I agree that you cannot always raise rents year to year to move steadily with inflation. Inflation is an average and our economy has unpredictable good years and bad years that can be amplified by local economic trends. Raising rents can be tricky because if you go too far, you have vacancies that cost time and money. Trying to squeeze an extra $25 here and $50 there in this particular price point can drive away good tenants and cost a month of rent that negates the benefit of the increase for many months. In my opinion, it makes sense to keep rents in line with your competition and even undercut slightly to keep the good ones. I try to only raise rents through attrition and/or to keep pace with an increase in taxes or insurance. The beauty of raising the rents when a tenant moves out is that if you are given the proper 30 day notice, you can raise the rent to test the market reaction for a couple of weeks where you are not vacant. If you are dead in the water price wise, then you have the opportunity to drop the price to a level that the market will bear before you have a vacancy. To me, it seems that the ROI for this is strong enough where you do not need to start raising immediately, unless you are well under market with rents, which it sounds like you are not. When someone gives you notice, raise the rent in your ad to see what kind of activity you get. Now, if you start seeing similar competing units renting for $750 and $800 and so on, then it's value add time.
Yes, there is rooms for $300 rent increase in total, however, I would have to update the units in a pristine condition in order to achieve that increase.
@James Syed, those "pro forma" numbers look good for you on paper. The two numbers that stood out to me as needing closer attention are cap ex and vacancy. Will $10k REALLY account for any/all deferred maintenance that might be waiting to pounce? And is 10% vacancy allowance enough in that neighborhood? ie. Can the seller prove its rental history accordingly?
If so, makes me wonder why they want out? Nonetheless, looks very promising.
Oh, but while those rents don't change - investor value will be seen as $177k, not $200k. Cheers...
@James Syed your numbers look pretty solid to me, your 30 year analysis is conservative by not using rent increases and appreciation in your numbers and even with your 10% allocation for vacancies you should still have a little positive cash flow if an extra unit was unoccupied! Keep us updated, Good Luck!
I am not sure how you were able to predict that I used "pro forma" numbers. I didn't. These are REAL numbers provided to me by the seller. That $10,000 is NOT for deferred maintenance, rather will be my first year expenses when I take over the property.
My monthly maintenance and repairs number is mentioned in my post "$300" a month. And yes, 10% is actually higher for this market because vacancy rate for this area is around 8%.
Now one question for you, how did you come up $177,000?
I plan to exit after 5 years so that is why I ignored 30 year analysis. I don't expect much increase in rent in 5 years as this area doesn't have any appreciation, but cash flow is your friend.
We buy property for one of 2 reasons - to create wealth, or to preserve it. In order to create wealth, you need back-end appreciation. In order to preserve, all you need is to keep up with inflation.
Now - you can accomplish either by buying at 4 cap, and at 10 cap. The CAP rate just doesn't matter much. If it's a quality asset, it should keep up with inflation. However, to create wealth, you must be able to do better than simply keep up with inflation.
So - A: what are you trying to do?
B: Does this building have enough quality about it in order to keep up with inflation?
C: Are you trying to do better than that, and if so - how?
Great response there. I admit that I failed to consider inflation rate. I assert it's 3% (not sure). Therefore, like you stated either appreciation or keeping with inflation.
In my best opinion, I would say I don't see any rent increase in the next 5 years UNLESS I update all units to most updated condition which will cost a large sum (haven't figured that out yet).
Keep in mind, I haven't bought the property yet and can walk away if needed to.
So, in your opinon, doesn't appear to be good enough?
Great response there. I admit that I failed to consider inflation rate. I assert it's 3% (not sure). Therefore, like you stated either appreciation or keeping with inflation.
In my best opinion, I would say I don't see any rent increase in the next 5 years UNLESS I update all units to most updated condition which will cost a large sum (haven't figured that out yet).
Keep in mind, I haven't bought the property yet and can walk away if needed to.
So, in your opinon, doesn't appear to be good enough?
Thank you.
I am not sure if it's a good deal - depends what is a good deal to you. You think you can get the rents up is you fixed up the units? What would be the capitalization rate on the dollars spent on this value add, James?
Your statement regarding rent increase indicates you are not a experienced investor. The cost of living rises every year and there for it follows that a landlord, in order not to lose money, increases rent every year. If you do not raise rents on your units you are doing two things. Giving away money every month by supplementing your tenants rent from your pocket and devaluing your property based on cap rates.
A investor that does not realise their costs increase every year and therefor increase rents to maintain or increase profits should not be in business. If a rental unit is at $XXX per month and inflation rises X% then the unit in it's present condition (not renovated) should be rented at $XXX + X%. This is simple business 101 and a minimum increase without factoring in any other driving factors.
