Is it a good idea to raise the rent every year, especially if you have a great tenant? So many landlords don’t raise the rent annually for a variety of reasons, so let’s explore the benefits and potential drawbacks.
Don’t Want to Lose Your Tenant?
One of the most common reasons a landlord doesn’t raise the rent is because they fear that if they increase the rent, they will lose their tenant. Understandably, when a tenant leaves there is a cost associated with returning the unit to move-in ready condition, temporary vacancy and taking the time and effort to find a qualified tenant. Why would I risk a month or two of income (8-17% of my annual gross) for a 3 – 6% increase? It’s certainly not worth raising the rent if it costs more in time, money and effort than if the rent had stayed the same.
What about for the tenant? If a landlord raises the rent, what factors do they need to consider? Instead of status quo, they may reevaluate their situation. Are they happy with the home and is it continuing to meet their needs? Is the landlord providing good service and maintaining the property? Is there something on the market that is better and/or more affordable? If so, is it worth their time, money, effort and hassle of moving?
When your tenant chose to sign a lease, presumably they chose the home because it met their needs and it was listed for a fair price. If their needs have changed (new job, growing family, etc.) the tenant is likely to move anyway. On the other hand, if the housing market continues to move up, wouldn’t your property still meet their needs for a fair price?
For a $2,000 rental, 3-6% equates to a $60-$120 increase per month and with rental prices increasing steadily, this increase will keep pace with the market so the chances of your tenant finding something better for less money is unlikely.
My Tenant is So Nice
Some landlords prefer not to raise the rent because their tenant is nice and the implication is that raising the rent isn’t a nice thing for a landlord to do. However, every year your property taxes go up 2% and the cost of living goes up 2-3%. Increasing the rent is maintaining the health of your investment. Rather than being the proverbial “greedy landlord,” you’re ensuring you have the cash flow to meet the needs of maintaining your property. By not raising the rent, you are actually sliding backwards because your expenses have increased. In addition to a 2% increase in property taxes, a landlord pays for gardening, maintenance, repairs, upkeep, insurance, and either property management or they invest their own time in managing the property. All of these expenses go up as the CPI increases. By not raising the rent because your tenant is nice, you’re paying yourself less each year. If you increase the rent and re-invest in maintaining the property, the tenants will be very happy with their home when they compare it to other homes on the market at the same price.
My Tenant Can’t Afford to Pay More
Most government and private employers increase an employee’s salary annually to adjust to inflation, and in addition individuals have opportunities to increase their skills and education, find new job opportunities, and/or get a promotion. While most renter’s salaries increase annually, if you have a good tenant who you suspect can’t afford an annual increase in rent or whom you know is having a difficult year, this may be a good reason not to raise the rent.
Landlord-tenant laws are rapidly changing and if you don’t have your rents at market value, depending on where your property is located and what the rent-control laws are, you may never be able to get your rents up to market value. Taking the example again of a unit where the rent is $2,000 per month, if you raise the rent 5% every year for five years, the rent will be $2,425 per month during the fifth year. If on the other hand you let five years go by without raising the rent, at the end of five years you will have lost out on $5,169 in revenue, money that could have been used to re-invest in improving the property. Once you do decide to increase the rent to market, there may be (or already are) laws and moratoriums that prevent you from being able to bring the rent to market value. What you will likely be able to do is raise the rent the maximum allowable in your area each year, and gradually over time your rents will start to align with market values. This means that you can be out of synch with the market for 10+ years while your property plays catch-up.
Another important consideration when deciding if you should raise the rent annually is looking at how the rent affects the value of your property. While you may not be thinking about selling, plans change and if you are selling an investment property its sale price is largely determined by a multiple of the Gross Scheduled Income. If your renters are paying below market, and especially if your property is located within a rent-control area, that will negatively impact the property value. An investor would have to calculate how long it would take to bring the rents up to market in the current legislative environment.
On the other hand, if all of your tenants are paying fair market rent, it will positively impact the sale price of your property and the speed at which it would sell, which could add up to tens to hundreds of thousands of dollars and a faster transaction. While there may be a cap on rent increases, there isn’t a cap on the housing market and sale prices continue to rise. Keeping your rental income at pace with the market strengthens the value of your investment.
Revenues & Relationships
When it comes to raising the rent, what it seems to boil down to is that many landlords are uncomfortable with the rent conversation with tenants. While the conversation may feel uncomfortable, tenants are seeing price changes at the groceries, pumps, restaurants, etc. A 3-6% change should be manageable, and tenants should be aware that this is a standard practice for all landlords. What I’ve seen work is by writing a nice letter to the tenant letting them know that you value having them as a renter and informing them that the rent increase is simply to keep up with rising costs, landlords are able to maintain a positive relationship with the tenants they want to keep and maintain their properties and profits!
Mercedes Shaffer is an agent with Pacific Sotheby’s International Realty and specializes in investment real estate and 1031 Exchanges. For help with buying or selling an investment property, Mercedes can be reached by phone at 714.330.9999, by email at [email protected] or visit her website at www.ShafferRE.com. DRE 02114448