Landlords get starry-eyed when rents are going up. Rising rents signify strong apartment demand and can bring in higher revenues. How could they possibly ruin your bottom line?
It all depends on how you’re implementing rent increases.
When vacancy results from normal turnover – the tenant takes a faraway job or experiences a life change like marriage, etc. – you should certainly charge the next tenant whatever the market will bear.
But what about an existing tenant who wants to renew the lease? That question is harder. You want to keep pace with the market, and you need to offset rising expenses. But increasing the rents too aggressively might cause a tenant to move out.
If the tenant is a headache, this might be a good thing. And even if the tenant is a good one, if the current rent is far enough below market, then you might benefit from renting to someone new.
But the current rent must be very far below market to justify losing a good tenant. Otherwise, the new rents won’t recoup the costs of vacancy for a very long time.
Vacancy Costs You More Than Just Lost Rental Income
How does this work in practice? When a tenant leaves, you incur several costs. Obviously, there’s lost rent. Then add in “turn” costs; incidental costs, like utilities reverting to the landlord; and unanticipated costs that can arise when apartments are uninhabited.
For example, imagine your tenant pays $700 in rent – 5% below the market rate of $735. Assume it takes 30 days to turn and re-rent an apartment, a soft turn (painting, carpet cleaning, and light repairs) costs $400 a unit, and utilities cost $25 a month.
In this scenario, if the tenant moves out, you lose $1,125 from your bottom line. At $35/month in increased rents, it would take 32 months – nearly 3 years – to make up the loss! Even if the original rent was 10% ($70) below market, the gap wouldn’t fill for 16 months.
Then imagine it’s a harder turn, where you must replace the carpet for $1000 rather than clean it for $100. Your total cost is now $2,205, which would take you a shocking six years to make up if the rents were only 5% below market!
Now multiply this across several units in your property, and you can see why rising rents can destroy your bottom line if you’re not careful.
Bad Things Can Happen in Uninhabited Apartments
And these costs are not the only ones that can result from vacancies. Bad things can happen when no tenant is present to report problems to management. In cold weather, pipes can freeze and cause flooding. In hot weather, unnoticed leaks can cause mold outbreaks, which can quickly overtake an apartment. Remediation costs can wipe out a whole year’s rent, not even counting rent lost during renovations.
The lesson is to be judicious when raising rents. Work hard to retain good tenants. Raising rents only 2.5% to keep one in place will add $210 in annual revenue versus $1,125 in vacancy costs, a difference of $1,335 to your bottom line. It could even make sense to renew the lease at the original rent, if the alternative is the tenant moving out.
Normal turnover and natural vacancy are facts of life in the apartment rental business. Good operators budget adequately for these costs. But good operators also know that the key to maximizing profits is minimizing unnecessary turnover and its associated costs.
I love counter-intuitive arguments that change people’s perspectives on an issue!
Keep up the good work.
I agree with your analysis completely, especially in the case of properties few rental units, where the loss of just one tenant could result in a significant decrease in rental income.
Spot on analysis! Well-thought-out multi-family management advice. Thanks!