I see it all the time… rental properties come to us with a current rent of $20, $30, and even $50 or $80 lower than market rate. The reason is a phenomenon I call “Rent Increase Inertia”. What is “Rent Increase Inertia” and what should Landlords and Property Managers do to avoid falling into it?
As a landlord of many years, I was often mift to find – whenever I had a chance to look into it – that my rent hadn’t increased in years and I was losing money! And if I was brave enough to request a rent increase, without exception EVERY SINGLE ONE of my property managers would try to discourage me…. “It’s a good tenant, we don’t want to upset them”… “There is an oversupply of properties in your area”…. “There are such and such issues with your property” OR “The market is bad at this point in time”…
Only when I became a property manager myself a few years ago, I understood some of the REAL reasons, and to be honest they are not that hard to guess. But let’s start at the beginning.
Rent Increase Inertia
The image below is a de-identified real life extract from a routine inspection we completed on a property we started managing recently. As part of our routine inspection, we always conduct a full rental market appraisal to make sure the rent is on par with market conditions. In this instance, our newly acquired property was an apartment on a highrise. Great little 1 bedroom property, occupied by a long term tenant who has been looking after the property well.
This particular property was rented for $400/week and it is on the 14th floor, with some spectacular district views. A quick review of the market at the time, showed us that 2 other 1 bedroom apartments were advertised on the same complex, both on lower floors and with not such great views. One of them was advertised at $430 and the other at $450/week! The one advertised for $450/week, was IDENTICAL to our property but 6 floors lower!
I then looked at the ledger we received from the previous agency, and to my surprise realised that the rent hadn’t increased in years! Our client was losing as little as $20 a week ($1040 a year) AND as much as $50 a week ($2,600 a year)! This phenomenon by which Property Managers don’t keep up with rent reviews/increases is one I call “Rent Increase Inertia” and sadly, I see it regularly on the properties we inherit from other agencies!
“Rent Increase Inertia” is the phenomenon by which Property Managers fail to keep up with regular rent increases, costing landlords thousands of dollars every year and a lot more in the long run!
To be perfectly frank, as a Property Manager I hate “Rent Increase Inertia”… I hate it because the aim of our agency and one of our main principles as a business, is to always be “fair” when we set and recommend to our landlords and tenants rent increases. “Fair” based on market conditions…. Fair for the tenant (who we understand has to make ends meet) BUT also fair for the landlord (who we know has a mortgage to pay). So when we inherit properties like this OR another that came to us recently whose rent was actually $80/week below market rate ($4,160 a year!!!), we feel we have an obligation to try and bridge the gap as best as we can. Unfortunately, when the gap is too big, the increases need to be more aggressive than normal. And tenants don’t like aggressive increases, and quite often decide to leave! When that happens, tenants “lose” as they have to move from a property they were happy with, and the owners “lose” as it will cost them even more $$$’s between having a vacant property and having to pay us letting fees! Not good for either!
The question then is why do Property Managers fall into “Rent Increase Inertia”?
There are many reasons but in my experience as landlord and understanding the property management industry, most of the time it comes down to TWO.
1. The first has to do with the relationship between Property Manager and tenant. The longer the tenant has been in the property and the better the quality of the tenant, the closer their relationship. The closer the relationship, the more likely it is that rents will be left unchanged for longer. Property Managers are human beings after all and as I often say “Property Management has very little to do with property and whole lot more to do with people and relationships“. Property Managers build relationships with people, just the same as everyone else. And the less problems they encounter with the tenant, the less likely it is for them to want to disrupt that relationship. Think about it… A Property Manager’s life is riddled with issues and issues create more work and stresses. So when a long term, model of a good tenant comes along, a Property Manager – often without realising it – will do everything they can to not upset them. In fact, in my experience, Property Managers are far more likely to be aggressive with rent increases on a “bad tenant”, in the hope that they will get up and go!
2. The second is the additional work rent increases create for Property Managers for very little reward. Rent increases are not as straightforward as they sound and there is a rigid process to follow, a process that starts weeks/months in advance…. This is additional work on the day to day life of a busy Property Manager for very little monetary return on the average increase. In addition to the highly regulated bureaucratic notification process, Property Managers [the good ones anyway] need to also pick up the phone and discuss with the [most likely] unhappy tenant, who will often try to negotiate (hence more work) but also has the right to refuse the increase as “excessive” (hence the risk of a LOT MORE WORK). Increasing the rent, is also often the perfect opportunity for the tenant to “suddenly remember” all those repairs and maintenance they were perfectly happy to live with previously, and coordinating those – once again – will create even more “unpaid” work! Best case scenario a rent increase done properly would be ONE hour’s work all up, worse case scenario THREE or FOUR hours if not more! And that would be 3 or 4 hours they didn’t have to do previously!
