By PETER ROSENTHAL, President
V.I.P. Trust Deed Company
If I could follow my own advice, my rents would have been much higher over the years. Many apartment owners, including yours truly, get to know their tenants over the years and do not adjust rents on a REGULAR basis. By the time we realize the rents are significantly below market (for long-term tenants), it becomes emotionally impossible to play “catch up” to current levels. If you’re comfortable getting $495 a month rent for a $625 apartment, so be it. The REAL problem arises when it’s time to sell the building.
Though apartments truly sell based on a CAP rate, most people use the layman’s guide – GROSS RENT MULTIPLIER as a quick guide to value. Almost all of my readers are familiar with 6 x gross, 7 x gross or 8.5 x gross, which is a multiplication of the annual gross rents. Lets assume a 15-unit building is put on the market with an asking price of $950,000. Unfortunately, the landlord has been a softy and the rent for these units average $500/month instead of the $650/month that they would bring today. A potential buyer or seller’s broker would find this almost laughable, as the seller would be asking a sum that is over 10 ½ times the gross rents. The typical seller’s response is that the rents can “easily” be raised to $650/month and, at $650/month the asking price is only 8.1 times gross. The seller is merely trying to have the buyer purchase the building based on future rents rather than existing rents. Apartment buyers are not stupid and they base purchase prices on existing rents.
In the example I have just given, the building will truly sell for more than 8.1 times existing rents, i.e. $730,000. It will certainly not sell for a future rent value. Obviously, the seller is trying to have the buyer do the “dirty work”. A seller with long term tenants is not realistically going to be able to raise rents from $500/month to $650/month in one raise to maximize the sale potential of the building. It’s only when the seller tries to sell the building that the above scenario comes into play and the seller realizes that few or no rent increases over the years will cost a substantial sum yearly (lost rents) and then many thousands.
Many owners believe that low rents equal good long-term tenants. This is a cliché and has been debunked over and over. The obvious solution here is to raise rents on a regular basis (usually yearly) to keep your rents CLOSER to par. I’m not suggesting one demand “top of the market” rents, though I am suggesting regular rent increases that keep the rents close enough to avoid the above scenario.
As an example, your newest tenants may be paying $650 a month. You may find that some of your tenants are paying $575 a month and have been for over a year. I would recommend an increase into the $610-$630 a month range. Whenever I increase rents I always include some verbiage to the effect that “we value your tenancy”; “we hope this adjustment will not be a hardship”; “we assure you that this adjustment is still well below current rents”. By constantly monitoring your rents you will avoid the major problem of trying to get a buyer to pay a price based on next year’s rents.
If I had just taken my own advice, I wouldn’t be faced with a similar problem on a 12-unit building I am now selling after many years of ownership.
Peter Rosenthal
VIP Trust Deed Company