more about how much is too much of an increase, or what is a reasonable discount. I'm not sure what you mean about hassle-avoidance. I'm not concerned the tenant will move if the increase is fair and handled well, so I'm not really worried about the hassle of a turnover. Even if the tenant does leave, which is always a possibility, turnovers just come with the territory. Not fun, but a fact of life. Thanks again for your input. I appreciate your longview approach.
Raise to market rents if you're not worried about turnover. Market rates are fair.
@Roy N. , I think you may be over-estimating the liklihood that the tenant would leave. After all, market rates are market rates. If they wanted to move, they'd have to downgrade or have that same rent somewhere else. They might only leave if they simply don't want to pay the increase and would rather downgrade.
So suppose they leave and it costs $3200 in vacancy loss, which you recover in 11 months of rent. That's a 100% ROI on that particular investment.
You plan costs about the same amount (I think, I didn't do the math on that) as having the house vacant for a couple of months would.
I have to admit that I've done it both ways. When I had only a single house, or even a couple, I felt the same way. Now that I have a few more units I feel like I want to just get it to market and keep it there. I feel the same about repairs. I used to fix things as they break, even if the house started with a fair bit of deferred maintenance. Now I just want to get everything fixed properly in one shot and get the most value out of the unit right away. It means more investment up-front in vacancy and repairs, but I think it'll return much better cash-flow down the road.
A good tenant is worth keeping. You might trade them for a succession of bad tenants. A lot depends on the desirability of your property. If you can turn it over in a week or less you have less incentive to accept under market rents.
Because my rents increase on average 6%+ it is hard to keep up with the market rent for a good tenant. I basically try to determine what it would take for a tenant to make the decision to leave. $50 dollars under market for them means it would probably cost them the $600 in one year PLUS moving costs/hassle of another $600+. Even on a $2,000 month rental that is probably not worth it for most renters.
If I need to raise rent I try to add value at the same time. New appliances/bath, kitchen upgrade. I amortize than over its life and add a bump for me. Happy tenant, improved property and increased rents. Everybody happy!
Shocking long-term tenants whose rent is substantially under market with a large rent increase to market (where permissible) is a tactic we employ to rid ourselves of inherited tenants we do not wish to retain.
If anything, I was being optimistic that the turn-around and relet after a long term tenant would be only two months (especially this time of year).
BTW: The 11 month recapture of the 3200 is not a 100% ROI. Keeping the long-term tenant and raising their rent gradually as outlined in my prior post would put an extra $925 in the owners pocket during the same 11-month period.
As @Account Closed pointed out there is also the risk of trading a known, good, long-term tenant for a succession of short term (more turnover) tenants, perhaps of lesser quality.
We have several multi-unit properties and, like in my other businesses, rewarding customer loyalty from your good customers is always to your benefit.
You're absolutely right about the property value. On the other hand, I don't think I'll be bringing the rent up to the exact market rate for a long term tenant. I will still offer something of a discount. Per a lot of the advice here and my gut feelings, I think I'll end up doing a gradual increase and then be consistent with increases in the future. Thanks so much for taking the time to consider my issue.
In Santa Barbara I think it's a good idea to get your tenant up to market in the next couple of years. Tenants with good a rental situation in SB (good location, condition and responsive landlords) do not leave based on reasonable increases. There is no place for them to move for a better value. I'm sure you are aware, it's not a renter's market here. Keeping a long term tenant with under market rent makes it that much harder for them to find a suitable replacement rental when the need arises.
You may already know this, but be mindful of the required 60 day notice in CA if you decide to raise the rent 10% or more.
Don't I know you? I'm Gabriela's mom from HBP.
@Roy N. , I think you may be over-estimating the liklihood that the tenant would leave. After all, market rates are market rates. If they wanted to move, they'd have to downgrade or have that same rent somewhere else. They might only leave if they simply don't want to pay the increase and would rather downgrade.
I think the OP could get to market rent in one increase (with the 60 day required notice here) and not lose her tenant. IMO it is unlikely the tenant could replace their housing easily for even market rent. Rental housing is very, very tight in SB and a tenant that is happy in their unit for 15 years isn't going anywhere. By increasing it over two years it acknowledges appreciation for a good long term tenant. But unless the OP's unit is undesirable or has issues with the neighbors, the tenant won't be shopping around.
