Rental Property Café™ - Episode 15: How to Raise Rents

In this episode, Cynthia Meyer and Veronica Woods tackle raising the rent, when it makes sense, and why rental property owners need a workflow for this decision.

In this episode of the Rental Property Café Video Podcast they cover:

Takeaway Quotes:

“You're not a bad person if you raise the rent. You're a good business person if you raise the rent, as long as you're not unfairly taking advantage of your tenants.” - Cynthia Meyer

“...tenants expect the rents to go up over time.” - Veronica Woods

About the Rental Property Café™: 

The Rental Property Café™ podcast offers a real estate tool kit for busy professionals who are building a real estate portfolio. In each episode, co-hosts Cynthia Meyer & Veronica Woods explore ways to grow a successful real estate business while growing your career. 

☕ See more financial planning guidance for real estate investors from Cynthia Meyer on the Real Life Planning blog: https://reallifeplanning.com/blog

Connect with Cynthia Meyer:

• Cynthia Meyer on Facebook 
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• Cynthia Meyer on Pinterest 
• Follow Cynthia on Duolingo: CynthiaCafe
• Email: cynthia@reallifeplanning.com   

Connect with Veronica Woods of Daniel Woods Real Estate:

• dwoodsrealestate.com/letsconnect 

Transcript -  Rental Property Café™ - Episode 15

[00:00:08] Cynthia Meyer: If you own rental property, you're probably asking yourself the question, Should I raise the rent? And hopefully you're asking yourself this question every year. Hi, I'm Cynthia Meyer with Real Life Planning. 

[00:00:17] Veronica Woods: I am Veronica Woods with Daniel Woods Real Estate. 

[00:00:20] Cynthia Meyer: And this is the Rental Property Café™. It's episode number 15 where we're going to talk about how to set rents.

[00:00:27] And this is a conversation I have with clients all the time who are trying to set some goals and workflows for themselves around when to raise the rent and how to think about doing it. 

[00:00:39] What are some of the reasons that people would consider raising rents? The first thing is to keep pace with the increasing expenses of owning a property. Those are things like property taxes and insurance and maintenance costs, and all of those things.

[00:00:53] All of your costs as a landlord are going to go up over time. 

[00:00:56] Veronica Woods: I do think it's important to not think about that first tenant you getting in and the rent, just being a "set it and forget it." It's something that you continuously need to evaluate based on the cost of doing business in your area.

[00:01:11] Cynthia Meyer: When we talk about real estate correlating with inflation, it doesn't correlate with inflation if you aren't raising rents to keep pace with inflation over time, right? So if you don't raise rent, your investment is not going to correlate with inflation. You may not be able to raise them exactly the same amount as inflation, but it's good to set some overall targets and that you have a workflow for consistently raising over time.

[00:01:34] Veronica Woods: And also consider the tenants expect the rents to go up over time. All their other kind of spending goes up at the grocery store. And generally, there's a rule of thumb that people are spending between 30 and 40% of their income. So it's just good to think about. It is expected to increase.

[00:01:54] It's not something that is set in stone for multiple economic reasons like we're talking about. 

[00:02:00] Cynthia Meyer: Sure. And for investment property owners, the value of the property is really tied to the income that the property generates, right? So certainly for a single family home, there can be potential buyers who are both homeowners and investment property owners. But particularly for a multi-family unit, the price that you would pay - that you would get if you sold it, is very tied to the rents that property could receive. 

[00:02:23] Veronica Woods: And more than the market rate - what you could get, cause a lot of times when I'm looking at potential properties for clients and they'll say, "Okay, I'm currently collecting 700, but it has the potential of collecting a thousand." As a buyer, you're looking at, well, why aren't they getting a thousand now? What's wrong with...

[00:02:42] Cynthia Meyer: Sure. Yeah. 

[00:02:43] Veronica Woods: So if you can create that thousand dollars a month rental, that's value that you are keeping in your pocket versus what you're expecting the other people to bail you out and hopefully get, they're going to want to pay a discount if they have to do that work.

[00:02:59] Cynthia Meyer: So we want to invite you, especially those of you who are new to being rental property owners who were thinking about doing it for the first time is to build into your business operating systems policies and procedures for when rents are going to go up, ways for evaluating the current market environment to see how much you should be charging, right? When to think about negotiating, for example, to keep a really good tenant in the units. We want you to think about this as part of the business of real estate, right? You're not a bad person if you raise the rent.   You're a good business person if you raise the rent as long as you're not unfairly taking advantage of your tenants by price gouging them, right? Or not delivering a safe and clean living environment. This is a normal part of doing business as a landlord and mastering this skill is super, super important. 

