Being a good landlord is also good for your bottom line.
Last year my partner and I bought a building in a transitioning neighborhood here in San Diego. To put its condition bluntly, it needed help. As landlords we’re often faced with the question of how much to do and when.
After putting out all the upfront money, the last thing many investors want to think about is sinking even more into a project. Many times minor cosmetic changes are all that’s necessary to raise the rent- especially in a market with a supply as tight as we have in San Diego.
How much work do I need to do, how much do I want to do?
In the case of the building we bought a year ago, leaving it in the original condition wasn’t an option. Living conditions were unacceptable and even unsafe, so it was our obligation to make repairs. The question became how far to take the upgrade.
While I understand the temptation to do the minimum, I prefer to remember that by taking on the responsibility of a property, I’m also somewhat responsible for the people who live there.
The tenant’s point of view
It’s not hard to see the situation from the tenant’s perspective: everything a landlord does to improve the property makes life better and easier.
- LED light fixtures and new appliances mean lower electric bills.
- New low flow toilets, showers and plumbing, and zero-scaped common areas contribute to water conservation.
- Upgraded common areas give people pride in their homes.
- Addressing tenant complaints and issues in a timely manner makes the tenant feel respected and that he’s getting value for his rent.
From that same point of view, while tenants are probably not thrilled with the rent increase that these upgrades demand, they also see and appreciate the value they receive in exchange. It’s a fair tradeoff, and one that allows you, as a landlord to feel you’re treating the people who live at your property as well as you’d treat a member of your own family.
The landlord’s side of the equation = Let’s do the math
“But,” many landlords argue, “I simply can’t afford to commit to that kind of capital outlay all at once.” As I always do in moments of doubt, lets look at the math.
Say the current average rent for a studio in below average condition is $600 and you could raise the rent to $750 without tremendous turnover expense. So you’ve done nothing for the tenant, but you’re making an extra $1,800/unit/year. Not bad.
Ok, now lets imagine you spend $5000 upgrading that same studio unit and now you’ve increased the market rent to $900. So now you’re making $300 more per month than you would have. But for the sake of this example, lets just focus on the $150 extra you’re able to charge because of the upgrades.
After vacancy and expenses, say that $1,800 gives you a $1,000/unit/year increase to your Net Operating Income. At a 5% cap rate, that increased the value of your building by $20,000.
So, for your $5,000 investment, your building is potentially worth another $20,000. Without refinancing and pulling money out shortly after the rehab, it may take 5 years to recoup that $5,000 investment/unit. But, you’ve also done yourself some more favors in the process.
Even more up-sides of that $5,000 investment.
- Moving forward with new appliances, plumbing fixtures and ¼ turn water shut offs, etc. you’ve probably reduced your total repair and maintenance expenses.
- Even if cap rates go up to 10%, you’ve still doubled your money by increasing your net worth and the building value by 2-4 times the $5,000 capital investment.
- By making it a nice place to live you’ve probably reduced long-term turnover.
Doing the right thing really does pay.
Time and time again, I find that upgrading a property far outweighs the shortsighted benefits of not doing anything at all. By giving people a good place to live you’re also making an investment in the community – which benefits you in the long term and increases property values in the area.
And, as always, it helps when you can look at a situation from several angles, and the math is on your side.