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In this episode, we bring back the showdown! Tom and Michael debate whether you should maximize rent growth or minimize vacancy.   --- Transcript   Emil: Hey everyone. Welcome back for another episode of The Remote Real Estate Investor. My name is Emil Shour and my co hosts are,   Tom: Tom Schneider,   Michael: and Michael Albaum.   Emil: And in today's episode, we're going to be doing an old school style showdown episode. And today's showdown topic is going to be rent growth versus vacancy.   Emil: All right, before we get into this episode, guys, we mentioned that we were doing a little giveaway to help us get over 100 reviews and we are now at 103. So thank you everyone who answered the call there and left us a review. We're going to choose two people at random here. And if you guys just reach out to us, we'll get you some some goodies. So first winner, drumroll please. First winner, Big Red 13 Thank you big red 13 for an awesome review. And let's see here. Our second winner is going to be drumroll again please.   Tom: Papa, papa, papa. Boom.   Emil: All right. And our second winner is Bobby tonsils. Bobby tonsils. Thank you for an awesome review as well. So if you guys just want to reach out to us, I'm at eshour@roofstock.com, Michael is malbaum@rootstock.com and then Tom is just tom@roofstock.com . Just reach out to us. Let us know we call your name. Since these are kind of like usernames, we don't know your first and last name. So just reach out to us. And we'll use the honor system. And we'll send you some goodies. Thank you guys so much. So let's hop into this episode. Alright guys, so today's showdown is going to be rent growth versus vacancy. And this is a good one because I think it is well debated. And there's good points to be had on both sides.   Michael: But there's better points to be had on my side. So let's go That's right. Well,   Emil: what is your side? Michael? What's that? Are you taking on this showdown?   Michael: I'll take the stance of rent growth because I think that's the more difficult position and I want to be a gentleman and give these your position to Tom to start.   Tom: A lready handicapping himself already sowing the seeds of defeat. I'm gonna reap a lot of failure harvest, okay, go ahead.   Michael: Good thing I studied Agricultural Engineering. I'm the best harvester in this group.   Tom: Oh, yeah.   Michael: That's like such a tough comeback. Like, Oh, yeah. Yeah.   Emil: So Tom, you're taking the side then of vacancy?   Tom: I'll start with vacancy. And then in tradition of the showdown, we'll switch it up.   Emil: By vacancy, we mean, making sure are trying the best you can to not incur a vacancy. Right.   Michael: Yeah, I guess that's good. Clarify.   Tom: Yeah, well, let's clarify the bait first. Yeah, they can see versus rent growth.   Emil: Yeah, like, We're not saying we want vacancy, we want to not have vacancy. So the question is, do we do all we can to keep the tenant in place, and maybe not charge higher rent, lease renewal, or we always go in for rent growth. So who wants to kick us off?   Tom: Well, in format, right, one side starts the other robots, and then the initial side gets to go again, Michael, why don't you lead us off, just cuz I feel like, you know, there could be some upfront bias on both sides. So sure, go ahead, lead the way. And then you'll then we'll change the order next time around.   Michael: I appreciate you baiting me now. So that's great…   Tom: Gentlemanly move, just trying to…   Michael: Humble brag. So I think it's so important to maximize rent growth, and really prioritize that over vacancy for a couple of reasons. One is when it comes to property performance, if we're maximizing rent growth, that's gonna have an immediate impact on the property's performance. And, as a lot of our listeners know, I'm a big fan of multifamily investments, I own a lot of multifamily investments. And so, minor incremental rent increases on a property on a per unit basis can have really profound impacts on the noi of a property and the ultimate value of a property.   So let's just walk through a quick mathematical example, if I can increase rents $15 a month on a 10 unit building, so that's $15 a month across 10 units at $150 a month in additional noi, if I multiply that number, then by 12, that's 1800 over the year, if that building is valued at a 5% cap rate, I'm going to divide the increase in noi by the cap rate to get my additional value added to the building. So when I take 1800 divided by point O five that's $36,000 in value I've just added to my building by increasing rents $15 a month per unit. Now that's mind boggling when you think about that and the power to do that is also mind boggling.   So when we Think about rent growth, it's in addition to having a profound impact, potentially profound impact on the value of the property. I think it's also important to just be reasonable and fair with your tenants. And so if you can increase your rents incrementally year over year, as opposed to keeping them stagnant and then having to hit tenants with a massive rent hike down the road, I think you're treating tenants a bit more fairly. And I think a lot of people expect minor increases, as they do with just average inflation, the cost of living the cost of goods and services costs more year over year. So of course, why wouldn't the rent keep up with that year over year? Mike, drop exit stage left? Tom, you have the floor?   