Every landlord wants to increase rent to at least keep up with inflation. However, regularly increasing rent is hard to do. Let me show you how you can increase rent with minimum tension.
Recently, I received a surprise automatic rental increase from my newest tenants in the amount of $200. They pay electronically on the first of each month and I forgot about the annual rent bump agreement.
When my tenants first found my listing of a newly remodeled rental home in mid-2022, I was asking $8,500. I hadn't rented out a single-family home in San Francisco since 2017, so I was unsure what to charge. But I scanned the comps on Craigslist and figured $8,500 was in the ballpark.
I had just completed a gut remodel on the ground floor by creating a bedroom, living room, full bath, small closet, hallway, and dedicated laundry room. The downstairs area expanded from around 300 square feet to about 600 square feet.
Prior to the remodel, I was charging $6,800 a month for the top two floors. Now the home was entirely remodeled with the highest quality finishes I could find in a nearby showroom.
The Rent Negotiation
Because I found the family of three to be a good fit, I accepted their initial offer of $8,000 a month. They were going off to Europe for 1.5 months and wanted to secure the property before they left.
$8,000 was still $1,200 more than I had been charging a month. And the increased rent equaled a 12% return on the cost of remodeling ($14,400 / $120,000). Not bad compared to the historical average return of the S&P 500 of ~10%.
However, because I find it uncomfortable to raise the rent, especially on good tenants, I countered their offer. I didn't want to lose them, but I also felt $500 below my original asking price was a lot.
I told them I'd accept their $8,000 a month offer for the first twelve months if they agreed to pay $8,200 a month for the second year, $8,300 for the third year, $8,400 for the fourth year, and $8,500 for the fifth year, if they were in good standing.
Over a five-year period, they would end up saving $13,200 in rent (year 1 savings: $6,000, year 2: $3,600, year 3: $2,400, year 4: $1,200) from my initial ask. It was my way of creating an incentive structure to sign the lease and stay long term. If I spent another month looking for tenants, that would mean at least $8,000 in lost rental income.
Ultimately, they accepted my counter-proposal. I was happy to lock in what seemed like good tenants on paper. The previous tenants were two toddlers, two parents, and a dog. So the wear and tear should be less with the new tenants with two parents, one child, no pets, and summers abroad.
When you just spent two years painstakingly remodeling, fewer occupants feels much better.
The Beauty Of An Automatic Rent Increase Clause In The Lease
One of the main reasons why mom-and-pop landlords like myself do not maximize profits is due to human nature.
Small-time landlords may find it difficult to raise the rent each year, despite their costs going up each year. As a result, if you want to invest in real estate, it may be more profitable to invest in a professionally managed real estate fund instead. No negotiations are involved given the sponsor manages the properties for you.
Over the course of five-to-ten years of no rent increases, mom-and-pop landlords may end up severely reducing their returns. In most cities, there is a maximum percentage increase in rent a landlord can charge each year. Therefore, by not raising the rent for five years and then raising the rent by the maximum percentage in year six (e.g. 3%) you will do little to cover your increased costs.
The only way to rectify the situation is to have your tenants move out and reset your rent to market rate. But sometimes, your tenants may stay far longer than economically optimal, especially if you don't regularly raise the rent.
Embedding an automatic rent increase schedule in the lease agreement helps do away with any awkwardness when it comes time to increase the rent. Every landlord should want to at least try and keep up with cost inflation.
The initial negotiation period is the easiest to implement an automatic rent increase clause because everything is new. The landlord is trying to find the best tenants and negotiate the best price. Meanwhile, the prospective tenants are surveying the rental market and trying to find the best deal and situation.
By agreeing to terms in the beginning, both the landlord and the tenant can model out their income and expenses accordingly. This way, there will be fewer surprises and more financial stability on both sides. Expectations are set, like a prenuptial agreement. This is a win-win situation.
When To Use The Automatic Rent Increase Clause
Landlords should always have 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 will allow. Ultimately, the market will decide whether the asking price and conditions are attractive. If the landlord has no takers, then he must adjust accordingly.
The easiest time to introduce the automatic rent increase clause is if a tenant tries to bargain with the landlord in the initial period. If the landlord likes the tenant, then offering a discount up front with a rent increase schedule can seal the deal. The automatic rent increase clause can be used as a compromise.
For me, being able to rent to a tenant who might stay for eight years is valuable. I say eight years because that's what the prospective tenants guided me toward given their daughter was ten. In 2030 she will graduate from the high school close by.
I'm used to average turnover of about every three years. The stability of cash flow also makes an asset more valuable if I were to ever sell.
One of the biggest reasons why I sold my main rental property in 2017 was because I had five roommates as tenants. As a result, there was always turnover every year for three years. With these current tenants, they act as a unit. As a result, there is less likelihood of turnover, unless there is a divorce or a school change.
Check Your City's Lease Laws
In San Francisco, a lease is only good for up to one year. After the one-year period is over, it's month-to-month thereafter.
Therefore, the reality is, the automatic rent increase clause is not enforceable. Instead, the lease is essentially a document of good faith. The more good faith that is shown by both parties, the better the relationship.
A landlord can charge more in rent after one year than the lease states, up to the maximum percentage by law. Or a landlord can stick to the original lease and rent increase clause. At the same time, a tenant can decide to give 30 days notice and leave.
Please check with your city's rental lease laws. Each city's laws are different.
A Good Relationship Between Landlord And Tenant Is Everything
Being a physical rental property owner is not an easy task. I've written that I have a love-hate relationship with being a landlord since something always comes up. However, as soon as I accepted being a landlord is like having a part-time job, my displeasure with being a landlord eased.
In the past, I would feel annoyed whenever anything would come up. That was the wrong attitude since owning rental properties does not generate 100% passive income, but semi-passive income instead.
If you can find tenants who respect your property, pay on time, and are considerate of the neighbors, you have yourself a winner. But in order to find such tenants, you must screen them like the CIA. Do no let emotion override your due diligence in understanding their financials, employment history, and rental history.
Spending extra time to find the best tenant possible is worth it. Because once you have a bad tenant, it may cost you a lot more money down the road.
Every agreement or term must be in writing. Otherwise, there are too many situations where conflicts arise due to grey areas.
Example Of A Minor Landlord / Tenant Conflict
In my lease, I write the tenant is responsible for maintaining the front and side yards. Maintaining includes weeding and watering all plants once a week. These are tiny yards, but are important for the overall aesthetic of the house. Unfortunately, the weeds have grown out of control every time I drive by and two of the large plants out front died.
My tenant then asked if I could remove the dead plants out front at my expense “because they were ugly.” But because I know they have not been maintaining the yard regularly, I now face a dilemma.
I don't think the mature plants would have died if they had been watered regularly. The plants had survived just fine for twelve years before they moved in.
Due to the desire to avoid conflict, I just paid some guys to dig out the dead plants and haul them to the dumpster. While they were there, I also had them chop down an overgrowing vine that was spilling over to my neighbor.
In the near future, I will plant some large succulent pups that are in need of more space. I've been wanting to simplify the front yard and beautify it anyway, as the final phase of the rental property remodel. But if I hadn't, I may not have obliged.
As you can guess, the $200 rent increase was quickly used up and then some. Ah, the never-ending cost of being a good landlord.
Low Turnover Might Mean You're A Bad Landlord
Finally, due to my desire to upgrade homes, I've been trying to figure out how to cobble together enough cash to make an all-cash offer. The most optimal solution would be to sell a property up to $500,000 tax-free and then use the proceeds plus my existing cash and some securities.
While reviewing my three-property rental portfolio in San Francisco, I realized I haven't had a vacancy in over five years. At first, I thought: Go me! I'm such a good landlord who is attentive to all my tenant's needs. I develop good relationships with all my tenants.
But then I realized the most likely real reason why I've had no turnover for so long is because I charge below market rent. If my tenants weren't getting such a good deal, they would likely have moved long ago! During the pandemic, the majority of renters won big due to higher utilization rates.
Every year that goes by without a rent increase means I'm earning less net rental income. Costs such as property taxes, insurance, maintenance, materials, and labor are all going up between 2% – 5% a year on average. But I eat the costs because I value continuity and harmony more.
The next time I need to find tenants, I will include an automatic rental increase schedule in the lease. I think prospective tenants will appreciate the rental visibility. Meanwhile, I will feel better knowing that I can at least cover my rising costs without having to notify tenants of a rent increase.
Reader Questions and Suggestions
If you are a renter, have you ever signed a lease with a rent increase schedule? If you are a landlord, have you ever included a rent increase schedule in the lease? What are some of the downsides and upsides of a rent increase schedule for both parties?
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After accumulating a total of four rental properties in San Francisco and Lake Tahoe, I reached my limit. I proceeded to invest $810,000 in diversified private real estate funds across the country to earn 100% passive income. It feels great knowing professional real estate managers are trying to optimize my returns for me.
What property management tools/software do you use to manager your rentals?
None. I’m a DIY mom-and-pop landlord. But I do use a vacation property manager for my Tahoe property.