[00:03:51] Veronica Woods: Yeah, and sometimes it's challenging if you have multiple properties and people have moved in at different parts of the year.

[00:03:58] The reason, Cynthia's using the term systems is because you do kind of have to map out when are the leases due? Let me make sure that I give proper notice. Communication, really, there's really a lot of communication strategy of giving people enough notice to plan; to make a decision to stay or go based on your rent increase.

[00:04:20] When you have them clustered and all your leases renew in June, it makes it a lot easier than if it's spread out throughout the year and the more properties you have, the more likely you probably have different clusters throughout the year. 

[00:04:32] Cynthia Meyer: The fundamental document for setting some constraints about when you can raise the rent and how much, for example, is the lease, right?

[00:04:40] Having a written lease or rental agreement with the tenants that clearly states when you can raise rents and how much in the terms of the lease. And that can be built in automatically. I'm curious to see how you do it in your property management business, Veronica. And obviously it's determined by local regulations, right? Like you have to follow the local rules about when you can raise rents and how much. Maybe we can dig into that a little bit too. 

[00:05:05] Veronica Woods: Yeah, the last part like, and things change over time. In Philadelphia, like a few years ago, they changed the policy, just Philadelphia County, not the suburbs- that you have to give tenant 60 days notice for a rent increase. Regardless of what you have in your lease. And the other thing is you don't want your lease to be in conflict with the local municipalities, because whatever the local municipalities is going to outrank whatever you have in writing that wasn't lawyer proofed. I would say commercial leases are more likely to have the built in increases over two years or three years because usually those leases are longer term. The average residential lease is one year. Obviously we'll get into like some of the benefits of having longer leases with people, but most of the time there's like an autorenew term to the lease. So those are the times where you have the opportunity to change any of the lease terms. Base rent is just one of them that you can recoup your costs. 

[00:06:05] Cynthia Meyer: Yeah, and it really does vary depending on the part of the country where you're investing, right?

[00:06:11] And so if you're thinking about investing out of state, for example, before you even look at properties, it's a good idea to research the local landlord tenant laws in your target neighborhood or jurisdiction and to make sure that you completely understand them. You understand the impact that's going to have on your ability to raise rent and also turnover units in the future.

[00:06:33] How much wiggle room are you going to have? You could be in a pretty -what I might say, landlord friendly state, like Texas for example. You could be in San Francisco, California, which is very heavily regulated. The Oregon just passed some state laws around this.

[00:06:47] The Portland area in particular is becoming more regulated. You could be in New York City, which is a whole thing in of itself, right? Is it rent controlled? Is it rent stabilized? When can you raise the rent and how much? So getting really clear about that upfront before you even start looking at properties.

[00:07:02] Veronica Woods: Yeah. One more point I just make, even like states that are right next to each other. The lease for New Jersey is different than the lease in Pennsylvania. I've owned rental properties in both states and it's like, "Oh wow, I had to- let me read the fine print about the termination part of the lease is different."

[00:07:20] So you really do have to be careful. You can't just say the Northeast or the south. It's really state and municipality driven. 

[00:07:27] Cynthia Meyer: Veronica, do you think that people who are doing it for the first time should have an attorney review the leases, or are there places that you can go to get standard leases?

[00:07:35] Veronica Woods: Well, I guess depending on who helps you procure the tenant.  If you use a realtor to help you find a tenant or a property management company, more than likely they're going to use their standard leases for the state that's been reviewed by 10 lawyers. So pretty much, those leases are updated every year. If you're using the state association's lease, you're pretty safe. If you're going to do anything non standard, then I definitely would recommend you have attorney look at it; even if you get your friends lease. So I know a lot of times investors and communities like, "Oh, I'll send you my lease." and you're in another state. You can kind of get an idea of some clauses, but I wouldn't take a Connecticut lease in Pennsylvania, even though they're close enough states. But I would have an attorney look at it. 

[00:08:23] Cynthia Meyer: That's a really good point. Really good point. Well, and so the second major thing we want you to think about is having a workflow, as we mentioned, to raise rents regularly.

[00:08:34] Now, in a general you're going to be looking at raising rents from 3% to 5% a year on the average, but it could depend, in between tenants you might be able to raise rents more. And of course, it depends on market conditions. 

[00:08:48] Veronica Woods: And where you are on the market spectrum. Because a lot of times if you buy your property; you already have tenants in it. Maybe they're already paying below-market rates. It's hard to just kind of jack their rates up to market rent. You may need a multiyear plan to get there and maybe the rough percentages. I do think those are good guidelines because it's easy to explain that to a person; cause really it comes down to communication. They know the price of their yogurt in the grocery store probably went up three to 5%. So maybe my rent will go up three to 5%. There are a lot of variables of where they are on the spectrum of how close they are to market rent. If they are already at market rent based on the comparables in the area, you're really hard pressed to go above that mean of like the top 5% of rents in your area. Just because you're saying, I'm going to like raise the rents 5% a year, it just may not make sense. 

