Friday, July 29, 2011

Increasing Income in Rental Properties (Part 3 of 3)

Hello Friends!  Thus far in the first two segments, we discussed potential opportunities to reduce expenses, which translates into increased income.  Now let's look at the flipside...increasing revenue.  I will discuss multi-family rental  properties first and explain using examples, how to increase cash flow and equity from a layman's perspective and then an interesting twist to single family home rentals and a method of increasing income there as well.

You're looking for an income property to buy and you've screened for artificially low rents.  
There are a couple of reasons owners don't raise rent:  because they're afraid the tenants will leave, or they will ask them to make repairs.  I used to have those same two reasons for not raising rents until I learned otherwise.  I was afraid that my "good" tenants would leave mostly because it wasn't "easy" to find them!, but here's what I learned:  Those reasons were not at the top of tenants' beefs.  The number one reason tenants leave is not rising rents but rather poor response to repair requests.

If your building is 100% occupied, you are not charging enough for rent.  It's time to raise rents if this occurs.  In fact whenever your property is anywhere from about 95% and up in occupancy, it's time to raise rents.  Train your tenants to expect some kind of modest rent increase each year, it could be $10, $20, $25 per month (within legal limits of course).  This is a small enough increase that it won't be the driving factor to have someone move out.  Now let's look at a measly $15 per month increase for a 100 unit apartment building.  That works out to about 50 cents per day increase or another way of looking at it is, it's about 1/3 the price of a cheap coffee.  

$15 per month x 100 units = $1,500 in added revenue per month.  Now we multiply that by 12 months and we get $18,000 per year in added cash flow.

Revenue has increased by $18,000 now per year and using a 10% CAP (let's recall that CAP rate  (%) = Net Operating Income (NOI) / VALUE of the property).  If we re-arrange this simple formula, we get VALUE = NOI / CAP, so in our case, VALUE = increase in property value.

We get:  VALUE (increase) = $18,000 / 10% = $180,000

What have we done by this small $15/month increase?  We've increased the value of our 100 unit apartment complex by $180,000 conservatively speaking.  This is the multiplying effect of the quantity of units a building has.  The more units, the more property value increase you will get for the same rent increase.  Nice huh?  With the stroke of a pen, we've increased our equity by $180,000.  This is real life, and remember, that the value of your commercial property is determined by the income it generates relative to expenses because of the income approach to valuation.

There are other ways to increase rents on takeover which are more involved but that is for another time....

If you haven't raised rents in some time in your existing property, and you do have high occupancy 95% +, then you need to start raising rents, even marginally as we've discussed.  Use the excuse that taxes are up, utilities are up if you have to.  They most likely are!'s not like you're making up a story.  From then on, you need to do this every year, and when leases become due, bring the rent up to market where possible.  You need to do physical surveys of your competition's buildings in the area to ensure that you are on a level playing field in terms of pluses and minuses in your property and theirs.  You could offer your tenant an accent wall, or a free carpet cleaning in return for signing a lease extension.  These offers won't cost you much in return for a longer term commitment.  Will some tenants leave?  Yes some probably will, but tenants leave for many reasons.

We've talked about multi-family properties, but what about if you aren't in that business and have a single family home?You're looking to make more money but not sure how.  Let's look at the following scenario.  This is not for everyone, but then again, nothing really is, is it?  I'm offering this information because it's not really common knowledge similarly compared to the above discussion about valuation increases in multi-family properties.  Unless you're in the business, these examples aren't common knowledge.  Back to the single family rental example....nothing comes for free, but if you do this work, you will increase your income but it requires added labor on your part and perhaps some cost.

