These 4 Things Will Make You Reconsider Rental Properties
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Wise investors do not buy for appreciation. They buy properties on a sound judgment that the property will produce more revenue than ownership expenses. They don’t care what the market is doing. For as long as the property remains rented and the cash flow is positive, they are secure, even if property values fall. On the other hand, if property values increase, they have the additional option of selling to pocket the profit.
With that said, historically, real estate values have increased over the long-term. This is how most wealth is built up in real estate. This is the “home run” that you hear about when individuals make a big cash windfall. While prices fluctuate in the short-term, property values have always risen over the long term and there is no reason to believe that will change.
What you will learn in this post
Build Wealth Multiple Ways
Increase Rents Over Time
Set It and Forget It
Increase its Value on Demand
A. Build Wealth Multiple Ways
When you do get real estate appreciation, it has a powerful influence on your ROI. Appreciation coupled with leverage provides enormous yields. For example, if you purchase a house in cash for $200,000 and it’s worth $220,000, you have an immediate 10 percent return on your investment. Most likely though, you haven’t paid cash for the property. Instead you’ve borrowed the money from the bank. If you consider that you might have put down 20 percent ($40,000), you’ve effectively earned a return of 50 percent on your cash investment. This is known as Cash on Cash (CoC) return. You can read more about this and other real estate metrics. If you rent this property, you should include the net annual cash left over in your calculation. However, since property values do fluctuate in the short-term, most cash-flow investors do not pay attention to appreciation and usually exclude it from the CoC calculation.
While the name may be misleading, depreciation is not the value of falling real estate. In fact, it is a tax word that describes your ability to write off a portion of the asset’s value each year. This decreases the tax burden considerably on the profit you make; effectively, providing tax-free income. Thus, giving you another reason invest in, and hold for the long-term, cash-flowing real estate assets.
Residential investment property is usually depreciated over 27.5 years. Every year, you can write off approximately 1/27th of the property’s purchase price. Let’s continue using our previous example of the $200,000 purchase price. You would divide that amount by 27.5 for a property to achieve a yearly depreciation amount of $7,272.73. This is the amount by which you can reduce the property’s profits for the year. Often, the depreciation amount is greater than the annual profits, which will result in a paper loss. Therefore, you will eliminate all incomes taxes and carry forward and unused losses.
For the details of this tax advantage, you should consult a CPA, but the fundamental concept is that the government considers property you purchase to wear down slowly over time, and you are permitted to write off that wear and tear, much like machinery for a company you own. I am sure you will agree that owning a property that provides a monthly check, increases in value over time, and reduces your income taxes on the profits is not a bad deal!
One caveat is that your primary home is not subject to this tax exemption. In other words, you cannot depreciate your primary home. Rental property has tax advantages as it is deemed a business where you can write off your expenses. This is not the case if you use the property as your primary residence. However, with new types of rental businesses such as Airbnb, you can rent out a portion of your primary residence and depreciate that portion of the property, which should cancel out the income. Effectively, earning tax-free income.
B. Increase Rents Over Time
When increasing a tenant’s rent, investors often must follow a legal procedure. The two main conditions to be followed by investors are to provide the tenant with a written notice of the increase and to give this notice a certain amount of days before the tenant’s lease expires. At the end of this section, I’ve provided a sample letter notifying a tenant that the rent will increase rent.
Many cities have enacted certain regulations that set rules for the maximum amount of security deposit that a landlord can charge based on the monthly rent. The security deposit, for instance, could be twice the monthly rent. Therefore, if the monthly rent increases, the investor might require the tenant to pay an additional amount towards their security deposit. Usually this extra amount would be due simultaneously with the rent increase. However, if you have a good tenant who pays on time, you may choose to forego the additional security deposit requirement.
Following are six important points to consider when raising rents while trying to keep your tenants happy. It is a good idea to follow these measures to be fair to your tenants and safeguard the tenant from absurd and unfair rent increases.
- Rent Cannot Be Increase During Lease Term – Usually a rent increase does not occur during the lease term unless specifically allowed by the lease contract. As a investor, you have signed an agreement to rent the property at a certain price for a specific length of time and you have agreed to accept the same price until the lease expires. When the lease is renewed or after the initial lease has been terminated and the tenant agrees to a monthly extension under new terms, you may choose to raise the rent.
- Provide Written Notice According to Lease Terms – Your lease should contain a paragraph describing the process for notifying the tenant of rent increases as well as the time frame during which you may send the notification. The investor must send a written notice to the tenant if he or she wishes to raise the rent. This notice may be sent to the tenant by hand or by mail. It is always a good idea to send this notification via certified mail so that there is a record of you sending it and that the tenant received it. You should never orally notify a tenant of a rent increase.
