Why tenants will stay if you raise their rent!
In the following video, I walk you through a spreadsheet on why raising the rent on your tenants is actually an incentive for them to stay.
How does this make sense?
First, you have to understand the landlord and tenant relationship a bit. At move in, a tenant is happy to pay market rent. You've listed your property for the market rent to start the relationship, they applied, and you approved the application. So the relationships starts with the understanding that market rent works for both sides.
The tenant's main motivations are to have a safe and reliable place to live and in exchange they are willing to pay market rate or below market rate in rent. A landlord's main motivations are to keep a unit continuously occupied at market rate rents or above market rate rents.
However, like all relationships, if the power dynamic becomes too lopsided it's going to eventually blow up and disintegrate. So the logical middle is to charge market rate and to do that you have to raise the rent incrementally a little bit each year.
As landlord expenses go up every year - insurance, property taxes, repairs costs, materials costs, and labor costs, the rent should go up to match. If it doesn't, eventually a landlord will start losing money on a property without price corrections on rent and the power balance dips too much in favor of the tenant.
When this day comes, a tenant will calculate the cost to move compared with your rent hike. For instance, if you raise the rent $50 a month, or a $600 a year, a tenant will figure out if it's cheaper to move or stay. I call this rent hike "the cost to stay." Does taking off work, hiring a moving truck, and the effort to find a same place cost $600 or less for the tenant? If it less, then they may move if they can find an equivalent property as the one they are currently living in. And that's okay.
However, a savvy tenant will most likely recognize you might not be charging market rate and they are actually saving money by staying. I call the difference between what a landlord should be charging in rent and what is actually be charged as "cost savings" for a tenant.
Take a look at this spreadsheet and let's assume a real estate agent says in year 5 market rate is $1250 a month.
What do you observe with no rent increases?
If you don't raise the rent, the tenant gets $0 cost to stay which of course they are thrilled with. However, they also get $600 in rent savings each year you don't raise the rent. Again, rent savings is the delta between current rent and market rent.
In year 5 this relationship will blow up massively with a necessary correction once the landlord realizes his small rental is not making ends meet. The tenant's cost to stay is $3,000 along with $0 rent savings.
Pretty much every tenant will move out in this scenario, which goes against the landlord motivation of keeping a tenant as long as possible. A surprise $250 a month increase is hard for anyone to stomach. It takes two months for the landlord to find a replacement tenant, which is additional money the landlord loses.
Now let's compare this to a landlord that regularly does annual $50 bumps up in rent to match with uptick in landlord expenses.
What do you observe with rent increases?
Each year, the cost to stay is $600 each year. The tenant figures hiring a moving truck, taking off work, and the effort to find a new place is more than $600, so the tenant stays.
In year 5, with the market rate should be $1250, but you are actually charging $50 less than what market rent is. The tenant is happy as the rent savings matches the cost to stay. It's a zero-sum game, so the tenant remains in place
Landlord keeps his property occupied and makes an additional $5,500 over the 5 year span but keep the relationship balance in check.
So how do you negotiate an annual bump increase with your tenants successfully?
This is easy, all you do is when you sign a lease with a tenant, you put in the lease amount what the rent's will be next year at lease renewal. Both sides have 12-months notice on what next year's rent hike is going to be and you avoid any surprise on either side.
If after 12 months, market rent does not go up in unison, you can adjust the bump down so the tenant's cost to stay is enough to keep them in place.
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