Let's say that you live in your house and you've been renting a basement apartment.  You're happy with the tenant, and they've been paying you with little problem.  Let's say it's a 3 bedroom basement apartment and you're receiving $850 / month for it.  Now your tenant decides to leave and you need to re-rent it.  You have some choices.  You could rent it out again, or you may decide to rent rooms instead.  Now, you could rent 3 separate rooms which could fetch you $400+ per month for each room, depending on where you are located.  Now you've done a few things by doing this.  You've increased your income by almost 50% from $850 to $1,200.  You've increased your gross income in this example by $350 per month x 12 = $4,200 per year.  You've reduced your financial risk if one of the tenants doesn't pay.  If your single tenant before didn't pay you, you were completely out of pocket, but now if one doesn't pay, you still have 2 that are paying.  This type of arrangement will require more work from you in management but if you live there and monitor the property, it's really not that much more work.  Ideally, if you're located on a bus route, or near a school, your target market could be students or working people without a car or if you have adequate parking, then it doesn't matter except that they have a steady source of income to be able to pay you and that they are an acceptable tenant.

Now, for some of you, this idea just doesn't work.  That's OK.  Like I said before, this isn't for everybody out there.  You need to ensure that your town ordinances allow boarders and you have to be within those legal limitations.  You will have to tell your property insurance company about this as well so there may be an insurance hike.  Investigate this before doing it to make sure that it still makes financial sense.  You will have to put door locks on their rooms (you can pick them up at Wal-Mart for a few bucks each), deal with the occasional noise, or complaint about someone taking their food from the fridge.  You will need to make sure that your tenants have adequate escape routes in case of fire and that this meets your town's by-laws etc.  Yes, it requires some checking into, but again...I did say you don't get anything for free!  How do I know this stuff?  I used to manage multiple rooming houses but I didn't live in them.  These were harder to manage because of the fact that I didn't live there and keep an eye out.  Remember, for some of these types of tenants, "when the cat's away, the mice will play".  For the time that I had them, they were very profitable, but when you have many of them, it can be very busy dealing with issues that happen occasionally.  It takes a strong personality to run this kind of show as some tenants (most won't if you're firm but fair with them) will try to walk all over you by delaying paying rent sometimes, or whining about this or that, but if you're screening well before hand and make sure that you lay down the rules, you will have little trouble.  Just make sure that you are clear on what they can and can't do by making sure they sign a rental agreement spelling out the do's and don'ts.  This is somewhat of an unconventional approach to increasing revenue for the single family homeowner, but it's entirely workable and from experience, they can be profitable as well.  You just need to make sure you're organized and understand what you're getting into before doing it and most importantly up front know that the numbers make sense first.  

By the way, if you're considering doing the above, the best way to test this first is to put an ad in your local paper.  You could even put in free ads using Craiglist, Kijiji etc.  Look at other ads for rooms for rent and see what other people are charging in your area.  Then use a similar figure in your ad.  It should be short and to the point, something like:

"Clean room for rent available Sept.1, non-smoker, $400/month 1st/last, bus route, quiet persons only, call 555-555-5555."

Run this test ad and see how many calls you get and keep a record.  You may want to run this ad for two consecutive weeks to see what happens.  Run the ad starting the middle of the month for the 1st of the following month.  When you get calls, you can show them the room and take a rental application or you can simply tell them that the room is rented if you're just doing a survey but of course don't tell the prospective tenant you're just doing a survey.  Just be polite and advise them that the room is taken.

Hope this helps some of you.  The latter discussion is again somewhat unconventional but it applies multi-family property principles to a single family home!

If a single family homeowner is looking for more income, this could be a great way for you to get it.  It will take some work up front, you need to be prepared to deal with some hassles, but it does work well once you've got the right people renting from you.  In one of my previous properties, I had many long term tenants with a couple of them with me for more than 6 years.  In others, there was more turnover, but the income justified the means as opposed to simply buying a single family home and renting it to one family.

If anyone has any questions please reply and I will respond promptly.  I hope you have some value that can help you with your properties.  

If you are interested in higher yield, 14%+ returns secured by multi-family real estate, please see our website:  

Thanks for reading folks and be well until next time.  

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