Based in Los Angeles, The Money Smiths is a blog comprised of thoughts related to personal finances, real estate investing, and musings on early retirement.

I Raised Rents For The First Time and it Was a Rush

I Raised Rents For The First Time and it Was a Rush

First - I’m Sorry

I haven’t posted in the past two weeks because I’ve been incredibly busy. In that time frame I spent lots of energy searching for new tenants, I went on a week long vacation to go skiing with my wife, and I accepted a new job! I was waffling about whether I should really focus on getting a new post out to you because I committed to one per week, but then I remembered my goal for November, which was:

The goal for November is to commit real time to relax and enjoy ourselves.

That’s exactly what I did! It felt great to shirk my responsibilities for the past two weeks, but I’ve had a few of you reach out and wonder if I was still alive, so to prove that I am, let’s jump into my post!

It finally happened

I successfully raised the rent for one of our units, and it felt sooooooo good! This is actually a really big deal for me for a few reasons. This is the first time that I’ve raised rents since purchasing our rental property in 2015, which meant that this would immediately be something that was alien to me.

This was also the first tenants that we officially moved into the house after buying it. I know that I’ve always been relatively lenient with them but as I’ve owned this property, I’ve learned how to start treating it more like a business. The fact is that while the tenant’s cost hadn’t increased for three years, mine certainly have. My taxes have gone up, expenses for taking care of the property have gone up, and I’ve had to spend a decent amount of time making sure the house isn’t burning down each month.

Because of these factors, I felt it would be appropriate to ask for an increase. My plan originally involved an increase of $100 per month. That would give me another $1,200 per year to put towards our debt pay-off, or into an account to purchase another house! What ended up happening was a negotiation with the tenant for an increase of only $50 per month, which nets me $600 per year. Unfortunately I didn’t think that I had a ton of room to stand my ground, because I’m still looking for a tenant to fill our current vacancy, so I inevitably agreed to the lower increase amount.

While I wasn’t terribly thrilled, knowing that I was giving the tenant’s a softball of a rent increase, it was still a great learning experience and I want to share that knowledge with you!

So what was learned?

Well, for starters, I realized that I treated a rental increase too emotionally. My main goal was to get more money, and that always strikes a spot in my heart, but what I should have done at the beginning was analyzed what my priorities are with the property. I’ve never actually sat down and decided what the main driver for this property should be.

For instance:

Do I want to maximize my profits with this property? That would involve dutifully increasing rents each year no matter what.

Do I want to minimize my personal involvement? Well, from my previous posts, you know that I can’t do that, as I have already made the call to still be a hands on landlord, despite living three time zones away.

Do I want to maintain a low vacancy rate? This was certainly top of mind for me, as I have recently been experiencing all of the effort that goes into tenant turnover, and that’s certainly not the fun part.

As I look back at my decision making, my #1 priority was actually to make sure that the tenants wouldn’t want to leave, and find a new unit to rent. This was mainly due to the fact that one of my units was already empty, and I really didn’t want to find an additional set of tenants, in the middle of winter. (Fun fact: It’s generally harder to find new tenants when there’s snow on the ground, as no one wants to move in the snow).

But Mr Money Smith - You said before that your rents are below market! Shouldn’t you be able to increase them as much as you want as long as you don’t exceed the market rate?

This is a good call out, I do believe my rent for that unit is below market, in fact I would estimate based on resources that I have at my fingertips, that this unit is $100-$200 below market rent in it’s current state. But the reason that I am not able to just instantly tack on another $200 in rent is because my tenants are used to a certain level of cost. They have also anchored their expectations on the fact that for the past three years, I haven’t increased their expenses at all. The main reason I can’t just increase the rents more is really because of my own lack of ability to run the house like a business from the beginning.

My tenants don’t care if other units are more expensive in the same area, they know that they already have a place to call home that’s been the same price since they moved in. Whether or not there’s a fair market value that’s more than what they are spending doesn’t count to them. All they care about is the amount of money that they have to spend and whether or not they can rely on the amount of rent that they are being charged.

