JF1431: 7 Factors To Consider When Raising Rents #FollowAlongFriday with Joe and Theo

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If you’re a value-add investor, raising rents is something that is near and dear to your heart. Today Joe and Theo will discuss in-depth details of what to look for when considering raising the rent prices. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

 

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TRANSCRIPTION

Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff.

We’re doing Follow Along Friday today. We’re talking about how to determine when you should raise rents. I’m with Theo Hicks, who joins me on Fridays… And this topic, on the surface, is pretty simple – you raise rents when the market will commend a certain premium, or when you property can commend a certain premium based on the market comps.

So on the surface, you might be thinking “Okay, well I just need to know what the market is doing, and that will determine how I raise rents.” High-level – sure, that’s accurate, but there’s much more to it. There’s a 2.0 analysis that you can do and should do, especially when you’re dealing with apartment buildings, because you’ve got some large financial implications when you keep rents the same or you’re not maximizing the rents that you can be getting. And then there’s also financial implications depending on when you’re selling, where you’re at in the business plan etc.

So we’re gonna talk about that… Theo is gonna lead the charge, I’m gonna chime in along the way, and we’re ready to go.

Theo Hicks: As Joe said, the short answer to when you raise rents is you have your property management company, or you yourself will do some sort of market comp analysis on a monthly basis, weekly basis or however often you want, and then based off of that, your property management company or you will find out that “Okay, we’re under-rented by $15, so on all new leases we’re gonna raise the rent $15.” That’s the short answer, that’s one way to do it… But there are a couple of exceptions where you don’t necessarily want to just continue to raise your rent… Not necessarily exceptions, but things you wanna look at first, to make sure that those are all good before you start raising the rents, because as Joe said, of course, when you raise your rents, the rents will go up, but there’s also other implications of other expenses that might increase or things that might decrease, and that could potentially end up decreasing your overall cashflow on the property.

I’ve got a list of things here that I’m gonna go over… One of them is pretty high-level too, but it’s what’s your business plan? What was your initial plan to raise rents when you were underwriting the deal? Well, first of all, did you have a plan? …which you should; if you’re a Best Ever listener, we talk about that all the time. What was your initial plan to raise the rents? Was your plan to renovate the units and then raise the rents once they were done? Was the plan to decrease the loss to lease… So you went in there and the units were fine, but they were under-rented, so it was a plan to go in and raise the rents that way?

Also, do you have investors that you offer a certain return to, that you need to hit, and in order to achieve that return, you need to raise the rents? That’s maybe more upfront…

In the long-term, you wanna see where you actually are in your business plan compared to what you projected. Again, when you’re underwriting the deal, you’ve got your month-to-month projections, so two years down the road where are you at? Are your rents where they’re supposed to be? If not, and the market comps tell you that you can raise the rents, then that’s something that you’re gonna need to do in order to hit your target.

Joe Fairless: Something else with the business plan… It’s incredibly important that we’re aware of when the projected capital event will take place… And by capital event I mean a refinance, a supplemental loan or a sale. Because in order to get your desired amount (or even greater) for whatever you’re looking to get from that capital event, you’ll want to have the rent roll to show as high of income as possible, which then consequently will have your income be as high as possible. Theo is gonna get into this in a little bit… You can do some things to maneuver the property so that it’s put in the best light with your leasing, to get those rents as high as possible and then also to maintain the occupancy.

It’s not necessarily mutually exclusive, where you get rent premiums and high occupancy; there’s a way to get both, but you might have to do some concessions, or something like that, in order to get those leases signed at a high rate and keep that occupancy high for that capital event… Whereas if you’re not about to do a capital event or you’re not planning on doing one, then you can let occupancy dip a little bit, stay strong on concessions, meaning you don’t have any concessions, and then do it a little bit slower, in not as much of a blitz pace.

Theo Hicks: Exactly… Because the value of the property is based off of that operating income, and obviously, the majority of the actual revenue is rents, but you have to keep in mind that there is other income and there’s other things that you’re doing to get renters that costs you money. This is a concessions example.

Something else you wanna look at, since I think it’s a pretty smooth transition into talking about concessions – before you go to raise your rents, take a look at what type of concessions it is that you’re offering. If you’re offering a ton or rent concessions before raising the rents, it’s probably not a good idea to raise the rents until you are able to reduce those.

