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By Dr. James M. Dahle, WCI Founder

We published a post recently about investing in mobile home parks, not terribly different from a post we ran about it in 2015. The reaction to the post in the comments section and across social media, however, was dramatically different. Part of that may come down to tone, writing style, and specific words used or actions described. But mostly, it was a reaction to rising rents, rising home prices, and the ensuing affordable housing crisis that has appeared on the scene in the seven years between the posts.

I was most concerned about knee-jerk reactions and the lack of understanding of basic economic principles seen across the WCI community. So, I thought it would be worthwhile to spend some time today on the concept of market rent and talk a bit about REAL solutions to the housing crisis (which naturally will have to get a little political. If you hate that, stop reading this post right here and come back tomorrow).

What Is Market Rent?

First, let's define what market rent is. Market rent is the highest price at which you can rent out a property within a reasonable amount of time using an appropriate amount of marketing. It's relatively easy to determine in a big apartment complex. If 95% of your units are rented at a given price, that's market rent. If only 90% are rented, you're overcharging. If 100% are rented (or worse, if there's a waiting list), you are undercharging. It can be harder to determine with single-family homes or other unique properties, but you understand the concept.

Contrary to popular belief, market rent is NOT set by the landlords. It is set by the tenants. A tenant who is out shopping for a place to live quickly becomes an expert 0n what market rent is. If you look at 10 or 15 available apartments or homes, you can reach that same level of understanding. Why would you rent this place right here when you can get [whatever feature or location or amount of space] for $100 less a month over there? Tenants rightfully don't care about the landlord's expenses. They don't care that property taxes or mortgage interest rates or landscaping expenses went up. They're only going to pay as much as they have to pay. Nobody gives landlords a break on their expenses during inflationary times. Thus, it doesn't make sense for landlords to provide a discount for anything less than market rent.

It's really a fair proposition. The landlord provides a clean, safe, functional place to live in exchange for market rent. That market rent allows the landlord to pay the expenses of the property (perhaps 45% of the rent on average); pay the mortgage; keep the place clean, safe, and functional; and presumably, if managed well, provide a little profit to make all that hassle worthwhile. This is why leases should be carefully written, clearly explained, and strictly followed by all parties. They outline the deal. The landlord should keep up their end of the deal. The tenant should keep up their end of the deal. It's a win-win, and everyone is happy. It only becomes a win-lose or a lose-lose when one of the parties does not maintain their end of the deal.

Why Should Landlords Charge Market Rent?

If a landlord charges less than market rent, they will not have the funds to properly maintain the property. Then, it becomes difficult to maintain their end of the bargain to provide a clean, safe, functional property as agreed. Renting out the space also becomes not worth their time because they may no longer be making a profit (or at least as much profit as they could make with another investment)—or even worse, they could actually be subsidizing the housing costs of their tenants.

When you charge less than market rent, you are, in essence, deciding that your tenants are your favorite charity. In essence, that money you are no longer making from your tenants could be used to support your favorite charity. However, it's worse than that. The value of a commercial property is almost entirely dependent on its income. When you are not charging market rent, you are lowering your income and lowering the value of the property at sale. You would be better off charging market rent and then writing a check to your tenants to help them out. This would allow you to support your favorite charity (those tenants) while still maintaining the resale value of the property.

Charging more than market rent is even worse. Above-market rent is its own punishment. It rapidly results in vacancies. What happens when you raise the rent? When you raise it, the tenant goes and looks around and discovers what market rent is. If you are charging market rent, they realize they're not going to get a better deal elsewhere, and they come back and grudgingly pay the additional rent. They probably also demand you fix that leaky toilet (and you should). If you are charging above-market rent, they leave and you get no income for that unit. Now, there is a certain amount of “stickiness” to a tenant. It costs money and takes effort to move; sometimes a lot of money and effort. Perhaps some tenants will put up with slightly above-market rent for a while, but you can't do that for the long term. Eventually, people move out, and nobody moves in to replace them.

What's the lesson? You should charge market rent. It's not only the best way to run the business, but it's the only way you can stay in business long term. No margin, no mission. Naturally, that means you may have to REDUCE rent at times to get to market rent. But more commonly, it means you need to raise rent. In fact, a lot of the “value-add” that a savvy real estate investor does to improve the value of a property is simply to find a property where a landlord doesn't know what market rent is, buy it, and then raise the rents to market rent as the lease agreements renew. That was partially what guest Paul Moore was writing about when it comes to mobile home park investing and what some commenters were getting so upset about.