[00:09:43] Cynthia Meyer: It's a judgment call as to whether or not you can raise the rent. It certainly, it could be a negotiation between you and the tenant; especially if you have a good tenant that you'd like to stay in the unit. There might be some negotiating happening but you have to stay grounded in reality, right? Just because you want to raise the rent to a certain amount doesn't necessarily mean that you're going to get it, I suppose.

[00:10:03] We have in our rental property business, we've worked with our property manager to keep a good tenant in place. We've negotiated say, maybe like, 2% in the first year and 3% in year two. And in year three, for example, as an incentive to keep somebody in for a long time that's worked particularly well with single-family homes where people have kids in school and they don't necessarily want to leave the school district. Have you done that in your business and what other things would you encourage people to look at in terms of structuring a workflow? 

[00:10:31] Veronica Woods: There's a lot of variabilities in the people. So it's kind of hard to have the diversity in the properties and the diversity in the people.

[00:10:39] It is hard to kind of have a macro workflow, so to speak. But I do think that we have a practice of just kind of evaluating the market every year. If you can do anything right- when you have a turnover, that's really the chance to do the biggest adjustment in rent that I find.

[00:10:57] So when someone moves out, don't kind of say, "Oh, I just want to put it on the market right back where they were." Or maybe even just the blanket 5%. It's really taking the time to do analysis of how does this property right now compare to the competition on the block? Is this an opportunity? If we add a central air, what would that be worth?

[00:11:18] So really at that point, we do a lot deeper analysis to figure out what should the right market rate be. And then you gotta put it out there and see what the market says. So I guess there's one thing about presenting to the existing tenant. The people who are looking for rents in this area, they're comparing our unit versus their alternatives. They're saying, "That's too high." Okay, let's go down 50. So it's kind of a test and learn nature to it. Now, when you have the existing tenant, then it's more like you're proposing. So it's not like, "Hey, I'm raising your rent." and they're forced to stay. You're presenting a proposal and then they have so long to get back to you whether they accept a proposal or whether they're going to move.

[00:11:58] So you need to kind of think about that timeline. So I've just kind of emphasized the timeline of the proposal and what you hear back, and is there a counter proposal or is there a move out? And then you're adjusting to the whole market again, like I said, and maybe you can make a shift. You really do have to listen to the market tells you. 

[00:12:19] Cynthia Meyer: I think that's a really fascinating point, Veronica, because tenants are our customers, right? As rental property owners and just like any other business, if we are improving or delivering more value for the dollar, that's going, hopefully, going to increase demand.

[00:12:34] If we aren't offering equivalent or higher value than other units on the market, we're going to lose that sale if you will. Another thing too, that I want to share with all of you is, there is kind of a maximum rent for a particular number of bedrooms and bathrooms, that in general anyone would pay for a property in a particular geographic area, right?

[00:12:57] Because above a certain point, except for those people who are just in town for six months or a year, right? At a certain point, somebody will buy a house as opposed to rent an apartment or rent a house, right? And so that's a natural cap. Obviously that varies city by city, right? But that's a natural cap on the total amount of rent that somebody would pay. 

[00:13:17] Veronica Woods: Yeah, that's a good point. I especially point that out to people when they're running their numbers, when they're purchasing a property. If you move this place to, you know, in our Philadelphia area, Rittenhouse Square. If this place was in Rittenhouse Square, yes you can $3,000 a month in rent, but in this lower income suburb, you're really capped and that is the reality. 

[00:13:39]  I would say there's a market of people with credit issues. They make good money, but they have credit issues and are forced to rent. Those are the people who would pay a little bit more for a rental because they kind of priced out of getting a home. The private investor really is catering to that market.

[00:13:59] Cynthia Meyer: Ah, interesting. 

[00:14:00] Veronica Woods: That's probably a whole podcast. 

[00:14:02] Cynthia Meyer: That would be a great topic for a podcast.

[00:14:04] Do you ever have to lower the rent? 

[00:14:06] Veronica Woods:  I actually haven't had to lower, just lower the base rent. But what I have seen is maybe giving a month free. That's far more common in today's market where when vacancies are low, as an incentive, to sign up a tenant, people are giving a month free. That's in the essence lowering the rent because you're reflecting 11 months of rent versus 12 months of rent. But I see that far more frequently than legit reduction. 

