Raising Rent (& Risking Tenant Turnover) vs. Playing it Safe (& Missing Out on Rent): Which Wins Out?

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I used to say that not everything is as it seems in real estate. I don’t say that anymore because it simply doesn’t do justice to the truth as I know it. What I say now is, “Nothing is as it seems.”

As it relates to income-producing real estate, neither the income nor the expenses are what you think they are going to be, which in and of itself is the only constant. I know, that sounds weird — welcome to real estate!

The Secret to Success

The secret to achieving success in this sport is first coming to terms with the above reality — the only dynamic you can count on is that nothing is as it seems. Once you accept this, the path to success is a function of developing an ability to see that which is not obvious. Basically, it goes like this — now that I know that nothing is what it seems, how do I figure out the real truth?!

real-estate-boom

The Flow of Money

The flow of money in income property is at first glance obvious. You have income, and you have expenses. The income includes rents and fees, and the expenses include, well, you know what they include — you’ll find all of them in the BP Calculator.

What you may not know, however, is that there are forces at play that silently impact both the income and the expenses, which can dramatically impact our bottom line. These forces of evil are typically referred to as economic losses.

Related: How to Estimate Future CapEx Expenses on a Rental Property

One subset of these economic losses are all of the costs that are the result of tenant turnover. For example:

Loss to Lease

Let’s say you are renting a unit for $1,000. The tenant signs the lease for one year, and things go well. When renewal time comes, you send the tenant a notice that their rent will be increasing from $1,000 to $1,040. The next day, the tenant walks into your office and says that they are not comfortable paying more than $1,000, and if her rent goes up, she will need to look for another place to live.

Now you have a dilemma. You think that you can rent the unit for $1,040. But on the other hand, you realize that it’ll take a month to turnover and re-rent the unit. You’ll also need to clean the carpets, replace some blinds, and perhaps do some painting. So, it ain’t like re-renting this unit will cost nothing. The question is, will it cost more than keeping the tenant’s rent at $1,000?

And the answer is, in most cases, yes! In this case, lost month of rent is $1,040. Plus repairs, let’s say all in, you lose $1,500 on the turnover. On the other hand, not raising rents by $40/month will only cost $480 for the year.

Which loss is better — $1,500 or $480? Think on that for a minute. 🙂

How to Become a Millionaire

You Lose Either Way!

Yep, you sure do. Why? Because even if you chose the lesser of the two evils, it’s still costing you money (be it less money). After all, if the market for the unit is $1,040 but you keep your tenant at $1,000, you’ve signed up for a loss of $480 on your bottom line — say hello to LTL (loss to lease). And if you are going to be intellectually honest, you are going to show a 4% loss to LTL somewhere in your pro forma. This is why when I see people throw around 5%-10% vacancy, I just laugh!

Related: 3 Little Known Factors to Help Minimize Vacancy Rates

Tenant Retention

The moral of this story, in a roundabout kind of way, is that while not always, in many cases it is cheaper to keep a paying tenant in place, but doing so costs money. The lost revenue is but one aspect of this. You may also paint an accent wall or replace a few blinds for them. Happy and paying tenants, producing stable cash flow for us, is worth the effort and cost!

Conclusion

Very few costs in real estate are obvious. I read on the forums this week some dude say something like, “It’s all about the numbers; plug the numbers into a spreadsheet, and if they work, they work.”

Yeah — but you’ve got to know which numbers to plug into that spreadsheet.

Investors: How do you approach this dilemma (risking tenant turnover due to raised rent)? Do you agree with this assessment?

Leave your thoughts below, and let’s discuss.

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

32 Comments

  1. Curt Smith

    Hi Ben,

    In Atlanta and other hot rental markets rent is rising so fast its very difficult to be even be close to median rent let alone the upper end. I have an annual rent raise clause in my lease. “Theres a rent increase every year even if only $25”. It’s just a practical situation for a renter in hot markets to stay. Its much cheaper to stay and pay higher and higher rent because the competition is usually much higher.

    My turn over costs are amazingly low. My top notch renters leave with hardly any marks on the walls. I always use flat paint and a standard color so I can foam roller over the marks in 2 hours. Thats typically it!! Oh I do have to vacuum cob webs out of the corners too. Plus I get a big rent increase. But I have very VERY little turn over.

    I’m adding $200/mo onto the new rent on turn overs even with rent increases during the stay. There must be an upper limit? And it will be your 3x rent for the combined income requirement. But at present I’m able to get 3x rent and more. So raise the rent.

