How to Raise rents to fair market?

Question

I have a rental property that I've just taken over from my parents who are in their 90's.  One of the tenants has been there for 18 years.5they are excellent tenants, pay on time, clean and never complain... however they're rent is about $1,000 below the fair market rent in that area. You see, for the past 18 years my parents have only been raising their rent about 2%. For some reason they thought the home was under rent control, but It is not. This 3 bedroom home is being rented for $1900 in San Francisco. The average rent for a home this size is $3000 plus. How can I aggressively raise the rent without losing the tenants?

Kyle J. · Answer

Only your tenants can answer that.

Seems reasonable to me though given how far under market the current rent is.

Bryan N. · Answer

Geez... 18 years... I would love that problem.  Follow Victor N. advice.  Or, increase $100-200 per year using the same advice as Victor.  Nickle and dime them over several years to increase.  18 years they are settled and won't want to leave.  Boring tenants that pay on time have a monetary value as well.

Victor N. · Answer

@Nat Tagle If they leave, Im guessing that you will lose at least one month of rent because it will take some time to repaint/ update an 18 year old apt if you are to get full market rent.

So before giving then a notice of rent increase, I would sit down with them and discuss the rent issue. I suggest arming yourself with reasons why the expenses of owning the property have gone up and you need to increase the rent to keep up with those expenses and plan for upgrades. For example, Im sure taxes, water/sewer, insurance, maintenance etc have increased in 18 years. You can also show them the current market rent of their apartment then maybe offer in increase of $500 instead of $1000. You can then slowly inch up to full market rent the following years.

You can certainly get them out and go for a new tenant paying full market rent but keep in mind that you are in San Francisco and you might have a hard time evicting a potential bad tenant.

Brie Schmidt · Answer

I agree with Elizabeth - this is a business.  Personally I would give them 60 days notice of the rent increase and give them a chance to pay or move.

Bill Gulley · Answer

I have no idea of the market in that area, but you might begin by understanding what or where the tenant's position is. What tenancy rights they have, sounds to me like a lease was initially made and has been automatically reinstated or is now a lease without a termination date, a year to year tenancy.

That's important because I'd bet CA has tenancy laws and restrictions as well as notice requirements. States often have rent escalation limits, not a rent control per se, but limitations to raising rents. We have a 10% limit here, this keeps landlords from jacking rents up to an unaffordable level simply to run tenants off.

After knowing what tenancy rights are held, then you should look to see if there are notice requirements might be. You may not be able to simply give a 30 day or 6 month notice, it could well be that notice is required to be given so many days prior to a termination date or an anniversary date. While giving notices at other times may not be a violation, they may not be valid and therefore not effective that may be enforced. Missing required notice dates can ruin you plans if you have to wait until the next required date to carry out your intentions.

As mentioned, if you have not inspected the property lately, you may not be at the real market rent assessment. You comparable properties probably haven't had 18 year tenants, those properties may have been updated over time to command those rents.

It's not just that you'll have rehab expenses from wear and tear, you may have significant updating expenses bringing your property up to the current market where you assume rents should be.

After knowing what time lines are for the tenancy, I'd begin with a notice to inspect the property first and really know what you have, inside and out.

Your tenants aren't Spring chicks, they are middle aged at the youngest and may be hitting senior levels or perhaps elderly as well. If they are up in years their ability to pay may be an issue, might be. So, when I go inspect, I'd explain that situation of your involvement if they are not aware yet.

I'd explain that due to the business requirements you are under with rental a property, you must have a lease, so it's time to update the lease and because of existing laws, you must have documentation as to their qualifications and ability to pay.

At that point, anyone with some common sense paying rents well under market will likely see the handwriting on the wall, that the rent is going up. I can see them asking that.

Now, my reply would be "it may be increased as rents have been far below the market" I wouldn't put them in cardiac arrest at that point saying that rents need to be determined fairly and I'd also stress that their long tenancy will be taken into consideration.

