$300-$400 below market rent: to raise or not?

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$300-$400 below market rent: to raise or not?

Jack B.
Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes

Had the same tenant two years now at $1,350 a month. Current market rent is $1,750, so I'm leaving about 5K profit on the table each year...They are for the most part taking care of the place, a few stains on the carpet but looks like carpet cleaning will get it out. Other than that, they don't bother me and seem to keep the place up.

That said, on paper the house is a loss. It shows up on my DTI ratio because at 70% of the rent being counted when I buy new houses, it shows up as something that isn't generating profit and thus hurts my DTI ratio.

On top of that, all but $100 a month goes to budgeting for expenses. Luckily it's not really a really time consuming tenant, and the house is in pretty good condition so minimal needs. I do need to put a new roof on it soon but with such low rent, it's a hard pill to swallow.

I may move back into the house in a year or two. It would be nice to use the extra rent money to fix up the roof, paint, etc. At the end of the day, I'm leaving roughly 20K on the table over four years by renting so low. As much as I like having a stable tenant, for 5K a year extra profit, it seems worth it to me to start raising the rent by $50 each year on this tenant. They won't be able to even get an apartment at what I'm charging.

If the tenant moves out, well, it's an easy property to turn, doesn't need a ton of TLC, just some cleaning and back to being rented. Even if it sits empty for 2 months once I get it rented I'm still 3K ahead first year, 8K ahead (total) second year, etc.

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Lauren H.
Investor · Colorado Springs, CO · Member since 2014 · 77 posts · 54 votes
10y

If they moved out what would it rent for? I like to research fair market value in my area, then increase rent close enough to fair market value to get my value, but not so much that the tenant is likely to move. For example, the range of similar properties in my area is $750-$1050. The vast majority of units in similar buildings with similar layouts are renting right at $825 per month. I raised rent to $800 per month from $650. You have to remember that this is business. If the tenant decides to move out when you raise rent, you will just price the unit to get someone in there quickly. A large increase in rent can be tough for a tenant, but you have to think about it like this: if the rent was already market rate and the tenant said they couldn't afford it, would you let them stay at a lower rate? If not, then why wouldn't you raise rent? 

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  • Ryan Dossey
    Real Estate Broker · Indianapolis, IN · Member since 2014 · 3k+ posts · 2k+ votes
    10y

    There's no way on earth I'd hang out THAT low below FMR for a 2 year old tenant.

    1Reply
  • Tzvi BalsamPro Member
    Investor · Brooklyn, NY · Member since 2016 · 226 posts · 45 votes
    10y

     I value a good tenant its worth a lot of money to me. And the same goes the otherway a bad tenant is hell on earth. 

    Why dont you raise him halfway or something like that, A good tenant is worth keeping happy. 

    You can explain it to him, if he is a resonable guy he should understand.

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  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Ryan Dossey:

    There's no way on earth I'd hang out THAT low below FMR for a 2 year old tenant.

     I'm kind of thinking the same thing. If I just keep the rent low, they are the ones profiting from the cheap rent. I'm doing this to help myself out, not other people. After all, it was my income, education, credit and sacrifices that made this rental possible. I take all the risks. 

    If I just leave the rent like it is and never go up and they live there for another 2 years, I'm really going to be hating life.

    I think I'm going to raise it $50 and if they ask me to waive it I will decline. As much as I like having them as tenants, I don't like them so much that I'm just giving away 5K a year to keep them. Plus it's not like the place needs major work to turn, just some cleaning, maybe the usual move their excess crap they left behind out (outsourced and paid for by their deposit). I'd frankly like to just charge the market rent but I know they can't afford that kind of increase. I figure if they move out it will be an even bigger win as I can charge market rent. 

    1Reply
  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y

    I think I will just explain that as much as I love having them as tenants I must increase the rent by $50 this year, and that they would still be $350 a month below market. I will time it for end of August since that's their two year mark. They are on a MTM lease by my choice.