Tom: All right. You know, before I like to talk about stuff, just quickly, defining our terms, right. So this is a debate about do you want to be penny wise, pound foolish and what I mean by that, if you are 100%, about rent growth, you're going to be pound foolish, you know, you may try to increase and jam on your tenants an extra 10 bucks, 15 bucks, 50 bucks a year. But ultimately, you're the one that's going to get jammed, because that tenants going to be like, No, thank you, you are jamming me, I'm gonna move somewhere else. Like, it's, it's stress. I don't if you guys ever rented in a place and every year, your landlord jamming you 25% I got out of there as quickly as I can. So that's the Pennywise great, you're earning an extra 10 bucks, you know, hundred and 20 bucks a year awesome pound foolish, you're going to run into vacancy, you're going to have people get leave, you're going to have people basically have the house open, where you calculate how much it costs to do a turn, versus those incremental increases in income that you're getting by raising the rent, the math speaks for it self, you're going to want to be have that occupancy, the weight of the costs that you have on a turn greatly, greatly are going to exceed those marginal benefits that you're going to get by raising the rents a little bit.   And also, if you have a good tenant that is paying on time and keeps the house in great shape, what a great way to mess up your investment by just continuing just poking them with needles with little increases in dollar rent, you know, do you want to be a needle poker, I don't think you want to be a needle poker I think you want to be an effective investor who is making sound decisions. And being Penny dumb, pound smart by really thinking having the big picture and making it work.   Michael: I love that you use this analogy of poking holes in the tenants because I want to come back to something that you've said over the years and that's being long term greedy. And as your expenses increase year over year, your property taxes might go up incrementally the cost of goods and services is likely to go up incrementally, your returns are now getting those same pin holes poked in them poke, poke, poke the return, poke, poke, poke your return, and you're going to start bleeding. And there's a phraseology out there death by 1000 cuts. And so how do you reconcile with yourself or with the potential return that you keep your rent stagnant while you then have to eat those additional costs year over year?   Tom: You as a savvy investor, you know, there are ways that you can look for more competitive rates. Because a lot of those costs me one of the beauties about real estate investing is you get these fixed costs, right, you lock in a lot of things, you fixed financing rates, taxes may move a little bit. But if you're proactive about them, you can make a case to the county and keeping those nice and low. So win win situation, you manage a few of those costs that might move a little bit of time. And you manages the expenses that related around terms by not incurring them by keeping your tenants in the house by keeping that vacancy number low.   I mean, every investor needs to look at the balance sheet of their property. And what's going to come up quickly come to the conclusion that you know, there's two ways to make money as in business as an investor. In any case, minimize your expenses, maximize your gains, and sometimes there's a little bit of trade off and in this question related to keeping your vacancy low or increasing your rent growth, it's a pretty simple equation, keeping your vacancy low you're gonna win.   Michael: Yeah, I agree. The equation is pretty simple, but $36,000 in additional equity is a pretty amazing. Emil care to step in here?   Emil: All right, guys. Yeah, you guys are starting to throw haymakers. So I'm gonna step in here.   Michael: It’s a bloodbath.   Emil: Yeah, it's there's there's blood everywhere. You guys both bring up good points. Michael, just to clarify your example there, increase in value that will typically be seen only on a commercial property. So in our case, talking about housing, that's a five plus unit building, right? If I own a single family up to a four unit building, increasing the noi doesn't really have an effect on the value of the building because it's not valued on cap rate is valued on sales comp,   Michael: Well if you sell it to an investor, but when if someone comes in to buy that building the bank with a mortgage, the bank is likely going to still make them get an appraisal and the appraisal is going to be based on comps.   Emil: Yeah, that's a good point. If you are able to raise the rent you are making it a more attractive investment for another investor right? So if you're selling it Yes, as an investment, you're right. It will be attractive even if it's not valued on cap rate. So good point there. And then Tom Really good points in turn costs, right? Like anytime you have a vacancy, those are one of the biggest of the like times where you have the biggest expenses or you can write, especially if the tenant has been there for a while, there's been a lot of deferred maintenance. I know personally, like whenever I've had a turn, that's when I have the biggest RaM costs. So and that's not even account   Tom: Plus no income. What's your sorry, I just took it right out of your mouth. I saw it in your mouth. I took it right out.   Emil: Come on, man.   Tom: Go ahead.   