I just mailed a batch of renewal letters for leases expiring April 30, 2012. All of them include rent increases, but most tenants will still be below market rent value even with the increase. More on that in a minute. Furthermore, many tenants will be paying a rent amount lower than the rental rate the house would have rented for 11 years ago. No, I’m not kidding. Austin rents peaked in 2001 and we’re just now starting to get above 2001 rates on some properties.
My Approach to Lease Renewals
I’ve been renewing leases in Austin for 22 years. I’ve mailed thousands of renewal letters. During that time, in dealing with tenants who are trying to decide whether to stay or go, I’ve noticed something interesting about basic human behavior related to lease renewals.
First, an increase above $50/mo. seems to trigger in many tenants in Austin a negative emotional reaction, causing the tenant to feel slighted, even if they logically understand the reason for the increase and the data supporting it. This results in some interesting phone conversations where a tenant confesses to knowing that the increase is fair, but it still makes so them so mad they might move.
Even though we all know that, in normal times, rents, like everything else, will increase 3% to 5% annually, there is something unique and interesting about that $50 threshold. At $50 or lower, renewal success rates are pretty high for most Austin Property Managers. Rent increases above $50 trigger complaints and more move-outs. That’s the reality of it. It’s been that way for as long as I remember.
Therefore, even in a hot rental market like the one in Austin 2012, if you’re my tenant, your renewal increase is probably about $50/mo. because I want you to stay and renew the lease. If it’s higher than $50, it means that a $50 increase would have resulted in the rent being so far below the current market rate, that a turnover will still be in the owner’s best economic interest.
For Owners: Why Don’t we Always Raise to Full Market Rate?
Because if doing so causes a turnover, you lose the gamble. Let’s say a tenant is paying $1,495/mo., and has been a good on-time tenant causing no problems or issues. If the tenant is paying $1,495 and the market rate is $1,600, and I raise to $1,550, that’s still a healthy 3.3% increase, and it increases the chance for a renewal greatly. The “turnover avoidance” is more valuable than the extra $600/yr. we might have achieved with a bigger increase.
If a more aggressive increase to $1,600 results in a move-out, which will typically cost the equivalent of about 3 month’s rent in vacancy loss, leasing commissions, and makeready, then that means you suffered a $3,000+ turnover expense as a result of an attempt to achieve an additional $50/mo rent increase, or $600 for the 12 month renewal term. That’s not a wise financial gamble.
For Tenants: What if Your Renewal Increase Was For More than $50?
Let’s stick with the scenario above and say that your $1,495/mo. lease is for a home than now has a market rent value of $1,800/mo. And let’s say I’ve raised you to $1,650, a $150 increase. That’s a pretty big increase, but you’re still $150/mo. below market, and you’ve been even further below market value for the preceding 12 months or more. As much as I’d hate to see you go, the owner is going to recover the full cost of your turnover in less than 12 months, and will enjoy full market value rents going forward.
Furthermore, when you go shop for a new house, you’ll find comparable homes listed at full market value, so you’ll either end up paying more than your renewal amount for a comparable home, or you’ll have to downgrade to a lesser home to maintain the lower rent. Plus you incur the cost and hassle of moving.
Do Owners and Tenants Always Make the Right Decision?
No. Unfortunately not. I’ve seen an equal number of owners and tenants shoot themselves in the foot over renewal increases. It’s almost always because of an emotional urge by the owner to get more, or the emotional reaction of a tenant angered by the increase.
Luckily, at this stage in my property management life, with the batch of client owners I currently have, all are very reasonable and trust my decisions in setting rents. I don’t generally consult owners when setting renewal rates but instead follow the $50 rule unless it’s trumped by the 12-month recovery of turnover cost scenario outlined above.
Tenants lately seem equally reasonable and understanding, even when I do have to make an occasional “bigger than usual” increase. But 2012 is a year of fast-rising rents, so we’ll see how this summer renewal season goes. In March, I kept 7 of 8 tenants on renewal, and the 1 move-out was a job relocation leaving Austin. That’s a ratio I’d love to maintain going forward.