Lesson 12
Rents
What Should They Be?
In the years BC, (before Carter and
double digit inflation) rent rates were usually a simple factor of a
property's value. Therefore, determining likely rents was relatively easy. A
typical one or two family home rented for about 1% of the
fair
market value. For example, a $50,000 home would rent for about $500.00 a
month and the tenant was responsible for all of the utilities and minor
maintenance.
A rule of thumb for multi-family housing was that gross
monthly rents should equal at least 1.3% of the value of the property. That is
the inverse of a formula that was sometimes used to determine the value of
income producing property called the Gross
Rent Multiplier.
The best guess estimates that were used back then
also factored in a decent cash return on investment when an 8 to 10% return was
considered acceptable. However, the rising property values and interest
requirements that resulted mostly from inflation, significantly outstripped a
tenant's ability to pay in many areas. Landlords found themselves owning a
property worth perhaps $100,000 on paper that could only be rented for $600 per
month. Investors soon discovered that property value bears little relationship
to the amount of rent that tenants can pay. Rental housing return is always
market driven because vacancies don't pay anything.
- Competition
- Your ability to market the property
- Government
- Tenants ability to pay
- Rent Control
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Rental rates, like most
prices in a free market, act like water and seek their own level based on supply
and demand. But today, tenant demand for a given rental property is an absolute
factor of the income in the area, and therefore tenants ability to pay. Back in
the days that landlords could use a rule of thumb, like those described above,
to determine property value and set rents, they also considered 25% of a
person's income to be the maximum that could realistically be paid in rent.
Today, tenants often have to pay 30 to 40 percent or more to find decent
housing.
When considering how much rent you can charge
today, the most important factors may no longer be competition or marketing, but
what government will allow under rent controls or under Section
8 or Section 42 programs and literally what
the tenants in your market have the income to support.
A landlord's success now depends on whether he is capable of finding, fixing and
providing rental property profitably, at rents determined by forces that have
little to do with a free market, or landlord's cost of doing business.
Average annual apartment rents
in 1998 were $12.78 per square foot, up 7.8 percent over the previous year. That
means a typical 900 square foot, two bedroom bath and a half, rented for about
$958 a month. Is that what you are getting?
Rent Control
Rent control obviously
effects everything you do in those cities that maintain government controls on
the amount of rent that can be charged. Some states, like Massachusetts, have
recently outlawed the practice, others forbid it entirely. A few still
allow it in some cities.
See several pages on the subject, including most
of the existing Rent Control Acts in our Property
Management Web available to supporting member.
Determining Market Rents
You can hire a real estate appraiser or broker
to determine the market rent for a particular property, but it is relatively
simple to do it yourself. Simply put, you see what properties that are
comparable as to type, location, and condition are renting for. Call on
signs and follow up on newspaper ads. Pose as a prospective tenant if
necessary to get details of available unit, even scheduling showings to
determine interior conditions of similar properties. If nothing else, for
vacant units, look in the windows.
Raising Rents
There are as many
misunderstandings about how, when, and why landlords raise the rent, as there
are misconceptions about landlords. Certainly, in a free market, competition is
the most important single criteria. However, in the real world, (at least
that of low and moderate income property) government now plays the major
roll in setting rental rates.
Most of the multi family housing that has been
built in urban areas of the US for the past ten years has been economically
feasible only with substantial governmental subsidies. See
our report on Cost vs. Value.
HUD now sets the rent for most rental housing
built or renovated since the 1986 tax reform act. Tenant-based Section 8
certificates and vouchers are also tied to what HUD determines is the fair
market rents is each community. And today, 25 percent or more of many
community's one and two family rental units are occupied by Section 8 subsidized
tenants. Section 42 projects, where developers
take advantage of Low Income Housing Tax Credit benefits, the rents of
qualifying tenants are also tied to the local economy, in this case the County Median Income.
In the private sector realistic
rent increases must go past gross scheduled rents, right to the bottom line. All
that really matters is the NOI.
(net operating income) of a property that is a factor of gross rents, less:
uncollected rent, taxes, government fees, insurance, maintenance and repair.
But then there are always the substantial
turnover costs like: vacancy loss, redecorating. advertising, marketing and
rental agent fees, which have to be deciding factors when landlords risk sending
tenants looking by raising their rent.
There are various methods and beliefs on how to
attain bottom-line performance. Some advocate that if stable occupancy is too
high, then rent rates must be too low. However, this approach must also consider what
impact a rent increase will have on current leasing levels and resident turnover
because higher turnover decreases profits dramatically.
A primary rule about raising
rents is to not raise them so high that a good tenant leaves. For a unit
renting for $500 per month, it will require 20 months at $525 to make up for a
one month vacancy. Unfortunately, loss of rent is almost always not the
only cost and it is often not the biggest cost of a vacancy. A vacancy has
other costs, including advertising, cleaning, and repairs and/or painting that
wouldn't have been required had the old tenant remained, So, it may in
reality require several years at the higher rent to make up for the vacancy and
tenants do not usually stay that long.
But, if market demand is strong, and the increase
sufficient, the differential may well increase NOI. Furthermore, if the area vacancy rate is very low, you
can get away with a larger increase because (1) rents will be higher elsewhere
and the tenant may even have trouble finding replacement housing and (2) the
tenant realizes that he will have significant costs of moving. However,
it is best to save large increases for a unit that goes vacant for other
reasons.
In the long run, an improved
rent schedule will build a greater income stream into the future, thereby
increasing the value of the property for borrowing purposes and possible sale.