    • Of course there must be a upper limit or you will price out the typical tenant. Just because you provide an inelastic commodity does not mean you have to take undue advantage of it. It does no good to say that tenants agree the rent is acceptable because tenants signed a lease. Look up “inelastic.” I always look at HUDs zip code specific analysis to get guidance on reasonable rent. Market rent is not de facto reasonable, just like inflated bubble house prices did not reflect fundamental value. It is not necessary to stay close to median rent if the median rent is too high. In my outrageously high rent community, I run my numbers with a view to reducing the rents.

  2. Mike McKinzie

    Ben
    All of Real Estate is about negotiation and compromise. I wanted to raise the rent $50 and the tenant wanted no raise. They were good tenants and paid on time, yet my Property Taxes went up about $200 this year, so I split the difference and raised the rent $25. While I could have held my ground, on top of the turnover expenses, my PM charges me 70% of the first months rent. So my expense would be pretty high. But raising the rent, even a little, lets the tenants know that rents will be raised annually. On a side note, you using the term “evil” made me chuckle.

  3. Brian Brown

    There are other factors to take into consideration… Like what is fair market value for your unit. It is going to cost the tenant just as much or more for them to move so there is a balancing act between those factors that you should look at.

    If you think back on the last time YOU moved and what a HASSLE it was you would probably would pay the increase if you looked around and found you could not do much better some place else.

    So I say do a market analysis and if you are not getting enough RAISE the rent you can always give in if you think the tenant would really move and you are going to incur turnaround costs that will blow it for your balance sheet IMHO.

  4. Pavlos Kasselouris

    When you manage your rentals by yourself you have the advantage of putting more effort to the turnover. I have instances that I have received layover rent.(the tenant moved out a week earlier and I had a tenant placed at the property earlier…
    Its all about having good relationship with the tenants so they can let you show the property while they are still in. Also the raise must be justifiable . If the tenant will not find a better place for that price it doesnt make sense for him to move in the first place.
    To be honest my properties are SFH on A and B areas so better quality over all…
    I’m sure that apartments or SFH at C and D areas, happens what you are describing.

    To conclude I will raise rent even if its just $10…

  5. Brian Moore

    Ben,
    Good article. Costs of turnover & vacancy can be very high and need to be considered when negotiating with tenants. That’s why I always propose a higher increase than I am willing to accept. The tenant feels better when they negotiate a “discount” and I still get my planned rent increase.

    HOWEVER, another factor to consider when forgoing a rent increase is how this will affect the market value of the property. Income property is, of course, valued based on the income. In my market, the hotter neighborhoods in Chicago, a $1 of monthly rent is worth about $150 in market value. If you plan to sell and you are charging under market rents you lose out on that additional value. In your case study, the $40 lost would reduce your market value by $6,000.

    This would change your loss calculation completely, again, nothing is as it seems.

    Brian

    • But if that “value” is not supported by other fundamentals, it might mean there is a bubble forming. Judging whether $40 lost reduces market price by $6000 or market value by $6000 requires a deeper analysis.

      • Brian Moore

        At the 2007 peak in Chicago, buildings were trading at over 200x monthly rent – clearly unsustainable bubble pricing. Current fundamentals support the 150x gross income multiplier (at least in Wicker Park & Bucktown where I operate) due to a) a lack of new development and b) INCREDIBLE demographic shifts bringing millennials and tech jobs to the neighborhood. Buyers must pay today for the rent increases/returns anticipated tomorrow.
        Pricing in downtown Chicago, where Class A+ development is rampant, is a different animal. Vacancies are already increasing and rent declines are inevitable due to the supply / demand imbalance in this ultra luxury segment.

        • “Buyers must pay today for the rent increases/returns anticipated tomorrow.” That is exactly the rationale agents used to persuade buyers to overpay in the run-up to the bubble.

  6. John Teachout

    I agree with assessing the competition when determining the risk that someone would actually move out due to a relatively small increase. Higher and higher prices are part of life and it is unreasonable to expect that as a tenant your rent will just stay the same from year to year. And a tenant will also be assessing their cost to move from one property to another. Unless they are going to “downsize” to a smaller or cheaper (less nice) unit, it may not behoove them to have to pay another round of application fees, pay for the move itself, and then bridge the gap in security deposits between the two units (even if they get all of theirs back eventually).
    So if the landlord is confident they are pricing appropriately, I feel an annual increase of some amount is warranted assuming the entire market is moving up.

    • john barnette on

      Exactly 100%. Know your market. Be a pretend tenant and shop for alternative places…even beyond the immediate neighborhood. I would also add that smaller annual rent increases is a much easier thing for tenants to stomach than no rent increases followed by an outsized one to catch up to market.