Again, concessions are things that are used, like first month is rent-free, a referral program, discounted rents… Anything that you’re conceding to the resident to get them to live in your building.

If you are already doing that at the current rents that you have, you’ll probably have to offer more concessions if you’re gonna be raising the rents. So concessions could actually be an indicator of whether or not you’re ready to raise the rents, kind of like occupancy. If the occupancy is really high, that might indicate that you’re under-rented. Having low concessions could also be an indicator that you could push your rents a little bit higher and increase that revenue.

At the same time, if you are increasing your rents by $300/month, but you have to offer $1,000 in concessions, it doesn’t really make any sense. So concessions is something else that you wanna look at and minimize before you go to raise your rents.

Something similar to concessions that’s also a revenue loss is bad debt and delinquency. This kind of also goes hand-in-hand with evictions and skips. So take a look at your eviction rate, the number of people that are skipping out in the middle of the night, and then once people skip out and they’re not up to date with their rents, then that’s bad debt. That’s money that you cannot collect.

If you’re having all these resident problems, minimize that first… Because again, if you minimize your bad debt, you minimize skips, you minimize evictions, your revenue is gonna go up without you having to even raise the rents, just with operational change. Once you’ve got all that figured out, you get the added bonus of eventually raising the rents.

Joe Fairless: And just to clarify a little bit on the bad debt… If someone skips out, you can technically collect, but you’ll likely have to go through a collections agency, and it’s gonna be a long time and you’ll just get a percentage of it, because the collections agency will take a percentage, too.

Theo Hicks: And Joe, you were talking earlier about things that you can do leading up to the sale – becoming more aggressive on your collections is one of those, as well. Of course, minimizing eviction and skips, but also if you’ve got bad debt that’s more than 3% of your gross potential rents, of course, the person that’s looking at your deal is gonna have questions about why is the bad debt so high. That’s something else too that you wanna address.

I was looking at a deal the other day where the bad debt was literally over 10% of the gross potential rent… It was just because of the resident space, but… Again, 10% of your gross potential rent… Think about how much money you’re paying for property management; it’s like 3%. So it’s three times as much as paying the property manager, money you’re just losing because you’re not aggressive enough on the collections. So that’s a way to raise the rents without actually having to raise the rents.

Another one – and this kind of goes back to what we were talking about earlier with the market comps, the competition… So what are your 2-bed and 1-bed rents compared to the similar apartment across the street? What are they offering currently? What type of concessions are they offering?

If you are wanting to raise your rents from $850 to $875 and someone across the street is at $825 and offering some concessions, it’s probably not the best idea to raise the rent, assuming that those are the exact same properties.

So the market comp analysis will take care of that… When you get your analysis back, you’ll look at your competition and see what they’re renting. But I’m not 100% sure if they have things like concessions or who pays the utilities on there… Does it, Joe?

Joe Fairless: Yeah, absolutely; a good analysis certainly does, because the good analysis will be that of a perspective resident at that property, and that perspective resident, when going through the process at the property, will come across if there’s a concession or not, or who pays what.

Theo Hicks: Okay.

Joe Fairless: And that should be done at minimum on a monthly basis for your property.

Theo Hicks: Exactly. And one of the main purposes of that is to minimize that loss to lease, which is something else that’s a loss… And if you can minimize that gap… Because loss to lease is the difference between the market rent and the actual rent, so for example — one of the deals you guys bought maybe over a year ago, I was reading through the investment summary and the owner was not aggressive on his rents, so it was 5%-10% below market rents… But they sacrificed that so they’d have a really high occupancy rate.

So it is kind of a give and take on all of these factors, and you kind of wanna just navigate them so you can have certain ones that are high, but then not have other ones go up because of that, and things like that… And that just takes experience and time.

Joe Fairless: All roads lead back to the business plan, which is why we started off talking about the business plan… Because if your business plan is to have returns that are desirable, so 17%-18% internal rate of return on a five-year project to limited partners, then it’s likely you’re doing a value-add play, so you’ll need to continue to be aggressive with income, or be focused on income… Compared to perhaps a family that purchases a property to beat inflation – they’re likely more focused on occupancy, sitting on it, paying off the debt and holding it long-term, maybe doing a cash-out refinance in the future, depending on how the economy does. It’s just different – different business plans, different perspectives on what to do based on certain circumstances.