I’ve been a landlord for 11 years now. After 6 years in and having zero months of vacancy, I realized that my rental unit is quite desirable. Thereafter, I always made market rate adjustments each year. The rental unit is immediately adjacent to a university campus and was remodeled and furnished to hotel level quality (it was an Airbnb for a short period before COVID shut things down). Some people are willing to pay for the convenience of not having to furnish or decorate. In addition, I keep the internet and utilities in my name so that saves the tenant a $100 set up fee that the utility company charges which I do point out when potential tenants are looking at the place. All tenants have to do is bring their clothes and quickly settle in. It should be noted that this is a condo that is rented to college students so saving $100 is a big deal.
I’ve heard of real estate investors that only purchase in A class neighborhoods due to the reduced risk of tenants being unable to pay rent. I just got lucky with the location since I needed to purchase a place that would allow me to quickly get to work by bicycle since I didn’t own a car until age 28. Making the place more lux is like turning it into an A class property. If the value is there for the customer then it shouldn’t be difficult to increase rents.
For my out of state and in Cali but out of SF rentals, I usually try to sign a new lease with potential tenants for a duration of two years instead of one, at a slight discount / below market rent. If the tenant only wants to sign a one year lease, then I usually charge market rate. Three months prior to the end of the leases, I usually reach out to the current tenants and ask if they would like to renew their lease for a duration of two years with a rent increase but at a rate lower than if they were to renew for a duration of one year. I’ve had much success with this method. Been able to renew leases and some tenants have rented for over 4 years.
I am like you and value harmony and a good tenant over aggressive rent increases. Most times, I also eat the costs of clearing the yards too even though I built in the lease provisions for the tenants to maintain front/back/side yards.
Will try your automatic rent increase next time.
Rent increase schedule – so simple yet smart, I love it! Plus in the beginning you don’t really have that relationship with a prospect tenant so it can be all business without the awkwardness.
But I don’t know if I agree with low turnover equating to maybe being a bad landlord. From the tenant’s POV, it’s awesome. I too, would value peace and harmony with an established, quiet and low maintenance tenant paying possibly a lower than market rate than taking a risk on someone new and months with no rental income.
This is a smart move, but I manage guilt free rent increases by just letting the rental management company do it based on their market knowledge. It has averaged 3.5-6% annually over the last 5 years.
No issues.
Then again, my SFH has typically been rented by groups of young 20-30yr olds and although the core group has remained, some room mates have switched out year to year.
Building in future rent increases into the lease is very smart. Not every tenant will be organized enough to remember to update their rent check when the time comes. But having the rent increases outlined in advance is a great way to help both sides plan and avoid friction.
I have been a landlord for 29 years in AZ. I have done it both ways. Rent increase in the lease and not. But I also have no
problem raising my rents. Tenants are often reluctant to make changes and often the cost and stress of moving is enough to convince them to just accept the increase. I have tenants that have been with me for 12 years now.
This sounds like a win/win idea. Not only does it help the landlord with the thorny issue of raising the rent, but it gives the tenants predictability as to how much their rent will increase each year, so that they can budget accordingly and not be surprised. A possible problem would be if inflation is lower or higher than expected over the agreement period; then the agreed-upon increases might be too high to be fair to the tenants, or too low to be fair to the landlord.
A little off topic but I started reading your blog weekly a few months ago. I find it useful + entertaining. I hope some “passive income” is coming in from the ads at least. I do have to ask, you seem very in love with the city of San Francisco from all your articles. Another headline today of a major hotelier abandoning ship there. Add this to the list of another dozen or so businesses who have left… are you still bullish on SF? What will take to fix the issues going on? Do you even see issues or consider it fake news? I am sure home prices are well for now but is there anything that would be a trigger for you to move the family and join the CA exodus? Just curious, may even make for another good article.
Hi Matt,
Thanks for your concern. Where do you live?
San Francisco is one of the most beautiful cities I have ever been to, and I’ve been everywhere. It’s really hard to beat the scenery here.
Then there is the weather, which is moderate year around. As a result, you can play a lot of outdoor sports and feel good all year.
Finally, the amount of wealth building opportunities is incredible. Lots of smart people with lots of companies and new ideas. One of my Softball friends went from a net worth of maybe $3 million-$50 million in a span of three years after joining Figma. He’s 35 years old.
The thing is, San Franciscans are shy to highlight how great the city is because it will attract a lot of hate. It’s a more expensive city to afford than average.
Given the elections are coming up, it’s natural to bash on San Francisco because it is one of the best cities with the most amount of wealth. The media likes to focus on the negatives as well, because that is one gets the most views.
