Raising rents or tenants paying utilities. Which is harder?

Question

Looking at a couple of different possible multifamily properties to buy and two of the properties I'm interested in have me wondering which is best. Property A has tenants paying utilities but the rents are well under market rate. Property B has market rate rents but the current owner is paying utilities instead of the tenants (though the units are on separate meters) .

All other things being equal, which is the better property? Is it harder to raise rents or make tenants pay for utilities?

Thanks,

Steven

All other things being equal, which is the better property? Is it harder to raise rents or make tenants pay for utilities?

Thanks,

Steven

Michael Totman · Answer

Either way the tenants will be pissed, as for difficulty it's a matter of lease and contract. In either case I'd go market rents and tenants pay utilities, but to answer the question it's likely easier to raise rents depending on the current agreements and State law.  Never pay utilities when it can be helped, no matter how many "my tenants are so grateful and never abuse this privilege ever" stories you hear.

John Underwood · Answer

Buy the one where the tenants pay their own utilities. You can raise rents later.

Erik W. · Answer

My first rule of considering a property: who pays utilities?  If LL, then can it be switched to tenant?  If not, I pass.

The first time you get a $600 water bill for one month from a single unit because the tenant "forgot to tell me about the leaking toilet" will help you understand why.  If they aren't paying, they do not care.  It only take one wasteful person in a dozen to destroy months worth of profit from the other 11 good ones.  By contrast, tenants who are paying their utilities are already more prone to thinking about wise usage and how their actions help control their bill.

I will NEVER pay tenant utilities.  Period.

Therefore, I think property A would be the best choice.  A utility bill around here is between $80 - $150 / month.  Most of my rents are in the $550 - $650 range, so that kind of increase would clobber most of my existing tenants.  I'd rather have tenants who already know that the bill is on their dime, and give them gradual bumps of 5 - 8 % per year until they are up to market.  Depending on what your rents look like, that could be a little or a lot.  For my average rent of $600/month, 5% is only $30/month or $1 per day.  No one moves over a dollar a day unless they were already planning on moving, in which case, you simply increase the vacancy to market immediately.

Jacob Sampson · Answer

This is a tough one.  On one hand you will cause a lot of turn over when trying to get property A up to market rents.  That is expensive.  On the other hand, getting all the infrastructure in place to be able to individually bill the tenants can be expensive, if possible.

I might take property B and then start charging a flat fee for utilities and over time up that flat fee.

By the way, when you say property B is at market rents do you mean rent minus the utilities the owner pays is market rent?  If yes, then I for sure take B.

Calvin Ozanick · Answer

I would say property A. Raising the rents even a small amount is much easier than getting tenants to take over the utilities after they have already moved in. Obviously, both of these answers are dependent on how the lease is structured.

Nathan Gesner · Answer

I would rather have tenants control the utilities and me raise the rents. Including utilities in the rent requires a lot more effort on your part and you're more likely to lose money when the tenant squanders the utilities.

Steven Andrews · Answer

Thanks everyone for the valuable input. Gives me a lot to chew on. The consensus seems to be that it's easier to raise rents than getting tenants to start paying the utilities. I appreciate the feedback!

Jerid Meagan · Answer

@Steven Andrews,

All things considered equal, property A is the one to choose. Including utilities adds another variable expense. There is enough uncertainty as it is in this business so you want to minimize variable expenses, so that most of your expenses are fixed.

It is always easier to bring in an additional dollar of income than it is to reduce a dollar of expenses, so when improving NOI look at the income side first.

As @Michael Ablan mentioned, depending on your state regs (places where rent increases aren't regulated so heavily) the general rule of thumb that I use when increasing rents is this:

1-5% increase: keeps up with inflation and generally not enough to force a tenant to move.

6-10% increase: tenants will start to weigh alternatives and will consider moving.

>10% increase: more than likely tenant will move unless the unit is grossly under the market and tenant understands that.

Apartment buildings are valued based on their NOI, so although tenant turnover may be an inconvenience, it is also an opportunity to add some value, increase rents, and ultimately increase value.

Michael Ablan · Answer

@Steven Andrews  -  It's a no brainer for me because of the new regulations in NY.  I can only increase rent by 5%, so I just go with the option increases my NOI.  I also find my lower income people have an easier time getting subsidized utilities, specifically HEAP in the winter, so giving them the fuel bill doesn't even affect them financially.

Chris R. · Answer

I agree with @Michael Totman on this one...our most recent acquisition is was a three family with severely under market rents and included HHW. Lucky for us, all tenants vacated prior to close and we were able to renovate each and get to market right away. We took the annual oil bill, divided by 12 and just tack it onto the rent ea month. The way I sell it is their heat bill never spikes in the wintertime. They pay heat every month even in the summer and I haven’t heard a complaint yet.

Raising rents or tenants paying utilities. Which is harder?

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