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

      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:

• Good information on the rental application
• Personal documented information that will make it easy to find someone who skips
• Strict qualification standards that are both legal and protect your interests
• Proper tenant screening
• Credit checks, reports and credit scoring
• Check references
• Project a friendly, but no-nonsense business attitude
• Strict collection options when the lease is signed.
• Personal and several liability agreements
• Guarantors/co-signers
• Collateral, security and guarantees
• Authorize a credit card or checking account
• Collect Rents Electronically
• There must be a definite system to know when rents are due.
• Help tenants build, or re-build their credit by reporting regular payments

Have a definite delinquency policy

• Rent due on the 1st day of the month.
• When 3 days past due, a friendly reminder - end of grace period
• When 5 days past due, a personal visit.
• When 7 days past due, notice to pay rent or vacate.

 Rent collection and procedures:

• A friendly but firm attitude is always important.
• Penalties for late payment
• Rewards based on payment history
• Deposits and advance payments
• Credit card and automatic bank transfers
• Copy all rent checks
• Require a promissory note for past due rent
• Past due rent is a cash loan and landlords are not lenders.

 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).