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  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    10y

    You've already worked out your own answer. Good tenant < profitable property. The issue really isn't what the market is for the property, the issue is that the property is a loser for you. If it's a loser, it makes no difference if it's rented below market, at market, or above market. Since you've only had them 2 years, my guess is your math was wrong at the time you rented to them, unless you've done something with equity in the house that has made the previously low-profit situation unprofitable. 

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  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Tzvi Balsam:

     I value a good tenant its worth a lot of money to me. And the same goes the otherway a bad tenant is hell on earth. 

    Why dont you raise him halfway or something like that, A good tenant is worth keeping happy. 

    You can explain it to him, if he is a resonable guy he should understand.

     Knowing her income I know she can't afford it. When she leased the house it was a two income household. Now it is just her with two teenage kids.

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  • Nancy Curran
    Real Estate Investor · Chicago, IL · Member since 2014 · 286 posts · 159 votes
    10y

    Why did you rent it so low to begin with? Personally, I would raise it more than $50, probably $100. You may lose them, but as you say, not a biggie. I'm all about keeping good tenants, but not to the point where I'm subsidizing them. Nobody is that good.

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  • Account Closed
    San Jose, CA · Member since 2015 · 4k+ posts · 3k+ votes
    10y
    Originally posted by @Jack B.:

    Had the same tenant two years now at $1,350 a month. Current market rent is $1,750, so I'm leaving about 5K profit on the table each year...They are for the most part taking care of the place, a few stains on the carpet but looks like carpet cleaning will get it out. Other than that, they don't bother me and seem to keep the place up.

    That said, on paper the house is a loss. It shows up on my DTI ratio because at 70% of the rent being counted when I buy new houses, it shows up as something that isn't generating profit and thus hurts my DTI ratio.

    On top of that, all but $100 a month goes to budgeting for expenses. Luckily it's not really a really time consuming tenant, and the house is in pretty good condition so minimal needs. I do need to put a new roof on it soon but with such low rent, it's a hard pill to swallow.

    I may move back into the house in a year or two. It would be nice to use the extra rent money to fix up the roof, paint, etc. At the end of the day, I'm leaving roughly 20K on the table over four years by renting so low. As much as I like having a stable tenant, for 5K a year extra profit, it seems worth it to me to start raising the rent by $50 each year on this tenant. They won't be able to even get an apartment at what I'm charging.

    If the tenant moves out, well, it's an easy property to turn, doesn't need a ton of TLC, just some cleaning and back to being rented. Even if it sits empty for 2 months once I get it rented I'm still 3K ahead first year, 8K ahead (total) second year, etc.

     It sounds to me like it's more important for you to show a profit on that property than to keep this tenant.  But, a turnover won't leave you with $4800 profit, either.

    Let's say you raise the rent to $1750 and they decide to leave.  And let's say it takes one month's rent's worth of money to turn it over - lost rent, cleaning, painting, etc.  So, how long will it take to recoup that $1750?  Divide it by $400 increased rent, that's 4.4 months to recoup the turnover.  Now, your profit for the year is $3050.

    If that tenant stays, and you don't move in the following year, then your profit will be (in theory) $4800.

    If you didn't need to show a profit on that property, and really wanted to keep this trouble-free tenant, I'd probably advise you to raise the rent $300 instead of $400.  Or even less, if you weren't in the process of growing your business, but were more in retirement mode.

    But, finding problem-free tenants is not impossible, especially in your market.  If you get rid of this tenant because they don't want to pay market rent, your next one will not think you are evil for advertising a unit at market rent.  Screen well and be picky.  But, you're not under any obligation to keep these tenants or give them a deal if it's not also in your best interests.

    Conclusion: I'd raise their rent to market and see if they stay, and if they don't, rent to new tenants happy to pay market rent - after doing thorough screening.  Show a profit on that property, and carry on.

