Rent Increase – An Easy Boost To Cash Flow
Nobody likes a rent increase. Except for the landlord.
For too long, my rental property has been squeaking by on meager cash flow. Check out my monthly investment income updates and you’ll see the regular income it generates is about $70 per month. That’s a positive number so I can’t complain too much. But in the real estate investing world, it’s crap.
On the plus side, that $70 is after all expenses. So even when something goes wrong that requires a fix, my positive cash flow remains steady because I’ve set aside sufficient funds for repairs and expenses.
Condo ownership reliably causes a few unnecessary headaches each year. Last month the association charged me $260 to paint a rusty railing that was done poorly the first time. I could’ve done it myself for about $10. So I wasn’t happy about that, but that’s the nature of condo rentals.
Surprises like this are part of the reason why I’m considering selling my condo next year when my tenants move out. They’ve suggested they might leave after 4 years of residence and flawless rent payment but are still trying to figure out their life situation.
Why A Rent Increase Now?
My tenants are ideal. They have two incomes, are highly educated and morally outstanding people in my judgment. So am I putting at risk this convenient situation by hitting them with a rent increase? I don’t think so.
They’ve lived in the condo for nearly four years and I haven’t raised the rent. It’s overdue, especially since rents have increased so much in the Washington D.C. metro area. They know that.
Rents have increased due to rising incomes. Surely over the past years, my tenants have experienced raises in their income far beyond my rent increase.
According to Zillow, the new rent level is still below market rates. I didn’t want to raise the rent too much or a trivial amount. So I increased the rent by $50 per month or $600 per year. This was a reasonable amount for the tenants to adjust to, and enough to buffer any upcoming increased recurring expenses (i.e. higher HOAs and taxes).
Ultimately, I’m raising the rent now because I can and I need to so my head stays above water.
Why Did I Wait So Long?
Four years is a long time to keep rent flat. In hindsight, I wish I had built an automatic annual rent increase of 1%-2% per year into the lease. That would have made things easy.
Frankly, I was a little nervous about a rent increase because I have a good personal relationship with the tenants. We are friendly.
I really just didn’t have the guts to man-up and break the news to them. Then something changed my perception.
Recently, I’ve been listening to podcasts during my daytime work commutes. The podcast subject matter available is so vast now and everything is right at your fingertips. I use the Stitcher app for iPhone.
One of my favorites is the BiggerPockets podcast. It’s a weekly show about real estate investing. The hosts Josh Dorkin and Brandon Turner interview regular real estate investors from all around the country. Topics include flipping houses, wholesaling, landlording, creative financing and how to find excellent deals.
The benefits of listening to the show go far beyond real estate investing. It’s also about productivity, good business practices and entrepreneurship.
While going through the backlog of podcasts, one of the hosts or a guest said something that struck me. I already knew it, but the bluntness of the statement kicked me in the ass.
It was something like “Hey, you’re running a business here. It’s not about being friends with the tenant, it’s about making the most of your investment. If the numbers say you need to increase the rent, you should do it without hesitation.”
And just like that, it clicked. It was time to raise the rent.
How I Went About Raising the Rent
The first thing I did was read the lease to make sure a rent increase was within the boundaries of our agreement. It was.
Even though my tenants are cool and I didn’t expect any problems, I wanted to make sure I did it the right way. So I googled ‘rent increase letter‘ or some variation of that, and came up with some guidelines. I also checked out some blog posts on BiggerPockets.com
I didn’t want to come across as super-formal because I do have a personal relationship with the tenants. Plus it’s 2015, so sending an actual letter would be too stern. Email was fine.
So I drafted the email based on the recommendations in the various articles I found on the internet. The main points I wanted to convey to my tenants were:
- Thanks for being great tenants and always paying on time.
- The rent is going up $50 effective the first day of 2016.
- Taxes and HOA fees have steadily increased while rent has been flat.
- The increase is the lowest possible amount.
- Rent is still below market rates.
The notice went out more 60 days prior to the effective date. I felt this would help alleviate the burden. It’s also far more lead time than stated in the lease and complies fully with the law.
I stated that the email was the official notice and asked them to reply with an ‘OK’ to give me a record of their acceptance of the increase.
In the reply, I also received some information about their future intentions. As a young married couple in the midst of quickly moving careers and family aspirations, I’ve always assumed their housing needs would change on the sooner side. The reply gave me some insight into their plans which helps me with planning, especially if I want to sell it or not.
They sort of acknowledged they may be leaving in the summer as I suspected. Though nothing is set in stone.
Bottom Line Impact to F12MII
Revenue for my property will increase by $600 per year. Accounting for allowances, the move increases my forward 12-month investment income (F12MII) by $552.
This number shows the income power of a rental property. I’d need to invest $18,400 in new capital in dividend stocks yielding 3% to achieve the same increase. Instead I accomplished it with one email.
If I decide to keep the rental beyond this tenant, the market rates suggest there’s another $50-$75 of rent increase I could add on for a new resident. That additional income would be nice, but I’d rather keep my current tenants than risk a new one or face a vacancy. Or, cash out. But I need to have a professional take a look at the tax implications before selling.
The new F12MII amount will be reflected on my monthly income report for December.
Have you ever had to raise the rent on a great tenant? Has it ever backfired? Anybody out there considering buying a rental property soon?