If you can not increase rents immediately without renovating you have no rent up side going into this investment. The up side to buying is increasing rents to market based on their present condition not injecting capitol to do so.
This investment looks OK but your business plan is seriously lacking.
There are markets where you can't raise rents every year. If you do, you will lose your tenants. I have been investing actively since 2007 in real estate and I have come markets where the rents didn't increase, even if they did, they were very minimal.
For example, I am getting $575 for my 2 bedroom condo since May 2012, had I increased rents every year by just $25, I would have to ask for $675 now, I can't get in my market because the competition will grab my tenants.
It's very funny how you ruled out investors out of business who were unable to increase rents. Maybe New York City, Chicago, Los Angles, Miami have a market where you can increase rent every year, but not all the markets are same.
I agree with you on business plan. I should think harder on exit strategy as well as future cash flow figures.
Rents do rise every year, the cost of everything rises every year. Landlords that attempt to justify not raising rents by the minimum amount of the cost of living out of fear of losing tenants do not understand and therefor fear making the right business decisions. They assume but do not in fact understand the market effects of inflation, do not make a profit and are the owners that eventually sell at a loss.
Basic economics prove otherwise but they do not want to hear it and will continue to argue that rents can not be raised. Head against brick wall.
I understand the basic concept of inflation. Dollar worth today is less than a dollar in the future. And also prices go up due it. Having said that, market dictates many thing and you can NOT predict market conditions in advance.
You are correct about predicting market conditions but it is reasonable to expect inflation. Assuming inflation rises every year I can guarantee my rents will rise every year. That is a absolute certainty. What I can not predict is whether they will rise more than the cost of living, that is driven by market conditions.
You are right. $177,822 was based upon 9% cap rate, but my purchase price is $165,000 so, it appears to be a good deal. I have been ignoring cap rates after listening to many investors say "cash flow" is the key.
I agree that you cannot always raise rents year to year to move steadily with inflation. Inflation is an average and our economy has unpredictable good years and bad years that can be amplified by local economic trends. Raising rents can be tricky because if you go too far, you have vacancies that cost time and money. Trying to squeeze an extra $25 here and $50 there in this particular price point can drive away good tenants and cost a month of rent that negates the benefit of the increase for many months. In my opinion, it makes sense to keep rents in line with your competition and even undercut slightly to keep the good ones. I try to only raise rents through attrition and/or to keep pace with an increase in taxes or insurance. The beauty of raising the rents when a tenant moves out is that if you are given the proper 30 day notice, you can raise the rent to test the market reaction for a couple of weeks where you are not vacant. If you are dead in the water price wise, then you have the opportunity to drop the price to a level that the market will bear before you have a vacancy. To me, it seems that the ROI for this is strong enough where you do not need to start raising immediately, unless you are well under market with rents, which it sounds like you are not. When someone gives you notice, raise the rent in your ad to see what kind of activity you get. Now, if you start seeing similar competing units renting for $750 and $800 and so on, then it's value add time.
@Greg Jeanfreau Well said! I'm about to make my first rental purchase in Texas and here you can withhold the tenants deposit if they don't give you 30 days heads up (assuming its in the lease). My planned policy is to base rent increases on a few factors:
What is the market doing? What are comps renting for?
What are my expenses doing? If expenses are flat, I can afford to be more flexible with rent.
How good is the tenant? Does he pay rent on time, pester me with small issues (or worse, fail to report big issues), take care of the property, get complaints, etc? If he is a good tenant, I save money and hassle by freezing his rent or pacing it slightly beneath the market.
Do I plan to sell soon? If so, I need higher rents to justify a higher sale price based on cap rates.
Am I missing anything? This is just my thinking going in.
@Nathan Seltzer Congrats on your first foray into becoming a landlord! I think that you have it covered as far as your rental rates and tenant retention are concerned. I would say that whether or not you need to sell soon or not will not necessarily dictate what rents you can or should charge. I do understand the need for higher cap rates for value, but vacancies can possibly put a monkey wrench in the sale if the hikes are too agressive. Of course, it depends on the number of units that we are talking about here. The rest of it I totally agree with. I'm still learning myself every time some new and interesting incident happens. My lease and rules addendum keep getting longer and longer.
Maybe I missed it,but you didn't mention heating costs and who is responsible for heat. Tenant or landlord? I jumped out of a 4 family in the Bronx after only 3 years because oil costs were increasing at alarming rates. The heating question can make or break the deal.