    1Reply
  • Lauren H.
    Investor · Colorado Springs, CO · Member since 2014 · 77 posts · 54 votes
    10y

    If they moved out what would it rent for? I like to research fair market value in my area, then increase rent close enough to fair market value to get my value, but not so much that the tenant is likely to move. For example, the range of similar properties in my area is $750-$1050. The vast majority of units in similar buildings with similar layouts are renting right at $825 per month. I raised rent to $800 per month from $650. You have to remember that this is business. If the tenant decides to move out when you raise rent, you will just price the unit to get someone in there quickly. A large increase in rent can be tough for a tenant, but you have to think about it like this: if the rent was already market rate and the tenant said they couldn't afford it, would you let them stay at a lower rate? If not, then why wouldn't you raise rent? 

    3Reply
  • Tzvi BalsamPro Member
    Investor · Brooklyn, NY · Member since 2016 · 226 posts · 45 votes
    10y

    @Jack B.

    Jack this is the reason I hate to hold properties, I see people working there heart out, I just have a really hard time raising rent.

    But $50 sounds more then fair you can even tell her it will be $50 raise for the next few years each year you will go up $50.

    0Reply
  • Michael D.
    Investor · San Jose, CA · Member since 2011 · 355 posts · 90 votes
    10y

    @Jack B. - You are donating $400/mo to this very nice person with two nice kids. How about the fact that $5k/yr at 7% cap rate is $72,000 of value lost on the market value of the property!! If she paid market rent, would you give away $400/mo otherwise? From your comment about the roof, I doubt it. In fact you may be falling afoul of gift laws and income tax evasion. You are required by tax law to charge market rents and to pay tax on that income. By failing to do so you're cheating the govt out of their money. No joke!

    A $50/mo increase is dumb.

    You really need to person-up on this issue.

    1Reply
  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Account Closed:
    Originally posted by @Jack B.:

    Had the same tenant two years now at $1,350 a month. Current market rent is $1,750, so I'm leaving about 5K profit on the table each year...They are for the most part taking care of the place, a few stains on the carpet but looks like carpet cleaning will get it out. Other than that, they don't bother me and seem to keep the place up.

    That said, on paper the house is a loss. It shows up on my DTI ratio because at 70% of the rent being counted when I buy new houses, it shows up as something that isn't generating profit and thus hurts my DTI ratio.

    On top of that, all but $100 a month goes to budgeting for expenses. Luckily it's not really a really time consuming tenant, and the house is in pretty good condition so minimal needs. I do need to put a new roof on it soon but with such low rent, it's a hard pill to swallow.

    I may move back into the house in a year or two. It would be nice to use the extra rent money to fix up the roof, paint, etc. At the end of the day, I'm leaving roughly 20K on the table over four years by renting so low. As much as I like having a stable tenant, for 5K a year extra profit, it seems worth it to me to start raising the rent by $50 each year on this tenant. They won't be able to even get an apartment at what I'm charging.

    If the tenant moves out, well, it's an easy property to turn, doesn't need a ton of TLC, just some cleaning and back to being rented. Even if it sits empty for 2 months once I get it rented I'm still 3K ahead first year, 8K ahead (total) second year, etc.

     It sounds to me like it's more important for you to show a profit on that property than to keep this tenant.  But, a turnover won't leave you with $4800 profit, either.

    Let's say you raise the rent to $1750 and they decide to leave.  And let's say it takes one month's rent's worth of money to turn it over - lost rent, cleaning, painting, etc.  So, how long will it take to recoup that $1750?  Divide it by $400 increased rent, that's 4.4 months to recoup the turnover.  Now, your profit for the year is $3050.

    If that tenant stays, and you don't move in the following year, then your profit will be (in theory) $4800.

    If you didn't need to show a profit on that property, and really wanted to keep this trouble-free tenant, I'd probably advise you to raise the rent $300 instead of $400.  Or even less, if you weren't in the process of growing your business, but were more in retirement mode.

