Most real estate investors tend to operate their properties with a simple rule in mind – If money appears in their checking account by the end of the month, their property is healthy. As long as they see the same amount every month, they’re happy.
However, this rule inevitably leaves money on the table. Sophisticated investors know that they need to plan for their properties to be successfully operated. They need to buy the right property and operate it with a vision in mind. That vision should include an annual focus on rent increases and tenant relations.
Residential: Multifamily or single family investors have the opportunity to increase rental income at least once a year through the annual budgeting process. This process starts with an annual inspection, followed by a local area renewal rate review (rental comparison survey). Keeping your property well maintained is the key to managing long term rental increases. Tenants will not be as hesitant to pay more if you treat them with respect and keep the property looking well-maintained. A clean property with great looking landscaping, a current paint job without any mold or a refinished roof will get you more rent. Yes, it will cost more to maintain, but in my opinion, the payback will be in the form of higher rent, longer tenancies and lower turnover costs.
Don’t forget, tenants want to be appreciated just like you do. If you have a property manager you work with, have them help you draft an annual budget and forecast the annual increases. Think into the future; plan your rent increases and capital expenses two to three years ahead so you can better control your long term destiny.
Commercial: Owners of office, retail or industrial buildings need to think through the same process. They need to develop a plan that lasts through the initial lease term and includes details regarding the tenant’s options to renew, (since commercial tenants tend to stay for three to 10 years, even more planning is involved in controlling the costs and the rental increases).
Annually, property owners need to review the comparative position of their property. They need to be realistic regarding the value of their real estate. Just as with residential investments, they must consider the condition and location of their investment. Commercial landlords need to have a long-term plan in place that keeps rent increasing on the annual basis.
If you make a concession regarding a starting rent to get a tenant in, plan to step it up to market value within three years. Aim for a minimum of 2 ½% to 3% in annual increases based off the pre-negotiated step increase or percentages that increase on the basis of a business’s success (typically used by retail businesses). I am not a huge fan of CPI (consumer price index) increases because the government has too much control of those numbers. Don’t permit expense caps unless you can stay ahead of the expenses, regardless of the caps.
Lease Renewal Time
Landlords and their property managers should not automatically cave into very low or zero rent increases at lease renewal time, even if the tenant threatens to move out. Run realistic scenarios regarding the cost of re-tenanting. Include vacancy rates, leasing commissions and tenant improvements in these calculated scenarios. Consider also, the moving costs an existing tenant will face. Understand their business and business goals, their staffing and their success at your location.
Make Repairs Quickly
Most importantly, while they are renting from you, fix repairs that are required by your lease and fix them quickly. Show your tenants you appreciate them by treating them how you would want to be treated, otherwise, they will blame you and possibly hold back rental payments, do the repairs themselves or worse yet, move out.
Last year there was a client who took two months to repair the air conditioning units on a newly leased space. It was wintertime and it was raining; the tenant was livid and hired an attorney to preserve their rights under their lease. The landlord wanted absolutely the lowest price for the repairs and getting the lowest price took over 30 days of negotiating with vendors. The tenant almost moved out because it took so long and alternative cooling systems needed to be provided. The experience drove them to become a hostile tenant and we aren’t sure if they’ll renew their lease when the time comes. These bad feelings could have been prevented and could have agreed on a rent increase and lease renewal with this tenant if the landlord would have allowed the property manager to be more proactive. Note: Typically, property managers have vendors they work with that are reasonably priced and who respond quickly; but they may not be the absolute lowest.
Inevitably, attention to detail, future planning, a current understanding of the marketplace and a fair and realistic approach to taking care of the properties will yield higher returns for real estate investors.
A key component to profitability is a focus on current and future rental incomes. Sticking to the basics with an annual planning process and taking care of your tenants will increase your annual yield and keep reliable tenants in your properties.
Clifford A. Hockley is President of Bluestone & Hockley Real Estate Services, greater Portland’s full service real estate brokerage and property management company. He is a Certified Property Manager and has achieved his Certified Commercial Investment Member designation (CCIM). Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM).