How Below Market Rents Can Earn Landlords More Money In The Long Run. | Nexus Property Management® Franchise

19 April 2024

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DOES IT MAKE SENSE TO KEEP RENTS BELOW MARKET VALUE?

Property values are through the roof and whether you bought yours recently or are just sitting back while your equity grows, your rental property’s earning potential is growing as well. The current rental market is growing as quickly as 10% a year and many landlords are cashing in. But is there also value in keeping your rents below market? The question seems counterintuitive: charge less to make more?

There are certainly potential upsides. Namely, increasing profitability by minimizing risk in the form of pricing that attracts the longest term renters. At elevated market prices, you may be able to attract someone who can pay, but are they as likely to stick around for the long haul? We all want our assets to maximize profitability but we also know that nothing hurts more than the zeroes that come with vacancies.

[Learn More: RHODE ISLAND RENTS HAVE BEEN RISING; MORE AFFORDABLE UNITS NEEDED]

Nexus Property Mangement’s Vice President of Franchise Sales, Greg Rice, decided to look into it. In addition to being a key cog in the growth and success of Southern New England’s largest property manager since the beginning, Greg owns just under 100 rental units, which makes him one of the company’s largest clients. In short…he knows his stuff. Watch his video below to learn more.

A QUICK SUMMARY OF THE MATH:

For simplicity’s sake, we’ll say you’re renting a single-family home and you are asking $2000/month. We’ll compare that to someone who is comfortable getting less at $1500/month. After a year, Tommy 2000 has pulled in $24,000 in rent while Frankie 1500 is only looking at $18,000. After one year we’re looking at a difference of $6,000 and after two years it looks like Frankie has left 12K on the table.

But…if $2000/month is at the top of the market, it’s more likely than not that you’ll be attracting a couple rather than a single tenant. In two years, a lot can happen: if they split up, can one of them afford the rent by themselves? Seemingly they could afford more with two incomes. Or, along those lines, they haven’t split up and instead realize they want to build a future together, and with that in mind and a rent that high, they’re ready to pay their own mortgage rather than yours. The reality is this: at the top of the market, you’re not likely to attract tenants who are in it for the long haul.

So…let’s say after two years, Tommy 2000’s tenants want out, but Frankie’s are more than happy to continue paying that comfortable, undermarket price. Tommy now has a vacancy. Nexus’ inhouse maintenance and leasing teams can get a new tenant in by the three month mark, which is a much shorter vacancy than the industry average, but we’ll still use that number. With three months of vacancy, Tommy is down $6,000 right off the top. The maintenance necessary to bring the house to “new” after two years of residency always includes at least one big ticket item and a fresh coat of paint. Conservatively (remember, this is a single home, not a small apartment unit) let’s say it costs another $6,000 for maintenance. Before you even pay someone to put a new tenant in (Nexus asks for half the rent while most property managers want the full $2000), you’re back to breaking even with Frankie 1500!!!

[ Learn More: PROFIT MARGINS: THE NUMBERS OF A TYPICAL NEXUS CLIENT ]

KEY VARIABLES:

We’ve established that there could certainly be some benefit to below market rent if you can attract a tenant who understands the situation, is happy with the value they’re getting, and subsequently sticks around for an extended time. The other key here is another one of Nexus’ principles: this arrangement is hassle free. You’re less likely to have to deal with the headaches and expenses that come with vacancy. If you got into real estate investment with the goal of stress-free passive income, you might be more of a Frankie 1500.

On the other hand, you might be more aggressive and try to maximize value by trying to be closer to market. On your side is the reality that the $12,000-$14000 we’re estimated a vacancy will cost is well worth it if the tenants stick around for more than two years. It’s also worth noting that the tenant paying $1500/month is by no means guaranteed to stick around. A vacancy with that approach 100% means money left on the table.

It’s also important to take your own flexibility into account. Your mortgage payment and monthly bills certainly play a factor in determining how much you should aim to take in. The amount of support you have is key as well. For investors like Greg, who have a professional property manager at their disposal, you can afford to be more aggressive. We decided that Frankie 1500 is the stress-free option, which implied Tommy 2000 is the stressful route, but so much of that stress disappears with a professional in your corner.

[ Learn More: 3 REASONS IT PAYS TO HIRE A PROFESSIONAL PROPERTY MANAGER ]

IN SUMMARY:

Whenever it comes to investing and markets in general, it’s those who are creative and can find value where others don’t who typically get ahead. While commonsense says get as much of the value the market allows, you may want to explore how a different approach could be beneficial. Like Greg did in his video, it never hurts to think about an alternative path. As a property management company with a decade of developing best practices in hand, we pride ourselves on adding value to clients’ portfolios. Thinking outside the box is one way to either discover stronger opportunities or help prove that the typical play is the best one. Don’t just blindly accept advice without testing it.

As always, your approach comes down to why you got into investment and what your personal goals are. Be true to your basic principles, not what’s trending on social media or in the headlines, to ensure you keep your eye on long term success. Be sure to reach out to our team if you have any questions or want to learn more about our services or franchise opportunities.

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Mick Lefort is the Vice President of Operations for Nexus Property Management®. A National Property Management Franchise that manages all types of rental property from single family homes or condos to large apartment buildings and complexes.

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