I also had to think about the relationship that we’ve had

Again, since this was my very first set of tenants, I have always been pretty soft with them. I actually told them, when they were first looking at the property, that I hope to never have to raise their rents. What a dumb idea that was…

At the end of the day, I haven’t had many bad experiences with them. Would I classify them as the ideal tenants? No. But I wouldn’t say they are the worst either. They seem like pretty run-of-the-mill, standard tenants to me. I had to ask myself what I would do if they decided they didn’t want to stay. If my answer is that I would cry myself to sleep for the next month because they were so awesome and perfect, then I probably wouldn’t even really consider a rent increase. Since these tenants pay their rent on time, and I don’t get complaints about them, but don’t go above and beyond in any way, I figured this assessment was a wash for them.

How much should you increase the rent?

I’ll admit that my view of appropriate rents has started to warp a little. Living in Los Angeles, which is one of the most expensive cities in the United States, has provided me a totally different outlook on rental costs. The last rental increase notice we got was $100/month and we were already paying at the top of market for our unit. To me, the 3% increase seemed absurd because I looked at it from a dollar perspective, but to my property manager, that was the standard.

Not all cities are equal - While a 3% increase in rent may be the standard in Los Angeles, the Massachusetts town where my property is may not support that. Having just been subjected to a rent increase myself, and knowing the different thoughts and emotions that went through my head when that happened, I was certainly sensitive to the increase amount I was suggesting. I knew that an increase of $100 to my tenants was over 8% and would feel like a wild amount to them. I also wanted to see what my boundaries were, some people will certainly just quietly accept what their landlord says and not put up a fight, but I also wanted to set the stage for what to expect in the next year if they stayed again.

Some rules of thumb about rental increases:

  • 1-5% Normal increase, this is what the general expectation year over year would look like.

  • 5-10% Above average increase, this is the range when a tenant really needs to assess the value of where they live, and decide if it’s worth it to them to stay.

  • 10%+ Crazy increase, unless you happen to live somewhere that’s severely under market, or in a market that supports these increases, you’re likely going to look for a new place.

There are some subliminal messages that are sent when a rent increase notice is delivered, or even not delivered. For instance, the fact that my landlord wanted to raise my rent 3% after the first year told me to expect that each year, I ended up assessing whether that was worth staying, and decided that it wasn’t, due to a number of factors. The fact that I didn’t give my tenants an increase for three years may have set that expectation with them - If I try to increase the rent again next year, will I have to overcome similar obstacles with them? I guess we will find out in 12 months…

You have to ask yourself if it’s all worth it

There’s always an inherent risk with real estate. For example, the risk of increasing the rent on this tenant could result in them leaving the property. Even if I propose an increase, but then negotiate no change, that could still put a bad taste in the tenants mouths and make them want to leave anyway. The costs of vacancy will definitely outweigh to benefit of just keeping them there.

Let’s look at how this could have looked for me if the tenant decided to move:

One Month of Vacancy: (-$1,200)

Repair Costs: (-$500)

New Tenant Search Costs (-$1,200)

Total Cost: (-$2,900)

That $2,900 is 4.8 times the amount of the potential increase I am getting from the $50 extra dollars a month. This is also a best-case scenario, what if the unit is vacant for more than one month? Sure, technically the missed month doesn’t cost me the $1,200 dollars out of pocket, but it is missed income that I’m planning to receive.

What’s the takeaway?

For me, the biggest takeaway is realizing that I need to double-down on treating my property like a business. Each action, or lack of action, has a consequence and I need to continue to understand the messages that I send to each tenant as they live in our units. I’ve also decided to look into rent escalation clauses in my leases. This is a statement baked into the lease that would automatically state the rental increase. Sometimes the rental increase can happen mid lease, this would get the tenant used to the increase months before renewal and would eliminate my need to communicate the increase at all.

The biggest takeaway is to make sure you understand that even this post doesn’t exhaust the number of variables that go into a rent increase. As with all real estate decisions, you need to be as calculated as possible and remove the personal emotions that inevitably come up.

At the end of the day, while the monthly cashflow only increased $50, I was able to increase our 1.1% in a matter of a few conversations with my tenant, and that increase works out to another $600 in my pocket year over year. If I can continue to do this frequently, I’ll continue to see additional profits from our investments:)

Got any advice??

Have you experienced a rent increase, either as the landlord or as a tenant, and have something to add? I would love to hear from you in the comments:)

Net Worth Update #5: November 2018

Net Worth Update #5: November 2018

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Net Worth Update #4: October 2018