- Provide Adequate Written Notice to Monthly Tenants – For month-to-month tenants, it is common practice to use the rent frequency as notification terms. Therefore, if your tenant pays rent every month, then you should provide a written notice at least 30 days prior to the rent increase; some investors prefer to send this notice 60 days in advance. Sometimes, state regulations will dictate the number of days required for notification.
- Rent Increase Amount – Usually, the rent for your property will be determined by the local rental market. A rent increase must reasonable to the local market. An investor must balance the rent increase with the possibility of a tenant moving to avoid the increase. Rent increases should be in small increments to cover increases in expenses as well as retain a good tenant. Increases can be determined by the increase in property tax and/or insurance premiums. If a property is governed by rent control regulations, there will be restrictions as to how much rents can be raised and how often rents can increase.
- Tenants Can Fight Illegal Rent Increase in Court – If a tenant feels that the investor increases his rent as an act of retribution or discrimination, the landlord may be brought to court. An instance of a retaliatory rent increase would be an investor raising the rent of a tenant because the tenant complained about a prospective issue with the property. It is better to not renew a tenant’s lease than to increase the rent an act of retribution.
- Right to Reject Rent Increase – The rent increase may not be acceptable to the tenant. If the tenant does not agree to pay the higher rent, the tenant must notify the investor of his or her intention to move out of the rental unit before the increase takes effect. If the tenant remains in the property after effective date of the increase, they will have to pay the higher rent or will become subject to eviction and legal action.
Sample tenant notification letter:
This notice is to inform you that the rent for (insert unit number), which is located at (insert property address) will increased to (insert new monthly rent) per month starting with (insert effective date), as the new monthly rent for the unit you currently occupy. This lease payment is due on the 1st of each month and considered late on the 5th day of the month.
If you accept this increase and want to continue your residency, please sign below indicating your agreement to pay (insert new monthly rent amount) as the new monthly rent. Please note that all other conditions of the initial rental agreement still apply. If you do not accept this rent increase, you should notify us of your decision to move in accordance with your rent agreement.
Tenant Signature Date
C. Set It and Forget It
Owning a rental property can be a rewarding experience as it often generates a constant income stream and does not require a lot of time. However, a rental property produces income only when there are excellent tenants who pay their rent on time and do not damage the property. It is possible to have problem tenants that make it time-consuming and expensive to own and manage a rental property. This is where a property manager becomes valuable to a investor and owning a rental property becomes a passive income activity. Using a professional property management firm has many advantages for investors, particularly those who want to grow their rental portfolio and own more rental properties. These advantages include saving a substantial amount of time and money for investors and make it more rewarding to own rental properties.
One of the greatest advantages of using a property management company is that you as the owner are insulated from the daily management activities. Your contact information is not shared with the tenants so you are protected from retaliatory issues that may arise with unhappy tenants. Additionally, investors can purchase properties in different states and cities and engage a local property manager to manage the property.
Another great advantage is that all prospective tenants will be properly screened by the company. Many times, investors do not conduct background checks to save time and money; sometimes, investors are not aware of resources to conduct these background checks. Renting to individuals regardless of their criminal background and economic history is one sure way to end up with problem tenants.
The legislation governing rental properties will differ by state and municipality. It is essential to understand how to correctly manage problem tenants and other rental problems. Property management companies are usually familiar with all the local rental laws. Property managers will handle evictions, inspections, lease negotiations, termination of leases, and tenant rent collection. They also ensure that each property complies with all property codes and security regulations. Having a competent property manager will prevent expensive litigation and legal issues.
To guarantee that property taxes and other expenditures are paid on time, investors need to collect rent on time each month. The collection of on-time rent is also the only way to produce reliable revenue for a investor. Unfortunately, the rent collection process is not managed well by some investors. They often fall victim to tenants’ excuses and allow individuals to pay the rent late. In many instances, tenants use bad checks to pay their rent, and the investor is stuck with bank charges and other issues. Property managers will ensure that rents are paid on time. If a tenant does not pay as agreed, the property manager starts the legal eviction process.
Another unpleasant aspect of being a investor is lease enforcement. Both the landlord and the tenant are protected by the terms of a lease, but the investor is the one who suffers if the tenant breaks the agreement. Property managers will be responsible for lease enforcement and deal with tenants who violate the lease terms. If a tenant is not permitted to have pets and someone reports that a pet is on the premises, the property manager will contact the tenant and request the removal of the pet within a specific time frame. If the tenant makes holes in the wall or makes other changes to the property that have not been discussed with the investor, the property manager can ensure that the tenant pays for repairs.
Without a property management company, preparing a property for rent, determining how much rent to charge, and marketing the property to prospective tenants may take several months for a investor. A professional property manager can decrease the time it takes for these duties to be performed. A property manager may also enhance tenant retention by being response and rapidly making repairs whenever an issue arises. This increases the likelihood of retaining a good tenant.