But “they will get paid for it” I hear you say “as the rent increase will also benefit the Property Manager”…. Sure, but let’s see what that actually is… The average regular increase on a $450-$600/week property – if done regularly – would be $10 a week OR $520 a year of additional revenue in healthy market conditions! Assuming an average management fee of 5%, the additional fee generated therefore for the agency would be a whopping $26 pre-tax over the following 12 months! Hardly enough to worth the hassles or the risks let alone the many hours of additional work a seemingly “routine rent increase” could generate! THIS IS EXACTLY WHY US PROPERTY MANAGERS DON’T LIKE RENT INCREASES AND SADLY, SOME OF US, WILL DO EVERYTHING WE CAN TO AVOID THEM!
Property Managers fail to keep up with rent increases because they either don’t want to disturb the relationship with the tenant OR because of the additional work they require, for little monetary reward for their efforts!
So what should owners do to prevent their Property Manager from the so called “Rent Increase Inertia”?
Our recommendation to landlords is to make sure to agree on a “rent review/increase” policy/schedule UP FRONT. The policy should commit the Property Manager to a rent review schedule, at specified intervals and at set increases – ideally as “small/manageable amounts”. In other words, agree from the beginning with the Property Manager when rent reviews will take place (6 or 12 months – the minimum your State’s legislation allows), as well as what the increase will be each time. This could be a set percentage of the rent OR a set amount such as $10/week. For the record, $10/week increase on a $450-$600/week and $15/week on a $600-$750/week property every 12 months, are my favourite increase amounts as in my experience are the most acceptable (not too much – not too little) for both tenants and landlords. They are also about enough to keep the rent on par with market value under normal conditions. That’s not to say that the Property Manager should “blindly” increase the rent by these amount. Circumstances change frequently – including the economy and the supply chain and demand – so common sense should prevail every time, but what will do having agreed intervals and amounts up front, is to force reviews to happen regularly and the conversation to occur between Property Manager and the landlord, and that is a conversation that will enable the Landlord – NOT THE PROPERTY MANAGER – to be in control of the rent review process!
Landlords should agree up front the frequency as well as the actual increase – preferably by small amounts – as a percentage of the rent or a set amount. That will remove a lot of the ambiguity, will force the conversation between Landlord and Property Manager and rent increases will be kept at a regular schedule and not “forgotten”.
And where does that leave the “busy” Property Managers and the additional work increases create?
The best advice I can offer, is that Property Manager should start making better use of the available technology! The easiest way to achieve the “regularity and consistency” is to utilise any of the modern softwares, all of which have a “Rent Review Reminder and Management” function that enables the whole process to be automated: from kicking off the review at a specified time, to notifying the tenant and owner, reminding the tenant closer to the date, and eventually adjusting the expected rent in the system, as well as scheduling the next review. Most of the work is done by the Software these days, but sadly from what I am seeing, a large cohort of us Property Managers still don’t make best use of the available functionality and, unfortunately, we should as it would make our lives a lot easier!
And what about the “unhappy” tenant and the additional work that a rent increase would create?
In my experience, the best way to minimise issues and also protect the relationship with the tenant during these “dreaded but necessary” rent increases, is to set the right expectations with tenants RIGHT FROM THE START. If for example, upon signing the agreement, the tenant is told of the agency’s policy to review and increase the rent at a predetermined time frame and the reason why this is part of the process, it will be a lot easier for them to accept it when it happens. And if the increases are kept at “manageable amounts” – perhaps using the “not too much, not too little” formula of mine, the process is guaranteed to be a lot smoother!
Using technology to automate the rental increases process and setting up the right expectations at the start of the tenancy agreement, is the best approach for Property Managers to avoid “Rent Increase Inertia”.
What is the big deal you may ask… As a Property Manager and Investor myself, my view has always been that EVERY DOLLAR COUNTS – ESPECIALLY IN THIS PERIOD OF THE PROPERTY CYCLE WE ARE GOING INTO. This year, a lot of investor loans – including mine – will be getting out of interest only and moving into principal and interest. On a standard $500K loan for example, the approximate increase in annual payments is expected to be about $2,500 a year! That’s is not small pickings especially if you happen to have 2, 3 or more properties!
Wouldn’t it be great if a large part of those new costs, were going to be covered by a fair rent increase this year and the same next? Wouldn’t it be even better if your great tenant was OK with it, too? I would think so…
In this phase of the property investing cycle we are going into, keeping the rent on par with the market over the coming years, may be the difference between holding onto or having to sell your property.
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NextGen Property Mgmt (www.nextgenpm.com.au) is a boutique Real Estate licensed agency that specialises in property management. NextGen Property Mgmt does NOT has a sales team unlike most other agencies that specialise in Sales and have Property Management as a side business.
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