Below market rents - To raise, and by how much?

4 Replies

I am nearing the closing date on a tri-plex in a suburb outside of Seattle. All the tenants are long term tenants with two of them having been there for over 10 years. The leases are all MTM with rents well below market rate for the area. In addition, the Property Management company that was in charge, failed to collect proper deposits, pet deposits, and pet fees. (No big surprise with the PM. Prior owners were an elderly couple and the PM did nothing in the interest of the owners. What do they say on the Podcast - most PM companies are crap?) So my concern now is A) Raising the rent so much on the tenants, about 35% more than what their current rent is (supported by Rentometer and calling surrounding buildings for rental rates), B) collecting additional deposit money to establish an industry standard, 1 month equivalent, and C) for the tenants who have pets, collect deposits and fees for them.

Since I am set to take possession later this month (November), my strategy was to give them plenty of notice of three lease options that will go into effect Jan 1st. 1) Continue MTM but rent would be raised from current to an amount $X. 2) Sign a 1 year lease and rent would be $X-$50. 3) Sign a 1 year lease with auto-pay and rent would be $X-$75. (Again, the rental amount $X would be approximately 35% more than what they are paying now.) In each case, the tenants would have to provide any short-fall in deposit funds. My thought being that if they accept the new rent of their choice, it's a win-win for both. They don't have to move and their rent is on-par for the area, and for me I don't have unit turn-over and I'm getting increased rent. If they leave, then I have the opportunity to rehab the unit then rent it out at a strong market rate. Either way, I would concurrently begin smaller improvements around the property and in the units that were noted during the inspection. This would not only improve the property, but also to show the tenants the new ownership cares about the condition of the building and is proactive in improving it, not just raising the rent. From a business side I am all for my plan and feel it is a solid one. On a moral side, I have reservations imposing such a large rental increase, especially during the holidays.

So to those BP members who have been faced with significantly raising rents after becoming the new owner, what say you?

 

@Will Kenner this is always the dilemma we value add investors face when we take over an occupied building. You have to make some tough choices on how much vacancy and unit turning you are willing to deal with early on. I am going through this right now on a six unit I purchased in Cicero, IL. My existing tenants were paying $650 per month for two bedroom apartments, and if I were to do some basic remodeling on these apartments they would rent for around $1100-1150 per month. I raised all the rents to $900, and none of the tenants left initially. One of my tenants decided to move out with no notice due to a water leak (supposedly caused mold). I just finished remodeling the one bedroom apartment, and am looking to rent her old $600 per month 1 bedroom for $875. 

Keep in mind that your existing tenants may truly struggle to come up with market rents, additional security deposit for a place they are already in, and pet fees. You may have to have some tenant churn and that is ok. A little bit of short term pain will set you up for great success in the long term. 

Thanks @John Warren . Sounds like we have similar situations with the percent rent increases. I too was thinking/concerned about the ability for the tenants to come up with the additional costs. There's no good way of knowing their financial capacity without being able to "re-screen" them. But I agree that getting off on the right foot is always better in the long run, even if that means some turn-over. 

I would first check your local laws about rent increases, notices etc. 

then, i would think about how much money you are willing to lose when the tenants move. It is worth it to have one month vacancy to facilitate x increase?

As for deposits - i would just let that slide. Whatever damage they have done was before you owned it. And again, you have to weigh how willing you are to have a vacancy.

Remember that vacancy is the killer of revenue.