Is the rent too High or too Low?

[TodorYordanov]

How do you determine what the rent should be and be comfortable with your decision?



I think most investors will not have the same answer to this question.



I am again faced with this dilemma and will try to go over all of the numbers and assumptions in describing this case.



Condo townhouse in Hamilton with B-rate tenants and properties.
The asking rent is $1250 plus utilities.
All expenses (mortgage, insurance, condo fees, property tax, property management, vacancies and maintenance) come to around $900-1000. The property is cash-flow positive.



The problem is not finding tenants for that price. Some landlords are even pushing it to $1325 ( with higher vacancy).



The problem is with keeping quality tenants for longer than one year. Usually they relocate to another place to buy or for cheaper.



In my experience a tenant who is leaving means few things:
1. One to two months vacancy between tenants - ( the places to do not show at their best when a B-tenant is the occupant, they show much better empty, clean and sometimes staged) - Average lost revenue $1250-2500
2. Extra cost. Cleaning, and small renovation or just paint touch up. Average cost $500-600
3. Tenant Finding fee (half month rent) or if doing my self Time to advertise and show the place, find and move new tenants - priceless, but let's say $650



Every time a tenant leaves in one of those townhouses the real cost is somewhere over $2000, plus stress and extra work.



This is Ontario and we do not have security deposits to offset some of the cost.



And here is the dilemma: What would you do if you have an A+ tenant, who rented it for a year @1250, who always pays on time, keeps the place spotless, communicates like a pro and it is the perfect tenant in every way, but now can only pay $1150 and will stay for few more years?



Do you let that tenant go and look for another tenant or do you continue to enjoy the worry-free property with somewhat reduced, but still positive cash-flow.



In my experience the best tenants are who stay the longest, pay their rent on time and communicate promptly when issues arise.



Would you take your chance with finding a new tenant for the higher rent, knowing that you may be vacant again in one year?
Or would you stay with the current tenant and pay from your pocket for the stress-less, worry-less work-less investment?
You will take a financial hit in both cases and the simple math shows that you will pay less today if you keep the tenant at a reduced rent.



I am on the other hand happy to see another tenant go this month, will happily clean and renovate and re-rent to someone else at market rent. So this is not by any means a blanket strategy to keep tenants by reducing rents. Bu a strategic move to keep the best.



What is your take on this?



I've heard phrases like "My properties are always full and my prices are always above average!" Anyone agreeing with that statement care to analyze their numbers and renting strategies? I am always open to learning.



Please share your experience and logic in similar situations.

 

[dplummer]

Keep the Aplus tenant. Your down $1200 over the year but you would of spent as you said about $2000 plus stress trying for another tenant. Just my 2 cents.



Doug

 

[acurAspec]

if there was a posibility of knowing that your current A+ tenant will stay for a year or two as you say, then why not leave it to them and let them pay you $150/per month knowing you don't need to worry about anything for that time.



However, what if one month they don't even have $1,150 to pay... what is the real reason why their affordability went down-- will this mean that the unit will not get taken care of properly perhaps?



Lots of questions arise and every situation is different but it would be enticing to have the tenant stay longer and pay you less to have a worry free property which is paying itself down as well!



Sasha

 

[invst4profit]

In the case of a supposed A tenant coming to me with the story that he can not afford the rent and needs a $100 per month reduction I would immediately down grade them to a B tenant. My impression would be that for $100 they were playing me simply hoping I would reduce to hold a A tenant.



I would let them leave however in my opinion, and in the case of most landlords I know, renting condos to B tenants there would ideally be no vacancy between tenants. The condo would be shown while the tenant is still living there and repair/paint would be a minimum of work.



A type rentals with much higher rents may warrant time between tenants to prep but rentals like the one you are referring to there should, under normal situations, be no vacancy period. Your putting too much effort, based on the level of unit, into turn around and it is cutting your cash flow to the bone.



With cash flow at $250/month ($3000/yr) and turnaround costs as high as $3750 , based on your numbers, your business strategy is faulty.



A condo renting to B tenants should be a one day prep for the next tenant. Ideally you would pull a all niter between tenants with some follow up after the new tenant is in.



Bottom line for me is I would not reduce market rent for any tenant simply to hold them as I would believe I was being played but I would not be facing the lost income you experience resulting from your high standards.

 

[DenisEncontre]

Another thing to consider is the 150 rule. For every dollar you reduce the rent per month you lower the value of your property by $150.00 So if you reduce the rent by $100.00 per month you de-value your property by $15,000.00 based on an 8% Cap Rate.

 

[Alvaro Sanchez]

Most of the clients that I get (if not all) are in the A+, yet my units are at market or better. They usually stay 1-2 years as they all have decent jobs and can afford to buy within the same period.(Most of them are out of province who need some time to locate their dream home).



I have yet to experience the vacancies that you mentioned as of the last 2-3 years, it has been zero. I do have the units professional clean (when new lease) and new paint every 2 years as they have to be shown spotless to justify our rates. Yes, there is some cost (stress and extra work) locating new clients but that is part of the business and at the moment I am ok with that as I am trying to maximize the income.



I am currently in buying mode so I need to show decent income to banks and JVs. Perhaps, when the portfolio is of a given size, I might relax a bit but not right now.



You might also want to consider that once you have identify and validate an A+ client, perhaps you might want to bring RTO opportunities to them. That has crossed my mind several times as all my clients bought property soon after. That is, your rental business is basically the RTO incubator...and in turn extending your client relationship for 4-5 years.

 

[kfort]

Personally, I would evaluate the cost (including priceless time involved) in filling that vacancy and if discounting the rent guaranteed (ie: lease) I would not have to input that cost I would consider doing it.



I take a "make life easier" approach. Does discounting the rent by $20/month ($240/year) save me $240 in costs to fill the vacancy AND time all while guaranteeing that I get 12 more months from the great tenant I have? If so, it's a no brainer. If it guarantees me 6 months then the $120 in discounted rent just postponed the $240 in advertising costs thereby increasing yearly cash flow for that particular property by spreading that $240 in advertising cost over 18 months vs. my budgeted 12 month schedule. I do not want to turn over tenants every 12 months, but I DO budget for it to be safe.



If not, you weigh the pros and cons. I certainly would not discount the rent for a tenant that had not proven to be excellent. If they have an impeccable track record with me, 7 weeks prior to the lease expiring I would present them with an option to extend and a discounted rate. I would also be working hard the entire time to make sure they are as satisfied as possible with the home. I would much prefer to spend $250 on upgrading window coverings or pulls on cabinets etc., something that "makes my life easier" in the future than spend that same $250 filling a vacancy and have nothing to show for it as far as payback (increased property value / appearance) and easy life goes.





That being said, I keep my rent(s) very high. I would much rather price out the deadbeats than deal with them! And I ALWAYS run projections at minimum 8.5% vacancy while estimating my rent (on projections) at roughly market value.... I figure if I plan for an absolute disaster by overestimating costs and underestimating revenue then when a disaster happens I sleep just fine. Making life easier!