A skilled property manager can add substantial value to your investment, which is why many experienced real estate investors will say that a good property manager is worth their weight in gold. The distinction between success and failure as a investor is the way you manage your rental properties. The only way to keep continuous cash flow is to collect rent on time each month. By hiring a property manager, you put a buffer between yourself and the tenant and let them manage the daily activities.
D. Increase the Value on Demand
All real estate investors want to see an increase in the value of their property. There are some immediate physical things that can be done to increase the value of a rental property while waiting for an upswing in the real estate market. Improvements in a rental property must be carefully selected for their potential to increase the property’s value and attract top quality tenants. Additionally, investors must strike a balance between the cost of these improvements and the expected return on the investment. In order to boost the rent and your bottom line, we will cover the best upgrades for rental property.
Kitchen and bathroom fittings such as faucets, sinks and sprayers can rapidly get old, dingy and look outdated. Investors should consider switching out any fixtures that are about 10 years old. Installing fixtures with current finishes such as oil-rubbed bronze or brushed nickel will make the rental property more appealing to prospective tenants.
Replace old laminate counter tops with new modern counter tops. Installing counter tops made of granite, slate, quartz, or another solid surface material will boost the look of any kitchen and bathroom. Stone options for counter tops include long-lasting and lovely composites of acrylic/polyester, ceramic tile and stained concrete.
Updating the flooring is another outstanding way to increase property values. Install a continuous new flooring throughout the rental property for a new modern and appealing look. Replacing conventional carpet and linoleum with modern materials such as vinyl planks, tile, stone or even hardwood will not only add value, but will also make it much easier maintain and repair.
Storage is one of the top priorities for renters, so by adding storage choices and closet space, investors can really make their property shine. Some simple and easy ideas for boosting storage include adding hooks to important areas such as entrances and bathrooms, installing closet organizational systems, and adding extra shelving in a closet. Additional storage upgrades involve installing continuous shelving in the garage, creating built-in racks or storage inside the wall, framing a new closet and adding a shed to the property.
Windows not only help to keep a property light and bright, they also increase heating and cooling efficiency. Depending on the age of the property, it may be necessary to install new windows. Investors should consider upgrading to double panel windows to better insulate and muffle outdoor sounds. Tenants will appreciate the utility expense savings. Other choices for upgrading include window blinds.
When a roof reaches the age of about 20 to 25 years, it’s time to get it replaced. In severe weather, neglecting the roof can result in severe property damage. Investors should check the roof regularly and arrange to repair or replace as recommended by a roofing inspector. Not only does a well-maintained roof look great, it also protects the underlying investment.
There are all sorts of distinctive upgrades investors can make to the rental property that will increase the value. Ideas include installing tankless water heaters, new landscaping, sidewalks, exterior painting, and even adding a few square feet, such as an extra bedroom or bathroom. Of course, the property location, type of tenant, rental market and potential rent increase must be considered before any improvements are made. If the roof leaks or the basement has mold, a fancy kitchen will not do much. Investors must prioritize basic maintenance over cosmetic improvements. Additionally, investors must take care to not over improve a property as the market make not be able to support a very high rent.
As an investor, you should always consider methods to boost your rental property’s earnings. Generally, avoiding vacancy at all expenses and maximizing rental revenue is the simplest way to boost earnings on a rental estate. Your property manager is best suited to suggest updates to the property to increase rents as well as the property value.
In addition, if you have pet-friendly properties, you can increase revenue by charging a monthly pet fee. Even an additional $25 per pet per month will add up to a couple of hundred bucks a year. There is such a strong demand for pet-friendly properties that renters with animals tend to move in-frequently. An assessment of FIREPAW, Inc. landlord studies discovered tenants with animals are staying considerably longer, an average of 23 months versus 15 months. That implies less turnover, fewer vacancies and more revenue from rentals. You can read more here.
According to a study by the National Apartment Association, adding a washer and dryer to your rental property can boost income by 15 percent. Consider installing a washer and dryer in return for a lease renewal from your best tenants if your property already has washer and dryer hookups. This added value secures a tenant rent paying for another lease term, and the rental revenue you will save from avoiding even a month’s vacancy should cover the appliance costs.
Think about the advantages of stating ‘yes’ if a renter comes to you requesting to paint a wall or plant a garden. Give your renters a palate of acceptable paints that could boost the potential for re-rent if they ever leave. In addition, lay down certain conditions in a formal written lease addendum that explains your terms for allowing the property to be altered, but that if the painting is not up to par or needs to be repainted at vacancy, the cost will will be deducted from the tenant’s security deposit.
Any customization you approve for your tenants — whether it’s a fresh paint coat, planting a garden, or installing new kitchen appliances — will help them feel comfortable and want to remain longer. The more your tenants feel at home in your property and the more energy they invest in tailoring it to their lifestyle, the more likely they are going to want to remain for a long time.