Emil: You're in your corner Tom. Is the referee speaking? The bell has rung. You guys both bring up various solid points. One thing I have this one property manager who every time the lease comes Do they have these three levels of rent increase, right, so they'll have like, aggressive, normal, and then do nothing. And so aggressive is like, Hey, we're gonna raise rent X amount. To get right up to market, the standard one, which I always go for is like a smaller increase. But what they say is that if the tenant looks like they're going to leave, because of the rent increase, they'll work with them to basically either keep rent the same, or maybe only increase it half of what they were going to do or something. So it's basically they're going to propose it and be flexible, obviously not going to say it up front. But when push comes to shove, they're going to be flexible with the tenant, versus instead of just saying no, this is the rent, increase, take it or leave it, that kind of deal. So I've always actually appreciated that what we're doing these consistent rent increases, but they're small, and we're willing to work with the tenant. So we don't have a vacancy. So let's switch roles. Tom, you're going to take the rent growth side. And Michael, you're going to take the reducing vacancy side. And hopefully let's let's not try to touch on anything that the other has already said. So better rack our brains for four cases. Michael, you started last one, Tom, kick it off.   Michael: Let's touch gloves, Tom.   Emil: Ding, ding.   Tom: All right. You guys feel that? It’s the winds of change. Historically real estate, as an investment, at least in the single family space has been limited to sales comparables. But it's a really flawed system for a variety of reasons. It's why commercial uses return base. And I think the winds of change is single family rental is going to go in that direction too. Just because the value of an investment, it shouldn't have to be with some arbitrary value of what the home's next to it is. It's it's what are you getting on that return? Right. So I think that over the next five to 10 years, there's going to be a dramatic shift in the way that valuations are done with single family rentals and being able to get debt based on what kind of returns you're getting. Because you know what, this is an investment and you know what the value of an investment is what kind of returns you're getting. So in the ability to increase the value of your home by continuing to push up that rent, it's really impactful and just playing defense and not necessarily pushing it up, you're leaving money on the table.   And I think this is going to be the shift that's going to be happening over the next several years with single family rentals, and the ability to get that in the same way that you're able to do with commercial stuff kind of a little bit repetitive, I'm going to say this is a Gandhi quote, Be the change that you want to see and the kind of change that I love to see his rent increases. So to that point I was talking about earlier, generally speaking, it's pretty fixed costs. So you know, say I am getting a return on a property like a cash on cash, like whatever 10% or something when those rent, when that rent increases, Ooh, baby, that's just like going directly to my net operating income. So be the change that you want to see. And that change that you want to see is rent growth and more annual increase in the rent that you're collecting.   I think also to not really piggyback but there's a couple of other values in increasing the rent. By doing it, you are creating general market pressure that other landlords are going to see. And it creates sort of a wave effect, or that's not the right word to use wave effect. But it has a bit of a compounding effect in that when you increase your rent, it creates a market comp for every other landlord to continue to tweak up just a little bit. And over time, you are helping that market rent increase by increasing your rent just a little bit. Now I'm not saying you want to necessarily jam it up, and it should be reasonable. But by sitting back, you're letting the market rent as a whole stay stable when you could be contributing to comps that is going to raise pretty much all market rents. So are you a market leader? Are you a market follower? I don't know. saw me someone pulled my mic. Oh, my mic.   Emil: All right. All right.   Tom: Those are all really great points. And clearly, you're going to be the Pioneer with the arrows in your back. The first one's always are. I never want to be the first one to do something in a market because there's a high degree of failure that can occur. So, you know, I think that's a really interesting point you make about being the comps are typically based on numerous I think are based on numerous indicators, not just a sole or single operator owner. And so I don't know if we can say that one, your rental being higher than the others is going to increase and raise up some of these other rents. And I just think that they can see is the fastest way to kill your returns on a property. And so like you were mentioning, if you are juicing your returns by increasing the rent, and your fixed expenses stay fixed, that the return is only to increase, if we have a month of vacancy, I mean, that could just decimate an entire year's worth of cash flow.   And to make an extra hundred hundred and 20 150 bucks annually, the risk reward is the risk is a full year's worth of cash flow and the reward is an extra couple hundred bucks maybe just doesn't seem worth it to me. And then, as you mentioned previously, this is when you have to take care of all your turn costs. So not only are you losing out on all of the income, but now you're forced to reckon with all of the repairs and maintenance issues that are needed. In order to get a new tenant in place, you're also going to be slapped with a new tenant placement fee. If your property manager charges one, you're also going to have to pay for any utilities that are associated with that property while it's vacant. So I think a lot of people don't really tally up all of the totals associated with losing a tenant and placing a new one. And I just think the the risk reward scale tips very heavily and very rapidly in favor of keeping a tenant in place even at a slightly lower than market rents.   Emil: Tom, you get final rebuttal.   Tom: You know what Michael? I agree. Wait, hold on, come on. Come on, Tom, get your face on get your game face on.   Michael: Get this guy some coffee.   