  7. Kyle Atans

    Ben,

    There is another aspect – tenant expenses.

    When they move out, they need to take a few days off (lost revenue from their end), they need to pay a new security deposit and in some cases, you spend additional money to rent a track and pay for an additional hand.

    So, the same diploma in on the tenant side – “should i spend “X” amount of money to find a new place (just relocation cost) or suck up the $40 increase ($480 per year)…

  8. David Gonzalez

    I say raise rents! The key is to raise it enough that you increase your monthly income but not so much that the Tenants find moving as a cheaper option. Many Landlords are afraid of turnover.I saw systematize it, manage it and embrace a reasonable amount of turnover. Turnover (at a reasonable level) is healthy for the business.

    My experience has been two fold:

    1) Tenants who live in units charged with below market rents stay longer but do not report issues because they do not want you to realize that you’re leaving money on the table.

    2) lLong term Tenants start to feel entitled to the property and do not always report maintenance issues.

    Both instances are bad! With either type of tenant when they finally move out the owner has to deal with lots of unreported maintenance issues and have to pay more to fix the issues when they could have paid significantly less to prevent (or mitigate) an issue if the problem was properly reported. (i.e. $100 to fix a leak vs $500 to $1k+ to fix water damage)

    Another issues is that the longer the tenant lives in the home the harder it is to deduct actual damage from the deposit since the tenant can argue that it was caused by “wear and tear” and wasn’t damaged.

    In conclusion: Raise Rents to increase your profits and invest a reasonable portion back into your property! Accept that higher rents will increase turnover. Embrace Turnover as the cost of doing business and as an opportunity to keep your property maintained.

  9. Gunnar F.

    This is an interesting issue for me. I have a quiet gentleman living in my unit for a rent of $875. The unit is paid off. Taxes are about 2K a year. The tenant has been there for 7 years thus far and I am confident that he will live there for many years to come — seriously, maybe 5-10 years longer. He pays the rent like clockwork, rarely bothers me and he is a veteran. I pay no management fees as there is no real maintenance other than having to fix the AC every 2-3 years. I live in Asia and never visit the unit. So this is in key respects the perfect arrangement.

    If I spent $5000 on the unit I could likely re-rent it for $1100-$1150 or so. Assuming the current tenant would leave in response to a major rent increase, which seems likely, I would then be renting it to someone who might leave after a year, causing me to incur hefty make-ready expenses of 1K-plus and considerable long-distance hassle to get the unit marketed and rented each time that occurred. I don’t relish that prospect. At all. My time is worth a lot to me.

    I could probably increase the current tenant’s rent to $900-$950 or so but he might sour on the place. Also, I get vague satisfaction out of subsidizing a veteran in this way.

    So on balance, I leave things as they are.

  10. Michael Boyer

    So true… For the DIY landlord take a look at your receipt pile from the turnarounds… Quite a stack…All the little odds and ends and sticky wickets to fix, and then you clean and paint. It adds up… Add in the vacancy plus your time (which has value) to screen, show, and onboard the new tenant… No doubt…It pays to keep good long term tenants as the bulk of the landlord work and money is in the turn over. Granted, you can’t fall too far under market, but raising rent when then tenant moves of their own accord rather than automatically at every renewal can make financial sense when you run the numbers. Also, key to check if the market even justifies an increase, or if you are already there or close enough considering the above rationale…Great piece.

  11. Chris V.

    All this depends on which market segment you are renting to. If you are renting to young professionals in San Francisco that can pay more if they choose to, your formula will be different from when you are renting to people in Stockton, CA that make $1750 p/m. Gross. Since I have no personal experience renting to your professionals I will spare you my *opinion* on that. However I do have experience renting to the lower income segment in Stockton CA, so I thought I’d share my actual *experience* with that particular market (segment):

    First off: My experience is that in my multi family housing segment the price elasticity is high. A moderate increase in rent can easily make people move. Price is by far the primary driver. Other drivers like for example quality are not nearly as important. Sure everyone likes all new cabinets, tile, carpet, two tone paint, recessed lighting, ceiling fans, etc, but it is very hard to find anyone who is willing to pay a significant premium for that vs. just any “clean” place. I found that a $12K+ rehab only nets me about $50 more than a $3.5K paint and carpet and fix up deal. Of course you can not keep doing the fix up deal forever, but I am saying that if you can, it is very hard to justify the total rebuild.

    To my surprise people do not look at the overall picture but are really focused on the “rent” sticker price. For example I don’t think i could get $100 p/m more if I would include utilities, while I know it costs my tenants a lot more than that to pay their own utilities.