Now, you are able to assess their ability to pay and you can assess the after repair value as well as costs required to bring the property to market rents. Properties I've seen managed and owned by elderly folks usually have a list of deferred maintenance issues and safety issues.

(BTW, you need to ensure the property is even in compliance with applicable codes, they may have had a substandard situation, like some electrical issue they never reported and just lived with, that could be a legal matter for you if it is mentioned in front of a judge if the waters get rough.)

You'll need to address any safety issues if there are any, ASAP upon discovery. That is a deferred matter, not something you can justify any increase in rents regardless of what they may have paid as your past rents received were taken for a substandard issue, it's the owner's responsibility to make those repairs without tagging tenants for costs beyond what they have paid as rents.

I would go for a win-win, but that, with me, means a real assessment of the situation. What would my real cost be to update, make improvements and bring my property up to market demands? Say it costs $20,000. How long at a new rent level will it take to recoup that, what's the present value of the increased rents less maintenance and market vacancy, because you will likely lose your long term tenant IMO, they aren't going to be happy with you if you just jack them to market rates.

I would also consider my cost of that 20K, what else could I do with it and what is the value to me to use that money doing something else?

On my side, in this situation, I would also give some thought to the needs of my tenant, in all fairness as they probably bought the place or most of it and it's being handed to me, more of a windfall of equity. As I understand it, it's being handed to you, you don't have any expense in it. Rather than taking a greedy attitude asking for more, I'd be thanking the tenant making it possible for my parents to be granting me the that had such a good occupancy rate. Had the property been leased over that term at market, it's possible that you could have had effectively had a year and a half of vacancies, cleaning, advertising and more administrative expenses, not to mention the cost of a few evictions!

So, while you're looking at a monthly rent amount, consider the value of having had this long tenancy! What do you think the right thing might be with that value? Share it or you think taking the whole thing and sticking it in your pocket, so to speak, is the right thing to do?

Understand too, that the "additional" value that has been obtained in this property is an equity that will benefit you further, you may borrow against it, you'll have an advantage too simply on your financial statement in obtaining other financing to do other things, as a lender, I might be inclined to cut some slack on the debt coverage ratio in a new loan, a compensating factor having such a long term tenancy arrangement.

With all the numbers and the intrinsic values considered you can arrive at a win-win arrangement. A win-win is the least I would strive for with these tenants. I'd rather have a few hundred bucks less a month with stable long term tenants than jack up rents, bring the property condition to market today, enter the market with vacancy and brain damage with tenant turnover and possible legal issues with evictions, but, that's me.

After that assessment, I'd discuss the plan with the tenants, if rents were to increase (probably would) I would ensure that the increase was fair and affordable and agreeable with my tenants, my increases would be on the low side in an attempt to keep them, and keep them happy enough. Then, increases would escalate with economic conditions and perhaps a bit higher over time. Don't forget too, as rents increase, improvements will likely be needed too.

Reminds me of the little kid who going into the room with the Christmas tree seeing his new train set running, after playing with it, he looks at the book that came with the train set. After seeing all the other train cars available in the book that can be had with that set, he begins asking if he can get the additional cars too. Any morale point to that? :)

J. Martin · Answer

@Nat Tagle ,

I have units right at the tip top of market in Oakland and Richmond, and others that are below market due to rapid increases in market rents. For low-maintenance tenants who pay early, I usually don't increase more than 2-5%. For those who may have an attitude or don't pay on time, I'm going to get a lot closer to market.. @Victor N'Guessan is right.  There will DEFINITELY be some rehab costs and updating if you want to get good rents and it's been occupied by 1 tenant for 18 years.

DO YOU HAVE THE CASH FOR UPDATING?

@Brie Schmidt is right about thinking about the business aspects and how much you need it. But there is some mix of the business trade-offs and the human element. I don't mind giving tenants some time if it's not too tight on you.. As  @Elizabeth  Colegrove said, around $200/yr, or $100/6mo as you split it is not that unreasonable I don't think.. ALTHOUGH I would add that sometimes tenants in SF CAN afford it. They might be making good money, but never left this place that was a sweet deal. Maybe they can pay closer to market and would be happy to w/ a little updating..? (Especially when they are frightened when they go out and look how rents have changed over the last 18 years in SF!) And maybe they can't or don't want to. But don't throw the idea out completely before you find out..

