Should I increase the rent?

When I first ventured into the property management business in Toronto, I didn’t always increase the rent for existing tenants annually. The thought behind this was that we wanted to keep good tenants and we felt bad about increasing the rent. However, we quickly learned that not increasing the rent is a big mistake and here is why.

Selling your investment

In Toronto, housing prices have increased by 28% between 2005 and 2010. But, if you were to add up the allowable Rental increase for the same 5 years you would only be 10%

Even compounded the rate isn’t much better. Likely if you try to sell your investment property and have not at least increased the rent by the annual allowable amount, your rent will impact your ability to sell the property. Or you might not command the value you deserve.

In the real estate sales world, investment properties are valued based on a few factors. Cap rate, “ratio between a properties net operating income and its value” and Cash flow which looks at how much money is left from rental income after all bills are paid. If you haven’t increased the rent, this will negatively impact both of these measurements. Your property might sit on the market longer, get lower offers than the property is worth or you might not be able to sell the property at all.

Maintenance

With less income from the rent collected you will have less capital to spend on maintenance. This might not seem like a big issue, but after a few years the property will definitely begin to show signs of neglect if you haven’t maintained it properly. This means when your tenant moves out, you might not have the capital to complete small upgrades and command a higher rent which is a vicious cycle. In some cases, you might even have to decrease the rent!

Cash Flow

Probably the most important factor of all is cash flow. The difference between a Real Estate Investor and a Real Estate Speculator is cash flow. Banking on the market to grow and appreciate is a position that speculators take. What happens if it doesn’t? What if interest rates go up or unemployment takes a turn for the worse? When the real estate market panics many speculators will be run for cover. Investors on the other hand are less vulnerable to market swings. They focus on buying properties that positively cash flow. Banks and mortgage brokers love these types of properties because of their debt service ratios (http://www.cmhc-schl.gc.ca/en/hoficlincl/moloin/molointo/molointo_004.cfm). This is where consistent rent increases help weather the storm; provide channels for acquiring more properties or help when it comes to refinancing. Intuitively, as you increase rent, you increase cash flow (baring all other variables stay constant). There are exceptions to the rent increase rule for instance: the economy takes a major dive, jobs become scarce, high vacancy rates exist and real estate values go down. When the above factors come into play, you might want to wait a bit before you increase the rent.

However if you always impeccably manage your property, even when the cycle of harsh times arises, you can still justify a rental increase and your bottom line will thank you for it!

Mekler Property Management offers property management services in the Greater Toronto Area. For more information, please visit us at www.Mekler.ca - We help you be a landlord without being the landlord!

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