renting to friends and increasing rent.

melissa&mark · August 2016

We purchased a rental property in 2012 and decided to rent it to our friends who were in the process of house hunting for a home of their own. We rented it to them for slightly less than market value at $1650 per month and we had a positive cash flow of about $200 per month.

Fast forward four years....Property values and rents have gone WAY up in our area which made our friends unable to buy a house so they've stayed in our rental ever since. I've increased the rent very little over the years and they're now paying $1725 for a house that we could easily rent for $2,400 per month. I never minded a whole lot that we were below market rent because to me $2,400 is crazy and we still had a positive cash flow of $300 a month.

We recently refinanced that property and took 75k out to use as a down payment on a second rental property which has made our $300 positive every month turn into a negative of $175 per month. I would love to get their rent up to $1900 so we would at least be breaking even and they'll still be below market value but I don't feel right about giving an increase of $175 all at once. What would you do?

Also, our friendship has turned to almost non-existent at this point. We've both gotten busy with life and don't see much of each other anymore. I got super irritated when we got the appraisal done for the refi and I asked her if she could make sure yard and house looked good and she said they were busy and hadn't been feeling well so my husband had to go mow their lawn! You pay WAY below market rent and you can't even mow your lawn when I gave you 3 days notice!

Lastly, don't ever rent to friends!

AprilZ81 · August 2016

Part of me feels like they shouldn't be "punished" because you guys made the decision to refinance the house and pull money out, but I realize that isn't the overall point.

If you aren't concerned with maintaining the friendship I would send them a notice of a graduated rent increase to get it to fair market rent value. It is one thing to do a short term favor for friends, but at some point it has to be a business decision.

I would give them 30-60 days notice (depending on what the lease says about rent increases) of the bump up to your break even point, then I would raise it a little bit more in 6 months.

Also be aware that this might cause them to leave and it could sit empty while you find another tenant AND the new tenant may not be so great.

short+sassy · August 2016

Haha! I actually just gave advice in your other post that it is time to give your friends notice near the end of their lease...or now if it is month to month...that as of Y date, the rent will be raised to X.

You're essentially giving your friends a lot of money every month towards their living expenses...and now it is out of your own pocket instead of out of the profit.

The fact that you all chose to increase the mortgage on the house by doing a cash-out refi has no bearing on the decision.

Because they are friends, I'd probably give them 60 days notice of the change versus the more typical 30 days (obviously follow your jurisdiction's requirements for notice). But I would charge at least the $175/month that is now the difference. Which is still WAY below market. I'd even let them know what is going on and the reason for the large increase. I'd also point out the going rate for rent in that area, ie showing that you are still giving them a big break, but just can no longer afford to keep the rent so low.

If they can't afford it, than they can leave. You have already been very kind, but it is not your responsibility to help support their life style. They might have to find a smaller place. They might have to find a place with a less convenient location. But that's life and that's what happens sometimes. Whether you are the landlady or someone else is.

melissa&mark · August 2016

@short+sassy I totally agree with you and say this to my husband all the time, but saying it and doing it are different things and I just feel bad about it. I'm just being too nice about it but I need to try to get over that.

@AprilZ81 sometimes I feel the same way about it not being their problem that we decided to refi, but even taking that out of the equation bottom line is they're paying $675 below market value! I do care about our friendship though which makes this really hard!

brij2006 · August 2016

I would take the fact that you refi'd out of the equation when it comes to making this decision.

However, I would sit down with them and let them know that the rental market has changed drastically over the past 4 years and you need to make some changes in order to keep up with that and watch your bottom line. I would also pull a few comparables to have available to back the rent you're wanting to charge. Since these are friends I would also give them 90 days notice but also still keep it below market value so they are still getting a deal for the area. I personally would increase it to $2,000/month and let them know that there will be annual increases of 5% to keep up with the market. That way you aren't sitting down with them again in a few years and having this discussion again.

Another suggestion, this seems to be pulling yourself pretty thin as far as a rental investment sounds. There isn't any room for vacancies or extra repairs. How were/are you planning to handle those if they come up? Also, is the market booming and increasing at such a drastic speed that it will likely crash sometime soon? I know that this is after the fact but the cash out refi doesn't seem like it may have been the best idea at this point so it sounds like you're backpeddling a bit and wanting to make up for it somewhere. That is why I would take the refi out of the equation when it comes to the discussion with your friends on how much rent you're charging.

melissa&mark · August 2016

@brij2006 thanks for your input. Well the plan was to buy a second property and if we charged market value rent it would make up for the negative on our current rental so we'd still have a positive of about $300 per month between the two. But prices are going SO crazy that unless we see an amazing deal I've decided to hold off for a while, so you're right we definitely could have held off on the refi.

That being said, I still feel like we're in a good position with our current rental. We were able to take advantage of low rates and even after taking out 75k we still have about 200k in equity. I've never spent any of the rent that was profit so we have a maintenance/vacancy account of around $10k which is where I'll pull the $175 deficit from each month. Since that deficit isn't coming out of our regular spending we won't feel the effects of it, but it would obviously be much nicer to add $500 a month to that account instead of going backwards. I'm also a realtor so when we buy a new property I'll immediately put my commission (which will be around 10k) into an account for that property.

brij2006 · August 2016

I know this wouldn't make any sense right now since you just did a cash out refi, but this is my thoughts on your current situation.
If it were us in this situation and the market has exploded in the area to where it will take a lot of money to take on another property. We would actually take that $75k and put it back toward the principal on the rental property. Even if you refinanced it again to a 15 year mortgage, I bet it would give you a larger net income off of the rental. Since the principal would be lower, the payments will be lower. In turn causing your net income to increase since the mortgage payment would be less.
We're pretty debt averse though, but I would definitely run the numbers if I were you. What would it look like if you refi'd to a 15 year mortgage and put that $75k back toward the principal on the house? Would you then have a $500/month income on the rental? I would still increase the rent to keep up with the market though.
I would also take the entire net income on the rental and put it toward the mortgage. Especially since you already have $10k saved for incidentals on the home. The point being with this is that the sooner it's paid off, the quicker that entire property becomes 100% profit with every month of rent.
In the end things may end up balancing out. If you take $75k to put toward a different property and finance the rest, your net income from that property as well as this one may be the same as it would be on just this one alone with a lower mortgage payment, yet there's a lot more risk. It's also a good idea to run the figures even if you stay at a 30 year mortgage but put the net income toward the principal. The point being is that whether you have 1 property or 3 properties with equity split out amongst them, it most likely will end up being pretty close to the same amount of equity at the same time and the same amount of net income, just less stress/work in 1 property.

Erikan73 · August 2016

I think it's ok to raise their rent, but maybe do it more gradually? Right now it sounds like you have good renters. If you increase their rent too much too fast you risk losing them as renters. Then you have to find new tenants and your house could sit empty until you do, meaning no income. I would discuss with your husband a percentage increase and let your tenants know now then that you would really like to bring the rent up to current market value but you don't want to hit them too much in one year so that going forward, the rent will be going up x amount until the rent is more in line with the market. This gives them time to adjust their budget, shop around and compare, or save up to buy something of their own.

renting to friends and increasing rent.

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