Every single big city has its challenges. For the most part, the city is a wonderful place to live. When was the last time you lived here or visited?
You may enjoy this post: The Cheapest International City In The World: San Francisco
I was based in Louisville KY but purchased a condo in Las Vegas last year to live in more than half of the year… all to escape a 5% Ky state tax rate (now 2023 they lowered it to 4.5% with talks to keep lowering. TN eliminated it and they seem to be thriving!) I also was paying a 2.2% occupational city tax to Louisville (which I just found out this year it should not have applied to me so I’m fighting to get $25k+ in back taxes from the last few years) I know it’s all peanuts compared to California rates and yes, I will agree your state definitely does have the best weather so maybe that alone is worth it to you.
I have the privilege of working from anywhere. I am 35, single, no kids, & run some internet companies. I turned my Louisville residence into an Airbnb along with picking up two other condos in the building. Each condo was around $215k & has been netting around $40k a year w/ little effort. The derby alone makes $6k on each unit during a weekend.
I haven’t been to SF in 5 years or so. I just constantly hear so much hate in general from Californians who move into Vegas. If you have the money to live in gated neighborhoods and send your kids to private school, I guess nothing matters and the needles along w/ rows of tents can be avoided. But reading the news and watching videos of organized shoplifters take out stores and not have more severe punishments, sickens me. Seeing celebrities like Mark Wahlberg pack up and move his family to Vegas has been interesting!
Fascinating. What were your reasons for staying in Kentucky if you could live anywhere?
If you decide to visit San Francisco or move to San Francisco, I would not rent or buy an apartment in the several blocks in the Tenderloin district, where the media loves to highlight.
Do you like Las Vegas so far? Generally the people who leave San Francisco for Las Vegas are looking for a lower cost lifestyle. If you can afford to live in San Francisco, it’s pretty good.
If I had a family, I would be in Summerlin. Instead, I live downtown in the thick of it all in Vegas and I enjoy walking everywhere. This is where people say it’s not safe, homeless everywhere, etc. I have Freemont St a few blocks one way and the Arts District a few blocks the other way. The city passed a vagrancy law some years ago that keeps them from pitching tents and obstructing the walkways. I think Vegas has been doing an amazing job to tackle the problem all while trying to provide services to those who wish to take it with a new 24/7 center w/resources. The traffic isn’t nearly as bad as Cali, any type of food on demand, & it is the entertainment capital of the world. Being a financial blog, we have to talk money. Did I mention my property taxes on a $600k property are only around $1600 a year? Even back home in KY, I am paying around $3k a year per $215k condo. Despite having no friends out here and the dating scene sucks, everyone is friendly! We also have direct CHEAP flights to anywhere in the world it seems. Friends are always wanting to fly in, who says no to Vegas?
Will I be here the rest of my life? Probably not but who knows. It’s a transient city. I think if you really have millions a year in self employment income, moving to Puerto Rico is the answer. Some people I know online live there and ONLY PAY a 4% tax and that’s it. No 37% federal tax… all while still being a US territory. Personally, I can’t do PR but Vegas works for me.
I’m 51 and have lived in Calif essentially my whole life. I can’t recall ever hearing anyone say anything nice about it. Ever.
It’s the only place I know of where people will come to your house, stay as a guest, eat your food and drink your wine and sit out by your fire pit in the dead of winter in shorts and a tshirt and regale you for an hour about what an awful place your home is. I would never do that, but apparently fly here it’s not only permitted, it’s darn well expected.
I was born here. Educated here. Met my wife here. Got married here. My kids were born here. My family is here. My friends are here. My job is here. My investments are here. I own a lovely home on a half acre in a neighborhood filled with friendly people who have been here for many decades and look out for each other. We love our church. Our kids are in a great school. My 2nd grader reads at a 7th grade level.
I’m sure California has its many challenges and shortcomings. I hear about them every. single. day. But if I looked about a bit, I could probably find flaws with any place you could name.
California has the most oppressively hot deserts and the most beautiful lush forests. The lowest point in the contiguous U.S. and the highest. It’s difficult to fit it into a single description. But people sure try. Every inch of the state is a hell hole filled with homeless tents and hypodermic needles on the ground.
Whatever.
