Tenant paying below market rent in unit that needs rehab-

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Tenant paying below market rent in unit that needs rehab-

Kari Koszdin
Seattle, WA · Member since 2017 · 12 posts · 4 votes

I bought a triplex four years ago and inherited one tenant.  At the time, she was paying 1050/month for her small 2 bedroom apartment.  The previous landlord had not taken care of the property, so I needed to put in a lot of time and money to fix the place up. I did not raise her rent right away, since I didn't want to deal with a possible vacancy at that time.  She has been a good tenant- always pays on time, takes care of the property and is easy to deal with.

Over the past few years, I have raised her rent to 1325, plus now she is paying for all utilities. However, market rent for her unit, if I just painted it and did a few repairs, (would probably cost about 5K) would be about 1650.  If I did a more extensive remodel, I could get that up to 1850- but it is going to cost 15K. If I did get her out, I am leaning towards doing the more costly renovation, since in my experience, really nice units are easy to rent and I get fantastic tenants.

So here's the question- Should I just slowly raise her rent over time, as I have been doing, and not have to put money into the unit, but I will never get close to market rent? Or should I not renew her lease at the end of the term and do the renovations to get the higher rents?  

The current rent roll on the property is 4425, and I own it free and clear.  Property taxes and insurance are 500 a month. I have put a lot of work into this property, so I don't have other deferred maintenance issues- the property doesn't cost  a lot to operate.

So what I am basically asking is how much is it worth to have a good tenant in place vs getting more rent, but having to put in more more money?

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Angie Swader
Real Estate Agent · Imperial Beach, CA · Member since 2017 · 3 posts · 3 votes
9y

I have 17 years property management experience.  When you have a good tenant, who pays on time, keep them.  Always keep a good one, because you could spend all that money in repairs and turnover fees and end up having to evict the next one.  Just give her regular rent increases and continue to provide her with good maintenance.  She will move one day.  Then do the upgrades.  

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  • Walt Dockery
    Investor · Winter Park, FL · Member since 2017 · 171 posts · 165 votes
    9y

    Have you talked to her about it?  She may very well appreciate that you take better care of the place, and if the rehab work is stuff she wants would she be willing to pay more and stay?

    0Reply
  • Kari Koszdin
    OP
    Seattle, WA · Member since 2017 · 12 posts · 4 votes
    9y

    I have not, but I do not want to do work on the apartment while a tenant is in place.  In my experience, that has not worked well.  Plus I have a feeling that she won't be able to afford to pay more.However, if I did end her lease and renovate, I would offer her the place at the higher rent after the work was done.

    0Reply
  • Nathan S.
    Rental Property Investor · Minneapolis, MN · Member since 2016 · 50 posts · 15 votes
    9y

    You could talk to her about the following plan: wait until another tenant's lease expires, have her move to the newly vacated unit and renovate it, allowing her to move back or stay in the new unit.  As an incentive, you can offer to help her move or cover the expense and hassle by providing a credit for movers.  This way, you get to renovate and keep a good tenant.

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  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    It is always worth changing tenants, if necessary, to obtain market rents. Done property there should be very little down time on the unit and increased profits going forward.

    It is particularly important on a paid off property since you are likely receiving very little and more likely negative true cash flow from the property itself. All your cash flow is likely artificially created by your equity. The property may in fact be a liability. 

    As far as your situation is concerned being able to increase your rents from $1650 to $1850 at a cost of $15,000 is a terrible business decision. It will take 75 months to recoup your costs which as a business decision is very poor.

    Spending 5K to increase from $1325 to $1650 ($325/month) will take only 15 months to recoup your costs. My advice would be to give her notice to immediately increase her rent to $1650 and see what she does. IF she stays great if she gives notice to go do the lipstick reno and find a new tenant at $1650. A one month vacancy will be recouped in 4 months with the higher rent.

    Defiantly worth replacing her for an additional $325/month.

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  • Kari Koszdin
    OP
    Seattle, WA · Member since 2017 · 12 posts · 4 votes
    9y

    Thanks for the advice- I do tend to over-renovate, since I really like doing that. I think you are right on- on that part.  I cannot raise her rent right now since she is on a term lease, but will seriously consider just raising her rent to close to market at next renewal to see what she does. I guess I shouldn't really judge how much she is willing to pay.

    I was wondering though- what do you mean by negative cash flow on a paid off property?  Why is a paid off property a liability?  I understand that the equity is not working for me- I could take out a mortgage and either invest the money for return or buy more property- but I do not want to buy more property and I already have a lot of money in the stock market.

