As a landlord, it’s natural to want to raise your rent to keep up with inflation. But it’s not always easy to do so without causing tension. I recently found a way to do this smoothly when I received an unexpected automatic rent increase from my latest tenants. They pay electronically every month, and I had forgotten about our agreement to increase the rent annually.
Back in mid-2022, when my tenants first found my listing for a newly renovated rental home, I was asking for $8,500 per month. I hadn’t rented out a single-family home in San Francisco since 2017, so I wasn’t sure what to charge. But after checking similar listings on Craigslist, I thought $8,500 was a fair price.
I had just finished a major renovation of the ground floor, adding a bedroom, living room, full bath, small closet, hallway, and dedicated laundry room. This increased the area from around 300 square feet to about 600 square feet. Before the renovation, I was charging $6,800 a month for the top two floors. Now, the entire home was renovated with high-quality finishes.
When I met the family of three who wanted to rent the house, I felt they were a good fit. They offered $8,000 a month, which was $1,200 more than I had been charging. This represented a 12% return on the cost of remodeling, which was pretty good compared to the average return of the S&P 500.
However, I was hesitant to raise the rent, especially on good tenants. So, I made a counteroffer. I agreed to accept their $8,000 a month offer for the first year, but asked them to pay $8,200 for the second year, $8,300 for the third year, $8,400 for the fourth year, and $8,500 for the fifth year, provided they were in good standing.
This arrangement would save them $13,200 over five years compared to my initial asking price. It was my way of encouraging them to sign the lease and stay long term. If I had to spend another month looking for tenants, I would lose at least $8,000 in rental income.
In the end, they accepted my counteroffer. I was happy to secure what seemed like good tenants. The previous tenants were a family with two toddlers and a dog, so I expected less wear and tear from the new tenants, who were a couple with one child and no pets.
One of the main reasons why small landlords like me don’t maximize profits is due to human nature. It can be hard to raise the rent each year, even though our costs increase annually. As a result, landlords who don’t raise the rent regularly may end up reducing their returns significantly over time.
To avoid this, I recommend including an automatic rent increase schedule in the lease agreement. This eliminates any awkwardness when it’s time to raise the rent and helps keep up with cost inflation.
The best time to introduce this clause is during the initial negotiation period. Both the landlord and the tenant can plan their finances accordingly, leading to fewer surprises and more financial stability for both parties.
Landlords should always include an automatic rent increase clause in their lease. The increase can be as low as one percent a year or as much as the law allows. If the landlord doesn’t get any takers, they can adjust the terms accordingly.
For me, having a tenant who might stay for eight years is valuable. I’m used to tenants turning over every three years, so the stability of cash flow makes the property more valuable if I decide to sell.
One of the main reasons why I sold my main rental property in 2017 was because I had five roommates as tenants, which led to turnover every year. With my current tenants, there’s less likelihood of turnover, unless there’s a divorce or a school change.
In San Francisco, a lease is only valid for up to one year. After that, it’s month-to-month. So, the automatic rent increase clause is not enforceable. Instead, it’s a document of good faith. The more good faith shown by both parties, the better the relationship.
Being a landlord is not easy. It’s like having a part-time job. But once you accept this, it becomes easier. The key is to find tenants who respect your property, pay on time, and are considerate of the neighbors. But to find such tenants, you must screen them thoroughly.
Every agreement or term must be in writing to avoid conflicts. For example, in my lease, I state that the tenant is responsible for maintaining the front and side yards. But when the weeds grew out of control and two of the large plants died, my tenant asked me to remove the dead plants at my expense. To avoid conflict, I paid for the removal and also trimmed an overgrowing vine.
As a landlord, you might think that low turnover means you’re doing a good job. But it could also mean that you’re charging below market rent. If your tenants weren’t getting such a good deal, they might have moved long ago. Every year without a rent increase means you’re earning less net rental income, as costs like property taxes, insurance, maintenance, materials, and labor are all increasing.
Next time I need to find tenants, I will include an automatic rental increase schedule in the lease. This will give prospective tenants visibility on the rent, and I will feel better knowing that I can cover my rising costs without having to notify tenants of a rent increase.
If you’re a renter or a landlord, have you ever signed or included a rent increase schedule in a lease? What are the pros and cons for both parties?
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