    In my multi family units I have seen tenants move out to “save” $25 or $50. In one of these examples I spoke to the person by chance a few months later (its a small world, which you’d be wise to consider whenever you have people moving out…) and to my secret amusement it turned out that since they moved they were actually loosing hundreds of dollars per month because their “new” apartment’s A/C unit was so old that it used a lot of expensive electricity. The HVAC on my unit that they moved out of was newer and more efficient. They had never thought that something like that might influence their cost of living because they were so focused on the sticker price of the rent. Unwise but very common in this market.

    Secondly, vacancy is a huge profit KILLER. I found that more expensive apartments are harder to rent because of two reasons: a.) there is less of an audience for quality but more expensive units in my market. And b.) because the units are nicer, your stakes are higher so you’ll want to be extra selective on who you let in there. Someone that would qualify for a $700 unit would not for a $850 even though they think they might.
    Also, I found that people paying a rent towards the high end of the market rent tend to leave after their first year more often. That is probably at least in part because you selected a tenant that is *so qualified* that they actually got *options*… People that have options are likely not going to stay content living in my multi-family units however nice they might be. They will either want to rent a house, but a house, move for work etc.

    Now, when that tenant leaves, you have a vacancy. I see people here on BP talk about a one month vacancy after tenants leave. This is not my experience. I count on two months.:( Why? Because most *qualified* tenants already have a current lease that they will not break. So if tenant A lets me know on May 30th that they will move out on June 30th it will take at least a few days to get the apartment listed etc. Lets say I find prospective tenant B who is qualified on June 10th. B, being a responsible tenant, will most likely not be able to get out of their current lease until July 31st… And good luck trying to have them pay for a unit they are not moved into yet.
    So that means my unit has been empty for two months. During which I had to pay Electric/Water/Gas and waste time coordinating cleaning, touch up etc.

    For this reason I am actually considering giving month-to-month tenants a $50 bonus if they give me notice two months in advance instead of the legally required one month. I would add this “bonus” to their security deposit. This would give me some time to market the unit and find a great tenant that can actually move in right when the old one moves out without breaking their current lease.

    So don’t I raise rents? I actually do raise them:). On the units that are significantly below market value I raise rents every year but *very slowly*.
    Example: A unit that after about $3,000 in rehab would be worth $800 easy) is currently renting at $675 to long term tenants that are awesome. I will raise the rent with about $20 per year. This is a 2% to 3% raise which most people can absorb without too much problems. A unit that is renting for $875 which I could probably rent for $900 I leave alone. For now.:)

    What I buy with this is some stability. I have about 20 units and I don’t even want to think about how much hassle it would be having 15 or even 10 move outs/in’s every year… Plus the additional risk of picking up a bad tenant. Letting a new person in is even after screening in part a Russian roulette. Sooner or later…

    Also, I have build up some history and when I look at the profitability numbers, my legacy units (inherited with lower rent but including decent tenants and no investment made by me) those units are actually making me the most money and just as important, are costing me the least amount of work/time/worry.

    When these “legacy” tenant eventually do leave, I will redo the units and rent them out at a significantly higher price. But until then, but if the legacy renters are good tenants, I really see no benefit in driving them out. I’ve come to realize that good predictable tenants are worth a lot of money, particularly in multi-family buildings where one rotten apple can easily spoil the barrel.

    Anyway, I thought I’d share my experiences. Particularly because this was not what I expected when I started out. Naively I had expected that quality would demand a significantly higher price and retention rate. I also expected that it would be easy to just keep raising rents to keep track of the market and failed to realize the practical and financial implications of the preventable turnover that would cause. As I said above; other markets might be different, but I hope this helped people that are in a market similar to mine.

    • Chris, This should have been a standalone post; it is that valuable, especially because you are able to see the situation from the tenant’s angle as well. As you imply, landlords do not want tenants breaking the lease unless they are breaking someone else’s lease.

      You say, “Of course you can not keep doing the fix up deal forever, ” Sooner or later, you will have to do a full-on repair of all that deferred maintenance. Tenants do not want to pay extra for maintenance, whether done incrementally or in one fell swoop. Tenants are not swayed when landlords reframe maintenance as a “remodel.”

      And of course, even in San Francisco, not everyone is a professional. Landlords have to avoid pricing out their most precious resource—the typical tenant, who by the way, is not a professional.

      I do not blame or chuckle at the tenant who discovered the expense of the AC vs your HVAC. Their AC could have just as easily been fine. No one knows the future.