To each his own. I lived in CA for 40 years including several years in SF. Agree weather and opportunities are awesome and still plenty of great places to live if you can afford it. But when state tax rate hit 13.3% I decided to move to a zero tax neighboring state while still maintaining a home in CA that I visit for several months a year. Best of both worlds. The deterioration of SF is real and sad to watch. Neighborhoods like Sunset or Noe Valley are still nice but the trend is not good so I left. With the tax money I saved, I can travel the world in luxury. CA depends on a small pool of very high income people to fund all its programs and services. Once they start leaving it can snowball causing a fiscal crisis. CA politicians subscribe to the theory that the beauty and weather will force those who pay high taxes to just keep paying. I’m one who proved them wrong. Maybe 13.3% isn’t high enough to cause the avalanche. But what about 15.8%? 19.4%? 22.5%? Where does it end. I guarantee we will find out because the genie is out of the bottle now and politicians and special interests will always look to raise taxes. The recent failure of another tax increase on the ballot was due only to a stupid mistake on the part of Lyft to not give teachers their share. That caused the teachers union to go to the Governor and ask him to oppose it, which killed it. They won’t make that mistake again. CA is great if you are low to middle class, or if you are able to hide income through self employment. But if you’re an ultra high income W2 person, you are getting crushed and it’s only going to get worse. Good luck.
How do you like Nevada? Yes, if you pay a 13.3% state tax rate, paying 0% is great. I thought about setting up in Lake Tahoe Nevada side. But I didn’t have any friends there and the property was more expensive to reflect the tax diff.
Getting crushed? If you’re a tent-dwelling addict whose life has little left to offer you, that seems like getting crushed to me. An ultra high income W2 person… Crushed? Crushed into a mentality of over-attachment to material wealth maybe. God bless you and i hope your life of luxury fulfils your genuine childhood dreams of real happiness if you still have those.
Geez Nick, guess I hit a nerve. Of course by crushed, I meant financially. This is a financial site after all. I define crushed as paying higher than a 50% marginal rate. So a high income Californian pays 37 + 13.3 + 2.4 = 52.7%. That excessive in my opinion so I took action. That simple and yes I lead a great life and am very happy. How are you doing by the way?
I wonder where you’re getting the 13.3% from.
CA’s nine income tax brackets ranging from 1.00% to 12.30%.
Wrong. 13.3% is the max. Trust me, I paid it. I think there was a time where a 1% increase to fund mental health was called a surcharge, so maybe that’s the issue. Semantics. Maximum is 13.3% and the scary thing is the public voted twice to add 3 points on. The key was making it apply to higher income levels only (“the rich”). Californians are happy to increase taxes as long as someone else is paying. Politicians and special interests realize that and will keep adding ballot measures to further increase marginal rates until enough people take action and leave the state. That’s the only way this ends.
The key is to earn less than $250,000. That’s the ideal income for maximum happiness with a reasonable amount of taxation.
13.3 when I was there that’s also when Obama raised taxes including 3.8% on dividends. I let all my employees go and moved out. I do miss the weather.
You’re right, those rates are much too high. However, I believe those are marginal rates. Did you really pay 13% of your gross income to the Franchise Tax Board?
I do my taxes with Turbotax, and every year it tells me my effective tax rate, ie. what percentage of my taxable income did I pay to the FTB and IRS. I just checked 2022 and it was 15.25% Federal and 4.65% state. I don’t want to disclose my income but let’s just say it was six figures.
I have run the number on how I’d do in a “tax free” state like Texas, and if I’m a homeowner, the property tax makes me come out about the same. I ran numbers for Florida. The insurance rates and lower income (I’m W-2) make it a loss. I’ve checked into how I’d fare in Idaho, Tennessee, and other places. Same.
As you say, it each his own.
P.S. I believe the top marginal rate is 12.3% and applies to taxable income (assuming married/filing jointly) over $1,354,551.
Amazing.
I just went back to SD to visit, prior resident from 2008-2018 (love that city) and everyone was warning me what a shithole it had become…..
It was the same exact amazing city.
It’s no doubt true that most of the SF neighborhoods remain great places to live if you can afford it. Especially the ones further out from downtown like Golden Gate Heights out in the west. I would argue that the problems of homelessness and crime will expand and affect these nicer areas more and more if nothing is done. I used to live in SF and visited last fall. I was shocked to see so many boarded up and closed retail spaces in the Union Square area. Talked to a number of store owners and residents and heard personal stories of how crime has affected them. The recent news of the massive Nordstrom closing along with two of the biggest hotels downtown is also very ominous for SFs near term future. Think of the loss of tax revenue from the hollowing out of SFs retail and hotel core. Will affect police funding and services significantly. That deterioration will further reduce tourism and create a snowball effect. Of course things could turn around and the recent recall of a liberal DA who refused to prosecute criminals is a good sign. I am hopeful SF residents get their act together and realize they have to attack crime and homelessness or it will eventually negatively affect their quality of life.