Craig is a former IT professional who left his 19-year career to be a full-time finance writer. A DIY investor since 1995, he started Retire Before Dad in 2013 as a creative outlet to share his investment portfolios. Craig studied Finance at Michigan State University and lives in Northern Virginia with his wife and three children. Read more.
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Bigger Pockets is a great site, and resource. There’s simply way too much information there that I could spend all day just dissecting. I do know that from now on, I will follow their 1% rule as far as rentals go to somewhat assure a positive cash flow.
I wish I had this resource 10 years ago when I bought my first rental. That particular one is still negative cash flow but not as much as when I purchased it; via a round of refinancing via HARP. The next two I purchased are 0.97% and 1.05% respectively; and it sure is a nice feeling that $$ are hitting my bank account instead of the latter.
I’m glad you’re a fan of BiggerPockets! You’re definitely not alone in wishing you found the site back when you started . . . I too wish that! See you back on BP!
Josh,
Thanks for stopping by. I’ve been taking in a bunch of your podcasts recently. Lots of good stuff in there. Motivational, entertaining, educational. Definitely the podcast I look forward to most every week!
-RBD
I definitely agree. Had I even paid more attention just a year ago, I would have avoided some headaches.
-RBD
Sounds like things went pretty well on this for you – nice job!
I’m right around where you were with my rental house generating around $75 each month after expenses until, of course, that inevitable repair comes along. What’s been good for me is that the $75 is after my property management company takes their cut. To me, they are well worth the money. And when the rent needs raised, I don’t feel guilty because I’ve never even met my tenants so there’s no relationship to really consider.
However, I’m careful about raising the rent with them as they’ve been there now for around 6 1/2 years and have always paid on time. I would rather have some money coming in than no money for a few months while a new tenant is found. Plus the cost of replacing a tenant adds up as well – cleaning carpets, painting, etc.
Although I raise the rent maybe $5 or $10 every other year, I’ll wait until they leave before I really raise it. In the meantime, I’m not worried about the cash coming in. In fact, as long as they continue to pay off the mortgage and expenses for me, I don’t think about it at all (especially with the property management company handling everything with it).
I’m closing on my second rental property next month (a duplex) and, assuming both units are filled, I’ll actually have a little money coming into my pocket every month. That’s a bonus, but not my main goal. I’m excited to just have the passive income to look forward to once the units are paid off and I quit my job… that’s when the real fun starts!! 🙂
Good luck in all you do!!
— Jim
Jim,
I manage mine myself, so a management company would put me underwater. That’s another reason why I may sell. I live nearby and know the unit very well so there is no reason to outsource at this point.
While I considered the unit might end up being a rental one day, I didn’t factor that into the equation.
If I buy another place, I’ll be sure to get a better deal.
-RBD
That makes perfect sense – good luck to you!!
— Jim
That’s right. It took so little effort. The challenge really was to just suck it up and send the email.
-RBD
Thanks for listening to the BiggerPockets Podcast and for being a part of our world. We do our very best to make the show and platform an amazing resource to help investors of all experience levels. I’m glad you’re a part of the BP Nation!
Great stuff on raising the rent successfully. When I was renting, my landlord always raises the rent every year by inflation plus a certain percentage. This was a well-known practice in Vancouver. Maybe you can look into this?
BLD,
My margins are thinner and the taxes and HOAs have been slowly creeping up on me. So it’s becoming more of a necessity now. Don’t blame you for waiting your tenants out with $600 income. Nice.
-RBD
I’m a big believer in a gradual increase along the way for rentals. I made a mistake early on and kept our initial rent the same for 2 years. When I tried to increase it by a larger amount to the current market rate it hit a wall with the current renter. We negotiated the increase that year and now the rent is at current market value, but I could have potentially lost that renter and have already lost a year increase in rent from year 1 to year 2.
Couldn’t agree with you more on real estate being one of the best/fastest ways to financial independence.
As a long time renter, I’ve come to realize this is all about managing expectations. If a percentage increase is built into the lease/agreement, then I know what I’m getting. If a few years have gone by without an increase, then any increase of any amount will come as a nasty surprise… even though I’m getting a better deal in this situation!
This was especially true when I was younger and didn’t understand the perspective of an investor yet.
High five for going through with it and asking for the rent increase. I’m sure that caused you some stress! We have a long-term tenant in our one rental property, and we actually told him at the beginning that we wouldn’t raise his rent… ever. I’m realizing now that that was a mistake, since we’re basically breaking even right now (not counting income tax, which won’t matter once we retire and are in a low bracket, but for now it matters because we’re in a high bracket — so it’s actually a net loss for us at the moment, mostly because we decided to do a 15-year mortgage. we’re banking on paying it off and having the long-term investment). But we pay for garbage and property tax, and at some point those will go up — and then we’ll have to raise the rent at least a little. We’ll be able to back it up, of course, by showing the bills, but I’m not looking forward to that day!
I build in an automatic rent increase CAP if the tenants are good and follow the lease. For example, my tenants who moved in June 2015 know that if they are good, their rent will only increase by $500/month in June 2016. Otherwise, in the SF market, it might go up more like $600 – $1,000!
Gotta give tenants incentive to not destroy the house.
Sam
Sam,
Still baffles me what you are able to get for rent. When those big IPOs hit, who knows where the limit is. If I continue renting this property when these tenants move out, I’ll build in an annual rent increase. But the return on capital is low, so I’m probably going to sell it and move the money to another rental or put it aside as a large opportunity fund.
-RBD