    But, finding problem-free tenants is not impossible, especially in your market.  If you get rid of this tenant because they don't want to pay market rent, your next one will not think you are evil for advertising a unit at market rent.  Screen well and be picky.  But, you're not under any obligation to keep these tenants or give them a deal if it's not also in your best interests.

    The rental market in my area is strong. I was able to rent within DAYS of posting this and two other units. As in, the first or second person that came to look at it was a good candidate and very interested. Also unlike another rental, this place doesn't need any real turning as I mentioned in another post (you probably skimmed the rest of the thread that the post was in). 

    But guess what? Even though the other rental needed paint, flooring, new doors, locks, and cleanup, I was able to rent it in no time even while it was occupied (20 days notice before end of the month) AND get it ready for the new tenant to move in without any break in occupancy. This house is much much easier to rent. 

    Another poster asked why I rented it so low to begin with. Keep in mind at the time I leased it out I was renting about $150 below market. The rental market has become really hot over two years and now the market rent is $1,750. 

    Plus I was due to move into a new house I had purchased in two weeks and I wanted to avoid getting stuck with two mortgage payments at the same time. that were nearly 3K total a month. Yes I had reserves, as well as paid off rental income on top, but I figured it was better to get the house rented to this family that planned to stay in the house a long time, four years of high school. Whether they do that is really up to them, as I never made any promises not to raise the rent, just that it's something I consider if finances allow it and I like the tenant. I like the tenant but finances no longer allow it. My turnover cost will be almost non existent, as I have an air tight property condition inventory and pics of the ceiling, walls, carpets, doors front and back, EVERYTHING. 

    At best I spend a couple hundred bucks out of pocket. Actually, even that is coming out of their pocket from the $200 a month I've set aside for 2 years for vacancy and maintenance. Luckily the mortgage on this one is real low...

    1Reply
  • David Dachtera
    Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
    10y

    @Jack B.,

    With two teenagers, sounds like she may be an empty nester soon if they go to school or go to work and get their own place(s). She'd be more likely to move then.

    Can the kids work to supplement the household income and support a rent increase?

    David J Dachtera

    0Reply
  • Maran Banta
    Atlanta, GA · Member since 2012 · 32 posts · 8 votes
    10y

    Renting under market rates can also make the IRS challenge any losses on your return in the event of an audit.

    Consult with your CPA about that part. 

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    10y

    I can never understand how anyone can operate a successful business when they are ruled by emotions. What is the point in being in business if you are intentionally losing money.

    I would give her 60 days notice (whatever the state requires) that the rent is going up $400 and find a replacement tenant before she moves out.

    2Reply
  • Jason Hartley
    Vancouver, WA · Member since 2016 · 230 posts · 161 votes
    10y

    This doesn't require discussion.  Raise the rent.

    3Reply
  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    10y

    Gotta raise that rent, even though such raises are no fun when the tenant inevitably calls all upset and what not. But you just got to suck it up and do it.

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  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @David Dachtera:

    @Jack B.,

    With two teenagers, sounds like she may be an empty nester soon if they go to school or go to work and get their own place(s). She'd be more likely to move then.

    Can the kids work to supplement the household income and support a rent increase?

    David J Dachtera

     As full time HS students I doubt they could add much meaningful income.

    0Reply
  • David Dachtera
    Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
    10y

    @Jack B.,

    Every little bit helps. Plus, they can work more hours on weekends.

    A lot of kids do.

    David J Dachtera

    0Reply
  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Thomas S.:

    I can never understand how anyone can operate a successful business when they are ruled by emotions. What is the point in being in business if you are intentionally losing money.

    I would give her 60 days notice (whatever the state requires) that the rent is going up $400 and find a replacement tenant before she moves out.

    Nobody is ruled by emotions here, that's your assumption based on lack of reading or  comprehension of comprehension of what you read. As I said, when I rented it out the market rent was not that high. Lot's of landlords rent  below market as you would have noticed in the thread. It's easier to fill a vacancy that way.