    • By the way, my market has a lot of young professionals. They are the source of the pent-up demand for their own house. They would rather save for a down payment than pay extra rent for an overdone apartment. They expect a nice quality home where everything works, but they see no value-add for high end finishes, etc. Their attitudes are perfectly reasonable.

    • Ryan Jenks

      Chris,
      You made a lot of very good points and I can relate as all of our rentals are in Lodi, CA. One thing that hit home was whether you put in a lot or a little fixing a place up, the nicer effort might only rent for a few dollars more. That is so true. We really make an effort to rent out nice places and it feels like their is no benefit (dollar wise at least, maybe it is the cause of better tenants but that is hard to measure). Price is king for 99% of people.

  12. Ryan Jenks

    I love this discussion as we have just had to deal with this ourselves. We found ourselves fearful of tenants moving as it is a hassle and expense to have a vacancy that is “self-inflicted” from a rent increase. For some peoples situations and markets, it is a valid concern. My family and I found ourselves 30% under market across the board with 10 different units. Out of general human respect, we did not immediately bump all units to market but gave $50 here or $75 there. Our goal is in the next 2 or 3 years that they get to market. I have 2 points. First is if a tenant moves… yea! We can bump it to market and make 200 or 300 instantly more per month which adds up over several years. Second is if 1 tenant of 10 moves… the gross rent increases more than pays for that 1 unit’s turnaround costs just in a single month or two. Everyone’s situation is different but this is what we discovered for our little world.

    • Chris V.

      I agree that if a tenant moves that is a must-take opportunity to raise the rent. However let me show you why I would not say YAY! if a long term tenant gives notice…

      A real example: If an under market tenant moves out I can raise the units rent from $700 to $850.

      However, if it will cost me $3500 in carpet paint and small repairs, plus two months vacancy (which I will count at the old rate of $700) to do the work and find a new *qualified* tenant.
      $3500
      $700
      $700
      ===+
      $4900 Turn over cost. Rent increase $150. (21%)

      Months to break even = $4900/150=32.7 months before I break even(!!!). IF the new tenant proves to be stable and actually stay that long, many don’t especially the ones in my more expensive (nicer) units, because they have more alternatives… Just saying, a 32.7 month break even period is nothing to get exited about. Especially since I would have raised the $700 rent by maybe $20 every year anyway…:)

      These are just to cold numbers, they do not take into account the work *I* have to do to coordinate with the contractor, carpet guy, property management company etc. It also does not factor in the increased risk I take with an unknown entity in a unit that I just had partially redone, and the disruption that a remodel brings to the building (last time they broke a water line in a unit above another occupied unit. On a Sunday night. While the contractor was in Disney land… Anyway, I did not put a price on the hassle factor, but at least in my experience there is a very significant hassle before all is well.

      Again, I am not saying don’t raise the rent, but what I guess I am saying is cherish your long term tenants, even if their rents lag behind the “market”.

  13. Michael Sadler

    I think that it’s good to talk to your tenants and know the market value when deciding to raise rents. Since rents can inflate, I heard it’s good to regularly increase rents so that one giant increase doesn’t scare off tenants.

  14. one intangible fact not mentioned here are what I call “Gold tenants”: those are the ones who do their own minor repairs, never ever bug the landlord, pay their rent on time or in advance. I have tenants that have been renting from me more than 15 years. I have raised rent only to exactly match the increase in property taxes divided by 30 which is my complex size. My golden Tenants now number about 12 , have been with me more than 7.2 years, plant flowers, assist in bringing in good new tenants, keep an eye out for any problems,….ill tell you what….I make enough money without in any way stressing my Gold Tenants……Tru I am about 15 % maybe even a little more below market average but never worrying about rent / minor repairs is well worth it….

    • Gunnar F.

      I essentially have a “Gold” tenant as coined by Dave L in the unit I mentioned above. As the unit is paid off my analysis is that I am making a steady 5.5% net annual return on the amount my Realtor calculates to be the current likely sale price of the unit as-is. That pales in comparison to my returns in the market over 15 years. But it operates as a little hedge. So I suppose given the increased inconvenience of turning the unit over from abroad I am willing to accept that.

  15. Mike Tierney on

    I like keeping rents about $50/mo below market. Your tenants will figure out they are getting a good deal and will want to stay. When they want to stay, they shift the way they think and treat the place as a home rather than a rental. Keeping rents more than $50/mo below market doesn’t really get you anything more and drains you of funds that you could have reinvested in the property.

    Some tenants are transient – it’s just who they are. Keeping rents low doesn’t really matter to these folks – they are transitioning for non economic reasons. In my opinion, keeping your units nice and priced slightly under market is the way to go to get the best return.

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