[00:14:36] Cynthia Meyer: Yeah. Now I, I think theoretically it could happen but that hasn't been our experience over time that we've ever had to lower the rent. Sometimes we've had to keep it the same or occasionally, in order to get something rented, we've had to agree, like to put in a new washing machine or something like that. But in this current market environment, probably that's not going to be an issue as long as you're keeping the property in good condition.

[00:14:57] Is it in good condition? Is it marketable? If there were significant economic change in a particular area, then I could see a situation where rents would go down. Or if the condition of the property has deteriorated, like you mentioned, central air. If you had central air and now the central air is broken, right. I suppose, that could cause somebody to lower the rent. 

[00:15:14] Veronica Woods: Right. But I think that's probably more of a negotiation between a tenant and landlord versus a blanket statement about an area's average rent going down.

[00:15:25] For the most part rents are- or even let's say subsidized housing, like a HUD voucher, they have a rent schedule which is a good benchmark. If that's a potential class of tenant that you're looking at, the HUD has a rent schedule by size of an apartment that generally ticks up a certain percentage every year. So they're expecting that the cost of their landlords doing business has increased. So, they're expecting the prices to go up, which is a good thing. 

[00:15:57] Cynthia Meyer: Yeah, that is a good thing. 

[00:15:58] Rent setting is kind of an art and a science, right? So you talked about this online resource, the HUD, produces the Fair Market Rate Analysis by Zip Code. Is it every market or is it just like the major ones? 

[00:16:10] Veronica Woods:  I think it's in like 22 markets; so all the major metropolitan areas. If you go to hud.gov, there's a section that discusses this fair market rents, and they're trying to improve setting rents.

[00:16:23] The concept of not having like a broad metropolitan set rent rates, but really getting down to the micro level because they realize that there's differences in different sub neighborhoods across these larger metropolitan areas. 

[00:16:38] Cynthia Meyer: One of the tools that I use almost daily really in doing both planning and deal analysis is Rentometer. Rentometer.com. Where if you're a tenant looking to see if where your proposed rent is on the spectrum in the neighborhood, you can check that out.

[00:16:56] And if you're a landlord looking to see if you know what you're thinking about charging is reasonable for the area that's also can be a good place to look. There are both free and paid services.

[00:17:06] Veronica Woods: Yeah, and it's pretty accurate. I've seen some properties that I've rented on there. I'm like, Yep. Sometimes they might be a little sparse in the sample in certain areas. So if that's the case, and you had to broad the radius out too large, you can't trust the results as much. But it's definitely my go-to starting point. 

[00:17:24] Cynthia Meyer: There's other rental listings that you can look at Zillow or do Trulia or something like that. I would say also talk to a local market expert, right? If I was buying an investment property in Philadelphia and I wanted to know what to charge, I would call Veronica! 

[00:17:37] The other thing a professional Realtor® has, so there are some rental listings on the MLS. There's one thing about going to Zillow and seeing they asked for 2000, but more importantly, they actually got this number. Looking at the asking rate is data, but that doesn't mean that they got somebody who want to pay.

[00:17:57] Ah, interesting. Ah, that's good tip. Anything else that you would share, Veronica, with folks about how to set rent? 

[00:18:04] Veronica Woods: Well, one thing to mention that- look out for different things to charge for. We're kind of just talking about the base rent, but in some markets people are charging extra for storage. They're charging extra for some service, parking, pet rent is now very popular. So that's just something to think about. Is that a way that you can cover your cost that may not be in the base rent; something that you can consider to your holdings.

[00:18:33] Cynthia Meyer:  Oh, I think that's a really good point. Yeah. And many of our units, we do accept pets. We take a nonrefundable cleaning deposit. It's a slightly higher rent to the pet owner. In the lease we have pets that we will accept and pets that we won't accept, for example.

[00:18:45] And that's probably another topic that we might want to tackle later on, right? Is to take pets or no pets, huh? 

[00:18:50] Veronica Woods: And just to make a point that pet deposit is state specific. So in Pennsylvania you can't charge extra for a pet. You can't call it a pet deposit.

[00:19:00] Cynthia Meyer: Really?

[00:19:01] Veronica Woods: So here it's more likely to add extra rent because the security deposit laws are just two months rent, period. You can't add extra. 

[00:19:09] Cynthia Meyer: Can't add extra just because you might have more wear and tear on the property. 

[00:19:12] See, this is why you've always got to check and getting a local market expert who can help you is obviously going to be a really valuable component to your real estate team.

[00:19:21] Thank you very much Veronica for joining us in the Rental Property Café™ this morning. As always, you're one of my favorite people to talk to. If anybody has an idea or a question that they would like to share with us, please leave it in the comments or email us at podcast@reallifeplanning.com.

[00:19:38] Don't forget to subscribe, so you'll be notified of the next episode.

[00:19:42] Thanks very much. Have a great day everyone.

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