Theo Hicks: Exactly. And with this business plan, everything that we’re talking about, you’ll want to make sure that you’re aware of this when you’re creating a business plan. This is not something that you want to do two years in, and be like, “Alright, how do I raise rents on this property?” You should know as much as possible exactly what you’re going to do after taking over the property, so that you’re not scrambling last-minute to raise the rents, or you don’t know what to do when bad debt increases, and things like that.

Joe Fairless: Yeah, you should absolutely know who is your competition prior to purchasing the property, what you need to do to compete with that property… So if you’re doing a value-add deal, it should not be other properties that are where you’re at now, it should be the properties that you can compete against once you implement your value-add plan.

Then once you close, you implement the value-add plan, you then do an assessment to determine where you’re at relative to that competition, and how you can optimize that plan… Whether you can scale down on the upgrades, because maybe it’s overkill, whether you need to scale up, or whether you’re just about right, and then you can figure out how to maneuver afterwards… But you’ve gotta have that plan going into it, you’ve gotta know who your competition is and how you plan on competing against them and how much it’s gonna cost in order to do that per unit.

Theo Hicks: Yeah. Another factor to look at is the number of canceled applicants. These are the people who apply and then disappear. You wanna see how many people are canceling or have applied to move in and then the move-in date comes and they don’t actually show up. If you’re having a high number of these, that’s another area you should probably focus on first, because that’s kind of a sign of either something’s going on with the resident, or there’s something about your property that they don’t want to move in… So that’s something that you wanna find an answer to and figure it out, because that’s wasted advertising dollars, that’s wasted time for your leasing agents… That’s a unit that could have had a resident, but now it’s vacant for another couple of weeks because that person didn’t move in.

So all those things are losses against your revenue. If you’ve got a bunch of applicants cancelling and not showing up for move-in day, figure out what’s going on and address that before you go in and raise rents.

Joe Fairless: Two comments on that. One – in addition to it being applicants who were approved, you also might have applicants who applied, but then they went AWOL and they wouldn’t have been qualified anyway. It’s important to take note of how many you have of those individuals, because that could be an indicator of the market and the submarket. So you’ll want to see the trend there of all these canceled applicants and you’re not really getting the quality that you used to, or you’re getting better quality residents based on however you qualify the potential residents. So that’s one comment.

Theo Hicks: The other comment is these are all things that you should be asking your property manager on-site to give you information on… Whereas I imagine if you didn’t hear our conversation between Theo and I, you might not have asked about all these questions prior to saying “Yeah, let’s increase the rents.” And this is just a next-level way of looking at if you should increase rents and other considerations, because each of them have a way of hurting your property and your profits if you’re not paying attention to it. Canceled applicants, the number of evictions, the competition, concessions, clearly the business plan – these are all things that you should be asking your on-site team about, so that you’re educated, and then you can start seeing trends over the course of ownership at that particular property.

Theo Hicks: Exactly. And a couple more comments, or one… A lot of the things that we’re talking about – canceled applicants, the bad debt… Well, always the bad debt, but canceled applicants, evictions, skips… If you are underwriting a deal, or you actually have your property management company already managing the property, all of these things should be listed on the rent roll, assuming you’re using a really detailed software… If not, as Joe mentioned, you need to get this information from your property management company. This should be information you’re getting on your weekly performance reviews with the management company. You should have spreadsheets, you should have a lot more than just the number of canceled applicants, evictions, skips, bad debt and concessions…

You should make sure that you’re in constant communication with your property management company and you’re knowing what’s going on on a weekly basis in regards to these different factors.

Joe Fairless: And someone who has a large apartment building might be thinking, “Well, yeah, but Joe, I have an LRO (lease rent options) system to just tell me when I should raise rents”, and that’s great, but it doesn’t necessarily factor in all of these things that we’ve discussed. So even if you have a software program that tells you what the market rent is at your competition, what their occupancy rate is and what you should do on that particular day with your unit, you still want to take all these other factors that we’ve discussed into consideration.

Theo Hicks: Exactly. The last factor is the rental season. So figure out what month you’re in right now – we’re in August – and then determine how close you are to when the rental season begins and when the rental season ends. Of course, the rental season is gonna vary from market to market.

I know back in Cincinnati it was May, June, July, August, around that time. I did some research beforehand and a lot of people say summer… I’ve read a couple e-mails from your property management company, Joe, and they talk about April and May… So it sounds like between April and September – somewhere in there is when rental season starts and ends.

