Now that the COVID pandemic seems to be settling down, landlords can start getting back to business. Find out what (and what not) to do about raising rent.
Part of having a successful landlord business is making sure you have positive cash flow and are making a decent return on your investment. The most basic way to ensure those things happen is to bring in more money than you’re spending. And since collecting rent is the primary way landlords fund their operations, they need to make sure they’re charging the right amount.
So what is the right amount? It depends. Here are three decisions to make this year at lease renewal time.
1. How much do you need to raise the rent? You probably are seeing that your expenses have gone up tremendously post-COVID. Because housing values are up (around 20% in many areas since 2019), your single-family home is now worth more. Congrats on that. But higher home prices also mean you pay more in property taxes.
If you intend to hold the property, what you pay in property taxes is more important than your house’s value. While the appreciated value is nice, until you’re ready to sell, it shouldn’t be a priority on your list of important factors — property taxes should. Your property taxes are a huge factor in whether your rental property will make money for you. If taxes go up significantly, so should your rent, in most cases.
Property taxes aren’t the only expense you have that’s probably increased post-COVID. Landlord insurance has gone up in many places, as have materials and labor. When you need to replace an appliance or fence or paint the house, you can expect to pay more than what you did before the pandemic. You need to raise the rent to at least cover your expenses. But setting a rent price, as you probably know, isn’t based just on your expenses.
2. What is market-rate rent? You determine market rate rent by finding out what the rents are for similar properties near yours. Do an internet search for “homes for rent in X,” the X being your ZIP code or city. Look at the homes similar to yours and figure the average. You can’t expect to charge more than the average rent and still have tenants interested in your rental. In fact, I have found that it works in our favor to charge slightly under market rate rent to keep vacancies to a minimum and quality tenants in place. First-hand experience has shown that having rents higher than market will result in less-than-qualified tenants applying (because they are desperate) or cause a great tenant to get frustrated and move. Then we’re starting all over with an “unknown.”
3. Should you charge market-rate rent? There is more than one answer to this question, depending on whether your property is vacant or currently rented.
The property is vacant: Without an active tenant, you’ll want to charge as close to market-rate rent as possible. It’s easier to start a tenancy at market rate than to get an existing tenant to agree to a substantial rent increase.
If market-rate rent isn’t enough to meet your expenses, you probably can’t charge more because your potential renters will just rent elsewhere. Your options here would be to figure out how to cut expenses, and if you can’t or if the numbers still don’t work, you might need to sell the property. Owners will often tell me that my valuation doesn’t cover their costs, but an owner’s costs can’t determine value .. the market does this.
If market-rate rent is more than what you’d need to have a positive cash flow and a decent return on your investment, you can still charge top dollar, or you can charge slightly less to get more interest in your property. Remember that the more you charge for rent, the longer your property may tend to sit vacant. You might lose out on a month’s rent or more charging top dollar, so it’s a good idea to figure in that potential cost when determining how much rent to charge.
The property is currently rented: If you already have a tenant but they are paying much less than today’s market-rate rent after COVID, as I’ve found with some of Recovery Realty’s tenants, we have some work to do. Unfortunately given California’s legislative developments in recent years, we often have limits; currently the state of emergency limits to increases being no more than 10% even if the property is exempt from the AB1482 Rent Cap. It’s usually best practice to increase the rent between 2% and 5% each year to keep up with normal cost-of-living expenses. But you might find is that you’d otherwise need to increase rent a whopping 15% to 20% just to break even, which is a tall order for most tenants to handle. On the one hand, you hate to see a good tenant leave, but on the other, you don’t want to leave thousands of dollars on the table. Ideally, you’ll find a middle ground that both parties can accept.
It’s never easy to tell tenants their rent will increase, but with increased post-COVID expenses (property taxes, maintenance, materials, etc.), it’s even harder. Expect to make some tough decisions this year at rent renewal time.