KMP:
I would defer to you as I do not know the local market. Once upon a time here vacancy was <3% and you could have easily done the same.
The gradual raising of rent over a period (1-2 years) really comes down to a business style. In our practice, we like to work with our tenants to make the inevitable increase as painless as possible, particularly for those tenants who live close enough to the edge they could not re-adjust the lives to swallow the entire increase in one serving.
KMP:
I would defer to you as I do not know the local market. Once upon a time here vacancy was <3% and you could have easily done the same.
The gradual raising of rent over a period (1-2 years) really comes down to a business style. In our practice, we like to work with our tenants to make the inevitable increase as painless as possible, particularly for those tenants who live close enough to the edge they could not re-adjust the lives to swallow the entire increase in one serving.
I'm making a lot of assumptions about the location an desirability of the OP's unit. A $1900 rent here doesn't get you very much. It's the rare tenant that will move based on a rent increase alone as there is nothing else to rent. Moving to another city or elsewhere in the county is possible, but involves 30-60 mile commutes. If there are other negatives, that's when you get push back or vacancy for raising rents.
Weird update: My tenant gave notice today! No kidding! So I guess getting it up to market will be quicker than I'd anticipated. Tenant is moving out of the area and only gave "sort-of" notice today -- really more of a head's-up than notice. I will get 30 days written when dates are more solid. That is not a problem for me.
I'm not looking forward to turning it over in winter, but I am looking at this as a great opportunity to quickly do upgrades and get the rent up to market.
@Account Closed Ha ha! Yes, I do know you! I'm Daisy's mom. Small world! I really appreciate your local perspective. Definitely a tight market out here right now, and lots of tenants feeling really squeezed. In spite of this property being a bit older with some elements of "character" that newer units don't have, I don't think getting it rented will be as much of a challenge as it might have been in other years. So nice to see you here!
@Account Closed Thanks for your input. I like your measured approach. In fact, it's much like what my plan has been for this unit. In this and my other units, repairs get handled right away. It just doesn't make sense to me to let repairs go. What this unit has needed is upgrades, like flooring (just ripped out carpet and put in laminate), a minor re-model in the bathroom for aesthetics.
I don't know if you saw my update, but the tenant actually let me know that he'll be leaving, most likely before the end of the year. So that was some really weird synchronicity! I'd hoped to spread out the upgrade costs over time, but now we'll just bite the bullet and do what we can to get it in top shape for top market rent and, hopefully, a quality tenant. So I'm looking at 2014 taxes now and seeing what we can write of in the short term, etc. Thanks again for your time in exploring this question for me. Your approach to tenant relationships in the context of good business, really resonates with me.
I agree that there's an added value in keeping good tenants even if it means renting for a bit below market value. The tenants we have in one of our houses are fantastic, love the house, keep it in great repair, rent is on time, and they even occasionally send us a bottle of home made wine, which is always a pleasant surprise. This after our last tenant being an enormous headache, always complaining, seriously trashed the place, and then complained bitterly for months when she didn't get the deposit back. After that, smooth sailing has an added value. By the way, this house was intended to be a fix and flip but the market dropped so we're holding it until the numbers look better. It is presently net $0 so not so bad particularly because there's no drama and demands aren't being made on us as landlords. That said, I am thinking that we should impose a small increase just to keep up with increased overhead. Not sure we'll do it , but thinking about it.
Keeping good long term tenants is great but I don't understand why so many LL's are scared to charge for their services. I don't run a charity so I want rent to be near market value as much as possible and do regular small increases every year to try and keep it from getting behind. Unless comparable market rents don't go up at all.
If you are losing $270 a month that is $32,400 of lost rent over 10 years that you can never get back, multiply it by 10 units in the same situation and you just lost $324,000 (or $32,400 a year) of extra income over 10 years that you can never get back.
If it's already way behind it can be tough, you don't want to jack up the rent on someone by too much but if I had a unit that was that far behind I would either have to get it caught up in a few years or do my best to manage the tenant leaving and getting someone in at market rates. If I was in a super tight market and it took a long time to find a good tenant I might take more time to try and get the rent nearer to market.
