If someone were to ask you to picture a well-run business, what would you see in your mind’s eye? Amongst other things, you could be imagining people on the phone and at computers making deals. Accountants keeping an eye on the bottom line to ensure that the business is healthy and that the cash flow is pumping. The Human Resources team is making sure that everyone’s performance is up to standard. And the Sales and Marketing teams are working hard to meet their goals and targets.
In short, everything’s humming like a well-oiled machine with one key focus: profitability.
Profitability is the key to business success
Let’s face it, making profit is at the core of every business, or they simply wouldn’t be in business.
But making a profit isn’t always easy. Not only can it mean hard work, but it usually takes good negotiation skills; well-oiled systems and processes; up-to-date market knowledge; and keeping an eye on cash flow and the bottom line.
The same applies in property investment
For a property portfolio to be profitable, it also takes sharp negotiation skills, good systems, current market knowledge, and a wise financial eye. Yet the problem is that this doesn’t always happen, especially with regard to rent reviews.
There are two key reasons why rent reviews (or a lack of them) negatively affect a rental property’s cash flow:
1. Lack of local market knowledge
2. Personal views and opinions clouding judgement.
Both of these points ensure that rent is maintained at levels that are significantly under market. Let’s look at both of these factors in turn.
Reason #1: Lack of local market knowledge
Many property managers don’t charge the current market rent because they don’t know what the current market rent is! Even many professional property managers are under-charging tenants because they don’t know the current market. This is especially true when the property manager’s service area is too large.
For example, a property manager covering all areas from Massey to Pukekohe and Glen Eden to Howick will never get to know what the local market rent in a particular suburb really is.
We recently saw another property manager’s appraisal on a property for sale. The appraised market rent was lower than what the property was achieving two years ago. At current market rents, this property manager was going to be letting the property at $60 to $80 below market rent.
How do we know this example to be true?
Because we were the vendors of the property, and had managed it over the last twelve years. The agency selling the property had brought their own property manager through to make a rental appraisal, and that’s how wrong he got it!
Reason #2: Personal views and opinions clouding judgement
Another common reason why many property managers and owners don’t charge market rent is because they have personal or philosophical issues about charging top dollar. Their own views of affordability stand in the way of charging tenants as much as they could.
This ‘feeling sorry for tenants’ isn’t just a problem with property owners who do their own property management: it’s also an issue with some professional property managers. Their internal voice starts clouding their judgement, and that’s an expensive mistake to make. It also means that the landlord is not treating the property investment as a serious business.
One serious industry problem is where some property managers feel they are working for the tenants. This often directly relates to the practice of charging tenants letting fees.
Here’s the real cost of a property that’s let for $20 a week less than market rent:
If the property investor owned five two-bedroom units, the total lost over five years is a massive $26,000!
The really critical issue here is that if the above properties were rented at $40 a week less than market then the above losses would be doubled, i.e. a $52,000 loss over five years for the 5 two-bedroom units! This type of loss might seem extreme, but in fact it is common.
With this kind of approach to rent reviews, who’s got the successful cash management strategy in place: the tenant or the landlord? Not treating property management like a business makes it a very expensive hobby.
The correct, business-like way to handle rent reviews
To avoid making your property investment an expensive hobby, here’s the business-like way to approach rent reviews:
- Always have a handle on the current market rent so that you’re prepared to assess your rents every six months. That way, you can negotiate from a position of strength with your tenant or property manager. Make sure you have all the facts at your fingertips.
- Do not let your internal voice talk down or undermine your goal of increasing rents. As an investor, understand why you are in the property investment business. As a property manager, you are there to act in the owner’s best interests – not the tenant’s.
- Be prepared to increase rents every six months, and make this rent review a part of your management and business process.
- Treat property management and property investment like the business it is – aim to have all your systems and processes running like a well-oiled machine, with profitability and cash flow being your key driver.
Still on the topic of rent reviews, find out what the #1 fallacy is of rent reviews…
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