Tom: Yeah, you're you're either making plays Michael or you're getting played? Right? Way. All right, Tom. Okay, we're not talking about Armageddon. We are not talking about raising the rent, you know, over the market rate, we're talking about just slow, steady, incremental, I think being reasonable with your tenants. But what I'm advocating with increasing market rate is not, you know, throwing a hail mary and increasing it to the tippy top of the market, I'm talking about just incremental steady increase in rent. And over time, if you make these steady, reasonable things, you know, increases, not only are you going to see your returns increase, you're going to increase the value, not only the immediate income, but also the value of your property, as we talked about the winds of change, thinking about the value of a home on a valuation basis, which, you know, I'd say, to be honest, isn't really the status quo now, but I think over time, it's going to be going that direction.   But my final point is, it's not about these huge rent changes, it's about just being putting a little thinking about it. And subtly making continuing to make those improvements over time, and not getting so below under market and just kind of keeping up with the times right with what the rent growth is. If you can increase the rent less than the cost of move, you should know what those values are, and you know, have an open discussion with your property manager about what they think. And really, that's the best way to go about is to have an open mind. But Michael’s here old, don't ever change the rent strategy. Now you're just leaving money on the table. I wouldn't want to leave money on the table, would you?   Michael: I'm going to speak on behalf of all renters because I was one for a very long time and we make impulsive emotional decisions. If you raise the rent on me out, you just solidified a way to lose every single one of your tenants every single year. Congratulations.   Tom: You sound like a renter I don't want, good news. I just put in built in laundry, you don't get it now.   Emil: Back to your corners back to your corners. Gentlemen, a great show, please cut me I don't really have anything that I think we hit the pros and cons of each. I want to dive deeper with a couple questions. follow up questions for you guys. What about when you buy a property that already has tenants in place? And they're like, a couple hundred dollars under market rent? What do you do there?   Tom: First off, that's such as a great way to find deals or properties that have undervalued rent. I love that as a strategy. And to answer the question, I don't think first you're honoring the lease, it's their, their lease that they have, I would gameplan it with my property manager, I would first get an assessment of the house and of the tenant and if they have a long track record of paying on time and the property is still getting like reasonable returns, I know that I have a big pop in rent growth at some point in time, I wouldn't see necessarily see a reason to move it like immediately. I mean, there could be some states like California where you you know there's rent control and there's nothing you can do about it but even in an area if it doesn't have rent control if the property is continuing to operate well, you know, as they're paying their rent and isn't really bad repairs and maintenance. I'm okay just floating on that lesser cash flow, knowing that there's this big pop at the point at which the tenancy ends.   Michael: I think it's a super great point, Tom. And I would say it depends too, on how you bought it. And so if you're buying it, and it's performing well, like Tom says, great, if versus if you're buying on pro forma. So let's say the rents at 1000 bucks and investment only makes sense that you can get 1200 bucks for the property and market rents call it 13. So you think it's very realistic to be able to achieve that 1200? Well, are you forced to move it to 1200 in order to make the returns work? Or is it okay at 1000. And you can wait until like Tom mentioned, the lease ends, and then we can bump it to 12 or 13. So it depends on how you bought it, I would argue that you should be buying it based on today's performance and recognizing future value add opportunities, like raising the rent.   Tom: I'm nodding my head over here a great point, I think in evaluating it and buying it, you shouldn't put on pink rosy glasses, you should just assume that for whatever reason, the 10s are gonna be there for a little bit, and just have the Yeah, today's rates in the way that you're evaluating it and knowing that there's some pop on the other side.   Michael: And also, if you keep the current tenant in place, or tenants in place, and you're getting some cash flow, you can start to build up your reserve for when you ultimately do raise the rents if that tenant or tenants ultimately leave. So you can align your pockets a little bit, so to speak, for that inevitable expense for that vacancy expense, and all those other expenses that we talked about in the episode.   