In the spirit of disclosure, I own no rental properties so I can’t speak from personal experiences, only those of my clients who rent out single family homes. The common theme – none of them have a system for raising rents based on inflation or comparable listings (comps). When I ask why, they usually share that they’d feel bad doing so because the tenants are so nice.
I found a similar theme with my friends who have been renting out properties as a side hustle for years, and they also don’t like to raise the rent on tenants they like (the ones who pay on time and aren’t high maintenance). They think that there is a real risk of losing a tenant if they raise their rent, even if it’s just to keep pace with inflation and rental comps in the area. They’re speculating a higher cost to replace the tenant than the “extra” income they’d generate by increasing rent systematically.
Does it Really Matter?
Perhaps you aren’t worried about the extent of your earnings because you’re renting to a loved one or you specifically deal with short-term lease agreements (you can always adjust the rent with the next tenant). If you’re not dealing with a unique situation, and your tenants tend to stick around for the long haul, then it makes sense to know how much money you might be leaving on the table if you’re undercharging.
Let’s say you are charging $3,000 per month and don’t raise the rent for 10 years. If, instead, you added a 3% annual increase, you would have more than $50,000 of additional income in that period (even higher, if you reinvested the cash flows as they came in). For many property owners, that can have a real impact on their own personal financial life goals. That $50,000 could pay for a year or two of college or knock a year off a person’s work life, for example.
My friend and realtor, Craig, pointed out that it’s usually a bigger burden (time and money) for a tenant to move than it is for a property owner to lose the tenant. He feels that it’s a somewhat irrational belief that tenants will pack it in because their rent goes up by 3% every year. There is, he feels, a disconnect between the actual risk of a landlord losing his tenant and their perceived risk of it happening. To maximize income and the chances of retaining a tenant, his strategy is to keep the rent just a touch below the market rate (he checks comparable rental listings, AKA “rental comps” annually).
The Intimacy Factor
I once wrote about avoiding intimacy interference in your investments. If your goal is to get a market rate of return, but the idea of doing this regularly with your tenant causes you stress, consider hiring a property management company. Even though they’ll take a portion of your rent, you’ll likely earn more over the long haul with those modest annual increases. If that doesn’t sound attractive, consider investing in something else entirely (I’m sure your Abacus advisor will have some ideas).
Whether it’s a personal connection, or a fear of losing the tenant (or both), remember that your tenants expect rising prices on almost everything they buy in life, and their investment portfolios and/or wages are also probably rising at a rate that’s equal to or higher than inflation. In other words, small rent increases are normal and to be expected. They expect a good landlord, and hope for a good rent deal. If you’re still torn about the right path for you, you can always talk to your Abacus advisor.