@Bryan Neal , it's nice to have a long-term, low maintenance tenant, but in the SF market, there is so much demand, the landlording aspects are pretty minimal.. So I think it has less of an impact than it might in other markets.. Tenants in SF and Oakland regularly show up at open houses with all documents in hand, checkbooks/cash w/ prepaid rents and big deposits, etc..

@Kyle J. is right, the tenants will decide what is too much.. But definitely talk to them. In all honesty, $2k or even a bit more doesn't get much in SF, and lesser each day in Oakland also, so I don't think there's going to be any big advantage to jumping to another place unless they want to downsize for something more modern..

Elizabeth Colegrove · Answer

I personally don't see how raising rent $1,000 is possible while keeping the tenants. It really depends on what your goals are and if your able to separate personal with business. You can raise rent every year $200 or so but there is a good chance they can't absorb market rate into their budget. So you are going to have to make a choice. My biggest piece of advice is to take care of you and the market. Some "great" tenants have shown their stripes even years later.

Amit M. · Answer

ok, post 79 is different than SFH, which still has eviction control...hence the construed eviction possibility. Post 79 is like renting to someone in San jose- only state law applies, namely a 60 day notice to incr rent by over 10%.

Like you said, 3br is MINIMUM $3500. I'd renovate it, make it nice, and get a great tenant profile for $4000 +/-.  No way your existing tenants can be gradually increased, their base rent is way too low.  Only thing you can do is give them plenty of time to prepare, maybe cover last month rent as a gesture. But basically you're either going to be a private charity for them or do what you need to do and gain a significant Income. It's a binary decision IMO.

Nat Tagle · Answer

Thank you for all your feedback, everyone makes some very valid points.  This home is not under rent control as it was built in the 1980's.  The home is paid off as well.  The upgrades would be minimal cost to us because my spouse is a contractor and does all work in our properties.  The only thing that would be upgraded would be appliances and carpet.  @BiilG, it's not a few hundred that we're losing a month, it more like $1500+.  This property is in a prime location, the Mission, where rents are $3,500+ for a 3 BR, just check Craigslist. There's no way to reach market value at the rate we're going.  I know these tenants eventually would not be able to afford the rent increases.  They are both housekeepers and are getting older.  If I raise $100-$200 per year, we'll never get caught up. with the current rent they are paying now in SF, all you'd get is a studio/in-law.  I get really frustrated because i feel like I'm running low income housing or something and want to take aggressive action to raise the rent but at the same time I don't want to be that landlord and run out good tenants.

Amit M. · Answer

1- is this a single family home WITHOUT an additional inlaw unit of any kind?  If so, you're off rent control, but any inlaw, even an illegal crappy studio behind the garage makes it a 2 unit prop, and subject to RC.

2- even if a true SFH, while you can raise rent to market, you are still subject to eviction controls and the original lease terms still apply (except rent amount.)

3- other than true SFH, only post June 13 (I think)1979 construction is off RC.

Tread carefully. Tenants can still claim a "construed eviction" if you raise rent beyond market. Trust me, you want to avoid dealing with SF Rent Board on this issue :)

As others suggested, I'd talk with the tenants first and get a sense of where they are at, what they could afford.

Also consider the costs to renovate if they leave and you bring in new tenants. Financially speaking this is almost always worth it in SF, but can be a harsh blow to existing tenants....who usually have to pack up and leave the city. (Unless your have been in a coma the last few years I'm sure you've heard all about the high rents/tenant-landlord controversy covered by virtually every media source.)

What type of property is this and which neighborhood is it located in?  $3000 may be too low for a 3BR market rate, but I need above info to tell.

How to Raise rents to fair market?

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