Emil: Awesome. I like that I bring this up. Because I mentioned on a previous episode, I'm in contract for a three unit building. And it's definitely way under market rent on two of the three units. And I'm going back and forth on this personally, right? There's there's one tenant who their lease comes up in February, there's another one who's month to month, and I'm asking myself, Well, should I get it to market rent right now? Or do maybe something a little bit lower, wait till there's like a natural vacancy. It's still cashflows at the current rent, but obviously, I want to get it to market but I'm also trying to buy other properties, I wouldn't want to have a turn that is expensive right now. So it's like, Do I go buy more property and kind of just sit and wait on this one a little bit to raise rent, and have turns, or do I just do it now? So some of them I'm debating myself   Michael: Something to think about that I've used in the past as a stair step increase, where there are $200 at our market rent, you raise it $25 every other month, until you're in line with where you need to be keeping them month to month, so they can leave at any time, you can raise rent anytime, but you kind of talk about that or you know, $50 a month or whatever it is, but just in a way to ramp up into it. So it's not such a drastic increase. Because I think there's there's a pretty sure fire way that most of your tenants are going to hate you because you're the new owner jacking up the rent now, like Tom was mentioning, and so if you can just tell them, Hey, this is how this is going to work this, you know, this is why we're doing it and just have that open dialogue with your tenants. I think that makes that a much easier pill to swallow.   Tom: We are in a super weird time, like in the middle of a pandemic. So, you know, I'm not going out of my way to jamming any tenants on on rent, like if they have a place that they can live in. So I think that fits into an a broader discussion at least, which is like specific to now like a human being human about it. Like it's my last little tidbit.   Emil:  100%   Michael: No, it's such a good PSA.     Emil: Yeah, absolutely. That's another part of it, right? Like one of the tenants has a daughter. So it's a family there. And it's like, okay, we can bring the rent out. But a lot of people are going through some tough times right now. And it's like, again, property cash flows, can we do some, you know, solid by the tenant and wait till things kind of just get better as a country and do it then?   Tom: I think it's a misnomer that as an investor, you need to like jam everything.   Emil: Yeah, one last thing to say here. I think this is where your property manager is so good to lean on. They've done this a million times, right? Like they know, how much can we raise it? What are some good tactics to potentially keep them but raise it. And so like just having the conversation with the leasing agent, whoever your property management team to like talk this through and figure out what's a good strategy. Any other tips you guys kind of have in terms of when you decide to raise rent versus keep things that steady?   Tom: My tip would be to know what market rent is. So you know, you may change it, you may not. But you should know what that value is kind of in the same way that you know what the, the value of the home is, you should know what the value of the rent the market rent is, it may not necessarily be actionable. But just to kind of know where you sit is an important value. Even if it's not the current round, knowing what that market rent is, I would say to know that at any point in time.   Michael: Absolutely. And also if you are going to be raising the rent, if you can raise it and you're okay with being a little bit under market rent, that can be a really great way to go to because if folks are going to move they're likely going to look to move in the same neighborhood. And if all the properties are more expensive than where they currently are, well that's a really great reason to stay put. So again, just being aware of what's going on in the market. What the markets commanding.   Tom: My last tidbit is had calls with respect khadem II with with members talking about properties being vacant, it's like well, your rents probably too high. You know, like it's a pretty simple equation with if your property's not getting rented and it's a safe capital property. Take a look at what your rent is that look at market rent, look at how your property can be hairs and work with your property manager and you use one where it may make sense to adjust the rent just because as Michael was alluding to earlier, like vacancy kills like as an investor you it's hard to make money if you're not have any income coming in the door and paying off all those costs that the drums beat every month, mortgage payment taxes, all that stuff. So really thinking long and hard if you do have vacancy, changing the rent to lower it.   Emil: And even the inverse right like let's say you list it and day one you have like 100 applicants or something that probably means you're on our market, right? So it's it's the same vein and the inverse, maybe you're under where you should be. If you're just getting flooded when you first listed.   Michael: Something I'm worked in through right now is I've got this multifamily building I just process a finishing rehab and we're getting units online slowly but surely getting them listed and they're sitting for a little bit longer than I would like and so knowing Okay, well this is how much I spent. This is how much we projected we could get for and rents. Do we lower that and take a lesser rent or is it just kind of a weird time in the universe right now we just rent is taking a little bit longer units are taking a little bit longer to get leased up knowing where that balancing act is is so tough, because you definitely don't want to take you know, a real haircut on your rent after you just spent a ton of money on rehabs. It's a balancing act for sure.   Emil: Guys, this is probably a good spot for us then this one. Thank you guys again for bringing everything to the table leaving no punch on thrown on thrown is that a word? I don't know. We say a lot of things that were like is that word is that a phrase? That's kind of just like our mo on the show.   Michael: just own it. Just say it like it's a word.   Emil: Just make up words and don't even correct yourself. Alright guys, well debated episode. Hopefully our listeners got a ton of value. And we will check you guys out on the next episode. Happy investing.   Michael: Happy investing.   Tom:  Happy investing.