@Michael J.
It's a balancing act. You need to weigh your deficit to "market rent" versus the cost of turnover and vacancy.
As I mentioned earlier in the thread - forcing the good tenant of 15 year out and suffering 1-2 months vacancy as a result would take 11-months at the new market rent to recover the cost of the vacancy. Add in the renovations required to update the unit and you could be looking at 22 - 33 months to recover the costs of turnover.
A better option would be to work with your good long-term tenant to gradually bring the rent closer to market ... in small steps which are easier to assimilate into their household budget. We have had great success with this approach when we inherit tenants whose rent is considerable below market (>=10%): we propose a schedule, sit down with the tenant and iron out the final timeline. Sometimes it takes 12-18-months to bring their rent close to market {within 3-5% ... we have no trouble with a good, long-term tenant being a little below a new lease}, depending on the size of the deficit.
Weird update: My tenant gave notice today! No kidding! So I guess getting it up to market will be quicker than I'd anticipated. Tenant is moving out of the area and only gave "sort-of" notice today -- really more of a head's-up than notice. I will get 30 days written when dates are more solid. That is not a problem for me.
I'm not looking forward to turning it over in winter, but I am looking at this as a great opportunity to quickly do upgrades and get the rent up to market.
Jeri, just curious how things turned out with this tenant. Did they vacate? Did you do some upgrades and ask for $1900 for rent? Did you rent it yet? I always love to hear how things turn out.
As for the topic in general, for us (me + husband), we assess it on a case by case basis. When we advertise a unit, we typically advertise it a little under market so we can get some good applicants to choose from. We think of it as our competitive advantage.
We have a triplex we've owned for 4.5 years, and the 3 bedroom unit has a tenant who lived there for over 10 years before we bought the place. Her rent is significantly under market, but the interior would need major work if we got it back (all new flooring, new kitchen, paint, etc.), so we have only raised her rent a little. We will be raising it again this month, but not by a lot. She has mentioned that she has no desire to move, and we have no desire to get that unit back, so my husband and I have agreed to keep her under market.
We have some other tenants in several buildings we own who are also a little under market, but not too much, maybe 5% or so, but they've been there for years and pay on time and treat the place well. We have started raising rent on them, though, because we don't mind getting the units back because they wouldn't need too much work, if any, to be able to re-rent them.
The unit is still vacant. We discovered (and keep discovering) there were a hundred little fixes that needed to be done beyond what we anticipated. It's an older structure and so some issues just go with the territory. Although the place was perfectly habitable, to get the best rent from a new tenant. a fair amount of work was needed. It had an old floor heater -- I don't know how old it was, but it was a beast and poorly placed. So we had that yanked out and put a furnace in the attic. We still need to finish up the floors, and just discovered a plumbing issue. I need to buy a new fridge. I work full time about 30 minutes away from the rental so meeting with contractors has sometimes been a challenge. Still, there are worse problems to have!
The unit will definitely bring a higher rent, probably more than $1900, but I'm waiting till it's done to figure that out.
It sounds like you have much the same situation with your long term tenant. I think it's a good practice to increase the rent regularly, but if you want to keep it slightly below market for a long term tenant who takes good care of it and pays on time, I totally support that. Thanks for your interest and good luck to you!
@Michael J. Thanks for your comments.
I'm not afraid to raise rents, and I don't think any Santa Barbara area renters think that SB landlords are particularly charitable : ) The big obstacle to bringing the unit up to market was money. We didn't have the funds to make necessary improvements all at once. It was safe and solid, but not on par with our other rentals that fetch a higher rent. So my plan had been to make an improvement, then raise the rent and continue that pattern over a year or so. So it was never our intent to "lose" $270 for 10 years. We had just put a new floor in a portion of the unit and I was about to raise the rent around the time of the original post. And, just to be clear, the tenant had been getting regular rent increases, just at a lower percentage than our other units.
However, shortly after the original post, I updated with the news that the tenant was moving out. So now we're having to do improvements now that we would have spread out over the next year. It will all work out. We will have to use more credit than we wanted to, but we will make that back quickly enough once it's rented.