    I also had a vacancy at another house that did need a lot of work turning as mentioned before, at the same time as a rent increase would have been due for this house. Given a FT professional career in the low six figures and a full time grad school course load, it wasn't feasible to have two vacancies at the same time.

    0Reply
  • Jack B.
    OP
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @David Dachtera:

    @Jack B.,

    Every little bit helps. Plus, they can work more hours on weekends.

    A lot of kids do.

    David J Dachtera

     Either way, that is her problem not mine really right? She made the choices that she did to end up at the salary she is at with two kids. I will find another tenant above what I would be raising the rent to and below market in a month. In fact, I think I will post a recon add with pics and see how much interest I get before I pull the trigger.

    Since none of my rentals are in Seattle proper I don't have rent ceilings and such. I believe I can raise it as much as the market will bare, but still. If I raise it by $400 she will def. move out. I was thinking more like $50, but I suppose I might as well just get it over with...

    0Reply
  • Garrett Poshusta
    Rental Property Investor · Seattle, WA · Member since 2014 · 14 posts · 9 votes
    10y

    I too have struggled with raising rent on existing tenants. Seattle's hot real estate market has led to dramatically increasing rents in last few years. I take my role as a landlord to heart and actually care about the wellbeing of my tenants (which is a sentiment that seems in short regard in many posts on BP). But I also rely on my rental income to feed my family so one strategy I have used is to actually build an increase into the lease. I typically sign a one year lease and put in the lease that next year the rent will be increased by $100 or whatever. This way it's already expected when the tenant moves in and it keeps the rents at (or close to) market rates even if a tenant stays for a few years. 

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    10y

    Nobody is ruled by emotions here

    You asked the question "to raise or not"  the answer is obvious and does not need to be asked unless you have an issue.

    It was a logical assumption on my part since you said you were $400 under market and considered only raising it $50.  That indicated some sort of emotional response to the fact that it be would be a hardship on your tenant.  There is no other logical reason since you yourself indicated it would be easy to replace her if she left. 

    Doesn't matter as many landlords having financial problems do so because they allow emotions to interfere with business by put people ahead of profit.

    0Reply
  • David Dachtera
    Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
    10y

    @Thomas S.,

    You may want to consider, however, that REI is a people business first and a profit business second.

    I heard you choke on that, so I'll stop you right there. In -ANY- business: Profit is acquired by solving a problem. Profit is ALWAYS a by-product, NEVER a direct product. When business people get that wrong is invariably where you see their businesses fail, not to mention global economies.

    People pay rent. They pay you to solve their housing problem. If you turn that solution (back) into a problem, there goes your profit.

    That's not emotion - it's pure logic.

    David J Dachtera

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  • Account Closed
    San Jose, CA · Member since 2015 · 4k+ posts · 3k+ votes
    10y
    Originally posted by @David Dachtera:

    @Thomas S.,

    You may want to consider, however, that REI is a people business first and a profit business second.

    I heard you choke on that, so I'll stop you right there. In -ANY- business: Profit is acquired by solving a problem. Profit is ALWAYS a by-product, NEVER a direct product. When business people get that wrong is invariably where you see their businesses fail, not to mention global economies.

    People pay rent. They pay you to solve their housing problem. If you turn that solution (back) into a problem, there goes your profit.

    That's not emotion - it's pure logic.

    David J Dachtera

     I disagree.  Landlords who are not providing subsidized government housing, are not expected to provide housing that is priced under market value, any more than a car dealership is expected to sell cars under market value to people of low income.

    For some reason, there is a belief among many tenants that if they have lived in a unit for a long time, that this alone provides such value, that an increase in rent is not reasonable.

    Which of course, is an unreasonable assumption.  Try telling them that their salaries should remain the same from the day they got a job, because they owe it to their employer to not charge them any more money based on the fact that the employer hasn't fired them for so many years - and see if their logic holds up.

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