Then obviously in the winter is when it’s not rental season… So if you’re in the winter, you’re probably not gonna be able to get as high of rents as you would if you wait six months to raise the rents in the spring and in the summer… So that’s something else that you wanna take into account – where are you at in time, and is this the optimal time to raise the rents, or should I wait six months before raising those rents?

Joe Fairless: Winter is the time to hold tight on occupancy. November, December not only do residents not move, and if they do move out, then good luck getting someone to replace them at that particular time, but properties don’t sell.

Now, I’m making a general statement – certainly there’s exceptions, but usually you’re not gonna have a property of yours go on the market in November, because there’s just not as much traction as in the spring and in the summer, and every single-family home investor who’s listening to this is like “Yeah, no kidding…”, because you experience the same thing with single-family homes. You would think larger dollar amount transactions might buck that trend, but they do not.

When we sell our properties, we’re looking to sell in the same timeframe that you’ve just described.

Theo Hicks: Exactly, yeah. Maybe during that time of the year, in the winter, it’s the best time to buy a deal from someone, because they’re not gonna be able to demand as high of a price, but…

Joe Fairless: Yeah, absolutely. There’s a flipside to that for sure.

Theo Hicks: [unintelligible [00:19:02].10] So just to summarize, when to raise rents at your apartment community – the short answer is run a rental comp analysis and if it tells you to raise the rents, raise them. But there are some other additional factors to look at, too.

What’s your business plan? What kind of concessions are you currently offering? Take a look at the people you’re competing with, take a look at the number of evictions and skips, take a look at your bad debt and delinquency costs, make sure you’re up to date on the number of cancelled applicants, and then finally, make sure you’re aware of what time of the year it is, and whether or not you’re in the rental season.

Joe Fairless: I think that was seven things. That’s nice and clean for the title of this episode once it goes live.

Theo Hicks: Yeah, exactly. Moving on, Joe, to the updates – I know you guys closed on a deal yesterday, so congrats on that.

Joe Fairless: Yeah, that’s a pretty big update. We closed on a 436-unit property in Dallas, and I actually just sent out an opportunity yesterday to my private investor group about another property that is in that area, South Dallas area; we think there’s gonna be some good cashflow opportunity with perhaps some appreciation in the market, although we’re not counting on it… More of a cashflow opportunity and do our value-add business plan. I’m excited about that.

Then one real estate productivity-related thing that I learned last night was I watched the documentary Truth About Alcohol (on Netflix), and I learned some things that I’d heard before, but I didn’t know it was actually science… So for any Best Ever listener who does have a drink every now and then, or multiple drinks every now and then, this is information that you might find interesting (I did). One is the more water we have in our body, the longer it takes for us to get drunk, so that’s why larger people don’t get drunk as quickly as smaller people, because the larger people have more water in their body. That’s number one.

The more muscle you have compared to fat, it will take longer for you to get drunk. So if you’re more muscular, then you don’t get drunk as quickly as if you are fat… That’s another thing I learned on the documentary.

Third thing is we probably don’t know this, but I saw an experiment, so it proved it – if we eat prior to drinking, then we get drunk slower. The blood alcohol content that is in our bloodstream is lower if we eat prior to drinking, versus if we drink on an empty stomach.

And then four is we eat more when we’re drinking. Again, most of these things I had heard of, but I didn’t know if they were actual facts or not… At least they were from this documentary. The documentary is The Truth About Alcohol. I thought that was interesting, so I wanted to share.

Theo Hicks: So now if you don’t want to get drunk, you know what to do. If you also want to maximize it, you also know what to do… [laughter] When you’re working on your real estate stuff.

Joe Fairless: There you go.

Theo Hicks: Yeah, I mean… Whenever you watch an older movie, whenever they’re doing business transactions, they’re always drinking–

Joe Fairless: Sipping on whiskey…

Theo Hicks: Sipping on whiskey, and stuff like that.

Joe Fairless: Smoking a ciggy…

Theo Hicks: Yeah. They could probably make some more open and honest [unintelligible [00:22:22].13] business negotiations.

Joe Fairless: Yes, yes. What about you? Any updates?

Theo Hicks: No updates on my end. I’ve got my three fourplexes, they’re fully occupied, so there’s cashflow… I mentioned last week I’m gonna host a barbecue event in the next couple of months. I’m not gonna tell them when it’s coming, I’m not gonna tell them when the next one’s coming, and I’m excited about that.