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  • Angie Swader
    Real Estate Agent · Imperial Beach, CA · Member since 2017 · 3 posts · 3 votes
    9y

    I have 17 years property management experience.  When you have a good tenant, who pays on time, keep them.  Always keep a good one, because you could spend all that money in repairs and turnover fees and end up having to evict the next one.  Just give her regular rent increases and continue to provide her with good maintenance.  She will move one day.  Then do the upgrades.  

    3Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    @Kari Koszdin

    @Kari Koszdin

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  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    9y

    Karl: You answered your own question in your second paragraph.

    With cash valued at 10% return and mortgages at 3-4% it is costing you 6-7% lost income on your equity.

    Foe every 100K valued at 10% you need to deduct $866/month from your rental income to pay your equity a return. If you pull the equity you then have what is considered true cash flow only from the investment property instead of being generated by the dead equity. Pulling the equity and parking it in a income fund will generate returns and force the property to generate true cash flow. The two combined will produce greater returns than you presently have.

    As for the property being a liability...once the value of the return on the equity exceeds the available cash flow the property is a liability since by itself it is no longer creating any cash flow. You would be better without the expenses of having to maintain the property since it is only your own cash that is generating cash flow.  Sell the property, invest in a fund, enjoy the profits without the liability associated with maintenance, tenants and the rules and regulations of being a landlord.

    1Reply
  • Kari Koszdin
    OP
    Seattle, WA · Member since 2017 · 12 posts · 4 votes
    9y

    Thanks for the information. This calculation is based on getting 10% return on investment in the stock market vs 3-4% in the real estate market?

    Food for thought.  

    0Reply
  • Walt Dockery
    Investor · Winter Park, FL · Member since 2017 · 171 posts · 165 votes
    9y

    Dividend yield on s&p500 is 2%. To compare rental income / cash flow only to total return is apples to oranges comparison. From a risk standpoint, 10% equity mkt return vs a mortgage rate is also apples to oranges.

    Artificial cash flow is a made up term. I'd take $4k/month "artificial" cash flow if anyone is offering it.    

    1Reply
  • Kari Koszdin
    OP
    Seattle, WA · Member since 2017 · 12 posts · 4 votes
    9y

    I think this issue could be debated forever! Many points for view on whether or not it's good to have real estate equity or not.

    In Seattle in the past few years we have seen property appreciation at greater than 10%!year after year. This property was purchased for 388k I've put 150k in and it's worth 800k only 4 years after purchase. So for the past few years I think the investment has done pretty well. Plus I get the cash every month.

    2Reply
  • Walt Dockery
    Investor · Winter Park, FL · Member since 2017 · 171 posts · 165 votes
    9y

    Assuming the market returns 10%, of course borrowing at 3% and investing at 10% makes sense. But that's a big assumption.

    I'm in much the same boat you are in that the vast majority of my net worth is in stocks. I view rental real estate as a vehicle to build another income stream. I'm not in any way saying I think real estate returns will be superior to (or for that matter, inferior to) equity returns going forward.  But I do think comparing income only on one asset class to total return on another is an apples to oranges comparison, as is comparing returns on two cash flow streams of vastly different risk profiles.  

    You know your risk appetite, you know what the rest of your investment porfolio looks like, you know your own cash flow needs and retirement goals.  Nobody else here knows any of that.  Bear markets happen, if returns always equaled their historical averages we'd all borrow at 3% and invest at 10% into perpetuity and we'd all be billionaires, straight line assumptions in a spreadsheet don't always play out in reality.  

    1Reply
  • Levi T.Pro Member
    Rental Property Investor · Tucson AZ / Nice FR / Washington DC · Member since 2016 · 1k+ posts · 1k+ votes
    9y

    Hey man, I do dozens of these all the time, 6 in the last few weeks. We buy them cheap, and honor the lease as long as we are required, once it's time, we raise rents to $100 under market. It's a take it or leave it option for the tenants, no exception. If they bounce, we rehab and get a top notch tenant, if they don't, then we don't have to do a thing till the old tenant defaults or moves. Win-win!

    0Reply
  • Kari Koszdin
    OP
    Seattle, WA · Member since 2017 · 12 posts · 4 votes
    9y

    That's a great idea assuming you have the time and money to renovate. Next year I will have both so I think that will be the plan.  Maybe she will stay. I've only had one tenant move out over a rent increase in 5 years. The rent was 1200 and I wanted to raise it to 1400. They argued but I said Sorry this is the new rent. Now that same unit rents for 2400! I did put about 20k into the unit though and 4 years have passed.

    0Reply
  • Hunter Motto
    Investor · Seattle, WA · Member since 2017 · 9 posts · 4 votes
    9y

    I manage a building in Ballard and we're doing light renovations on all of our units (but good looking ones: floors, stainless appliance package, new paint, sing fixtures, updated bathrooms....no new counters). You will get $200-$300 more for a good renovation. I'd say post $100 less than than you want in rent and see if the tenant stays. 

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