However, the decision on how often, or how much, rents should be raised cannot be
reached by using simple formulas, but must be made taking all factors into
consideration.
Collecting Rents
Many tenant problems stem from
an improper business image. Tenants can and do manipulate landlords when
there appears to be no defined consequences for breaking rules. A very
informal tenant-landlord relationship gives this appearance. On the other
hand, formal organized rent procedures provide a powerful collection tool and
business-like appearance. Professional property managers have standard
procedures in place to provide this all important part of their business.
Tenants obey the rules because there appears to be serious consequences.
Methods to assure prompt
payment include:
Have a definite delinquency policy
Rent
collection and procedures:
Common collection failures:
- Fear of vacancy.
- Failure to take threatened action.
- Confusion of personal kindness with business necessity.
- Landlords who are not diligent.
- Inadequate
information on a rental application the rental application
Always take any action that has
been threatened, then make a deal, perhaps even paying the tenant to move.
Ask yourself what it will cost you to evict, in lost rent, legal costs
and time. The amount is substantial. Now consider that your dead-beat
tenant probably doesn't have the money for a deposit and first month's
rent in a new, even cheaper place. It may pay you to loan the money on a
promissory note, that includes your delinquent rent. The tenant will be
gone and you may well collect the note someday.
If you just want a little revenge against the tenant who
stuck you for the rent, and consider them uncollectible, send the tenant a
1099. You can report the unpaid rent to you as income to the tenant and
they will be obligated to pay tax on it. The extra income may also impact
their Earned Income Tax Credit and other government benefits.
Eviction
Although doing an eviction will
time and money, when all else fails you must evict. Basic information
about eviction process can be found on our Evict
page. For much more comprehensive discussions, take our Evictions
e-course. In addition to detailed general discussions of the subject, the
course has forms and information specific to several states.
Collecting Judgments
If you have a money judgment on a former tenant you can
garnish wages, bank-accounts and more. RHOL
has a comprehensive but easy to learn e-course on collections called Collecting
Judgments. Take the course. When you have finished you
will know more about collections than many attorneys and most collection agents.
RHOL can provide a full bad
debt recovery service that combines the most technologically advanced
methodology and professionalism of experienced private investigators, skip
tracers and nationwide network of attorneys to collect your money. Our pursuit
of your debtor is aggressive and relentless. We never close a file and never ask
for any up front fees or cost. All collections are handled on a
contingency only basis, with a 50/50 split of amounts collected.
RHOL can search and monitor Consumer
Credit Files to trace and track skipped
debtors and provide our members with the information you need to locate
former tenants and collect.
Many state landlord tenant law
addresses late payment penalties and interest, and in some cases they are
actually prohibited. Massachusetts, for example, does not even allow a rent
discount for early payment, arguing that the normal rent amount penalizes
tenants who pay late. Other states, like Michigan, require that any late
payment penalty be a reasonable reflection of the actual cost to the
landlord of a late payment. $5.00 per day might be reasonable up to a few
days, but quickly becomes onerous. Check your state law on our State
Pages, or the Landlord Tenant
Law Page to be safe.
Special Rent Collecting Services
There are a variety of methods to collect
rents rather than waiting for a check or cash from the tenant. Included
are credit cards and automatic debit services. With the latter, the rent
is automatically transferred electronically from your tenant's bank
account to your bank account on the due date.
Both credit cards and automatic transfers can
require effort and expense to set up and operate and, therefore, may not be cost effective
for the smaller landlord. There are now firms that provide the electronic
transfer service with little hassle and at a nominal cost. For example, ClearNow
(ClearNow.com) provides electronic
rent collection services for landlords and property managers which is both
easy and cost-effective. With their service, rent is automatically
withdrawn from tenants' checking accounts and directly deposited into your
property's checking account. ClearNow advertises that their service
provides the following benefits:
- Eliminate the headaches of collecting rent
- Eliminate time spent depositing checks
- Gain faster access to funds
- Receive prompt notification of who has paid
- Provide tenants with an ultra-convenient payment method
Government Rent Programs
Section 8 Housing
Section 8 is a
federal Department of Housing and Urban Development program to assist low income
tenants in securing decent, safe and affordable housing. Originally a subsidy
tied to projects, it now includes certificates and rent vouchers that allow
tenants to seek the best housing available in the private market as well. Under
the program, a tenant pays 30% of their income for total housing expense, (rent
and utilities) the federal government pays the balance directly to the
landlord. For landlords willing to accept the inspection and other formalities
of a government bureaucracy, it guarantees part or all of the tenant's
rent. See our Section
8 web pages.
Section 42 Housing
Section 42 housing is housing that was constructed
under the Low Income Housing Tax Credit program. This is a
cooperative effort between HUD and the IRS that provides tax credits to the
owner for a period of 10 years so long as a certain percentage of the units have
controlled rents. The rent that can be charged for a unit under Section 42
depends, among other things, upon the location of the property. Tax credit
properties must include units for low-income persons. At a minimum, at least 20%
of the units must be occupied by households whose income is at or below 50% of
the County Median Income (CMI) or at least 40% of the units must be occupied by
households whose income is at or below 60% of CMI. There are also restrictions
on the amount of rent that can be charged for a low-income unit. Rent is not
based on household income, but qualifying for such housing is. Gross rent paid
by tenants may not exceed 30% of the applicable qualifying income as adjusted
for household size. If utilities are paid directly by the tenant, the maximum
rent must be reduced by the amount of the utility allowance (determined
according to program requirements).
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