Joe Fairless: Well, you kind of wanna tell them a little in advance when it’s coming…

Theo Hicks: I’ll give them a week advance, yeah.

Joe Fairless: Right, right.

Theo Hicks: Then I’m also starting to work on doing my own syndication deal, so we’ll talk about that coming soon.

Joe Fairless: Fair enough.

Theo Hicks: I’m putting together a team right now and we’re gonna start looking for deals. I’m running some things, but not enough to share on this podcast just yet… But once I learn my first big lesson, I’ll definitely share it for everyone.

Joe Fairless: Well, Theo, we have some resources for you that will help you learn the process.

Theo Hicks: I’m leveraging all those resources, don’t worry, Joe…

Joe Fairless: Yes, fair enough. And for everyone else, you can go to apartmentsyndication.com, or multifamilysyndication.com (we’ve got both URL’s) and there’s all sorts of syndication tips and blog posts on raising money, and finding deals, and working with brokers, building out your team… All that good stuff.

Theo Hicks: Alright, so just to wrap up here – make sure you guys go to the BestEverCommunity.com…

Joe Fairless: You did it again…

Theo Hicks: What did I do again? Oh, guys and girls…

Joe Fairless: There you go. [laughter]

Theo Hicks: Guys and girls… [laughs] Make sure you guys go to the bestevercommunity.com, our Facebook group…

Joe Fairless: You just did it again… [laughs]

Theo Hicks: And each week we post a question of the week. If you guys and girls respond to it, you’ll be included in a blog post. This week’s question is “What is the biggest red flag for you when evaluating a market?”

I wanna add to this — I’m gonna go back and add to this and say “What’s the biggest red flag for you when you’re evaluating a market?”, but I also wanna know what the biggest red flag is when you’re evaluating a deal? Maybe that’ll be the question next week.

The biggest red flag for me when evaluating a market — of course, we talk about this all the time, which is job diversity… But something else is I wanna look at the median income, and — this is more for a deal, I guess… What the average rent is gonna be, and make sure that the median income can support that rent.

Most people spend around 30%-35% (I think that’s the high end) of their income on rent… So if the rents are below that, that’s a good sign; if the rents are 50% of the median income, then I’m probably not gonna invest in that area.

Joe Fairless: That’s a good one. Thank you for sharing that.

Theo Hicks: I got that from one of your clients, Dan.

Joe Fairless: Oh, cool.

Theo Hicks: I’d heard it before, but he articulated it in a good way, and it stuck.

Joe Fairless: Yeah, that’s good. I like that.

Theo Hicks: And lastly, make sure you guys and girls subscribe to the podcast on iTunes and leave a review, it really helps us out… And you might have the opportunity to have your review read aloud on the podcast.

This week’s review was from Hanna Bumper, and she said:

“These podcasts are extremely informative for first-time investors, through to those with [unintelligible [00:25:20].10] portfolios. I highly recommend it. Even the ones I didn’t think pertained to me had nuggets of information that were useful.”

And yeah, I agree, I’m sure most people when they go through your podcast, they look at the title and they read the bio of the person, and they see “Oh, they’re a wholesaler… I’m not  a wholesaler, so I’m not gonna listen to it…”, but real estate is so interconnected that you might learn some deal generation techniques that you could apply to your business, or some success habits that they use that is something that you’re struggling with, and once applied, could increase your productivity.

So I agree, every podcast has at least one thing that is new that you can learn and apply to whatever business, or even to your personal life. And at the very least, you’ll get a very good book recommendation at the end.

Joe Fairless: Yeah, I love your thoughts, Hanna, and also your comments, Theo. I’m the same way… One core belief I have is nothing in life has a meaning until I decide to give it meaning… So I determine what words mean to me, and it’s a fact that that’s how the world is, because everyone is interpreting our conversation slightly differently based on their own life experiences, where they’re at, their attention span etc.

So when I’m speaking to a fix and flipper or a wholesaler – I’m not doing that stuff, but I am learning about certain aspects of what they’re doing so that I can see how I can apply that to my business… And there’s always something I can learn from a conversation, so I’m grateful that we’ve got Best Ever listeners who acknowledge and embrace that. I too embrace that.

Thanks everyone for hanging out, listening, and we’ll talk to you tomorrow.

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