Either way, the property is now worth 10% or 25% more than the price paid for it, all due to the ignorance of the previous owner. Know what market rent is and charge it.

More information here:

Raising Rent: Is Dave Ramsey Wrong?

Should You Ever Make an Exception?

Sure. You can rent to your grandma for below-market rent (keep in mind if you get too far below market rent, the IRS may view the difference as a gift). You also don't need to throw out a tenant that has been excellent (i.e., pays the rent and doesn't destroy the place) for years just because they can't make rent one month while being treated for breast cancer. It's your business, and you can run it however you like. Here at WCI, we've had lots of great partnerships over the years with people to whom we gave “below-market rent.” It cost us some money in the short term, but we made a lot more in the long term due to investing in that relationship.

We also try to give back to the community that has given us so much, via the WCI Scholarship, Champions Program, and Financial Educator Award. But for the most part, we try to charge market rent. No more and no less. You simply cannot work for free for long, and that's what keeping non-paying tenants for too long or charging below-market rent is doing. You have to draw a line someplace. Reasonable people can disagree about where the line should be drawn, but they cannot disagree on the fact that it should be drawn. And who should get to decide where the line should be drawn? How about the person putting in all the work and putting their money at risk? That's right: the owner of the property, aka the landlord.

More information here:

How We Became Accidental Landlords

Is It Ethical to Invest in Rental Property for People with Low Incomes?

I argue that it is not only ethical but beneficial. If nobody invested in workforce housing (such as Class B or C apartment buildings), if nobody invested in mobile home parks, if nobody invested in Section 8 housing, there would be no place for low-income folks to live. They would be forced onto the street and into homeless shelters. In that respect, investing is a noble act. Sure, some ignorant people will call you a slumlord, but in reality, you are providing a beneficial service.

Just like Apple sells phones to low-income folks, just like Exxon sells them gas, just like Walmart sells them groceries, and just like you sell them housing. It's a beneficial transaction between two willing parties and exemplifies the best of capitalism. You can see a microcosm of what happens when there is no low-income housing in a Colorado ski town. All of the property owners realize they can make a lot more money renting their properties out as short-term housing to vacationers. So, they convert their properties to Airbnbs. All of a sudden, for the folks who sell stuff in stores to the vacationers and for those who clean the Airbnbs for the vacationers and who guide the vacationers around on hikes and who take them down rivers and who serve them meals in restaurants and who operate the ski lifts, there's nowhere for them to live.

Sure, for a while they can commute in from elsewhere, but at a certain point, a labor shortage results and the pendulum swings back the other way.

Solving the Affordable Housing Crisis

We have an affordable housing crisis in America. I don't even know how doctors can afford to buy houses in many areas. And rents are rising right along with the price of properties. Some of this is due to low interest rates. Some is due to excessive stimulus money. Some is due to general inflation. But mainly, it is simply a problem of supply and demand. There is more demand for housing than there is supply. As a result, the prices have gone up dramatically.

What is the solution? The main one is to build more housing. That raises supply and lowers the price. It's basic economics that you should have learned in the 9th grade. Yes, you can make a few tweaks around the edges. A community can give out fewer permits for short-term rentals. It can allow accessory dwelling units (for long-term use). It can subsidize the construction of high-density housing. It can raise taxes on secondary homes and short-term rentals. It can even provide stipends to low-income folks to help them afford the rent (a la Section 8). But that's about it. Mostly, it's about getting more units into the market and letting the market solve the problem.

You know what doesn't work, at least in the long term? Rent control. If a community dictates that a landlord cannot charge market rent, what is that landlord going to do? Probably sell the property and invest elsewhere. That landlord certainly isn't going to build another apartment building in that community. So, demand continues to rise and supply does not keep up. Now, there is nowhere to live. And in the long run, rents do go up, so even if you find a place to live, you can't afford it.

Rent control isn't the only thing that constrains supply. Sometimes NIMBYism (Not In My Back Yard) rears its ugly head. Sure, people want more housing units to be built, just not in their neighborhoods. Build them on the “bad side of town,” so we can have our beautiful one-acre lots and country clubs over here. Or regulators make it so difficult for operators, contractors, and tradespeople to work in a town that they just go elsewhere—also a bad idea if you really want to solve the affordable housing crisis. You can work on the other side of the equation, too. Instead of helping people by keeping housing costs low, you can help them to earn more money by investing in education and building good businesses that pay good wages.

Get Off Your High Horse

If your knee-jerk reaction to someone who invests in Section 8 housing or mobile home parks or Class C apartment buildings is that they are “unethical, immoral, un-Christ-like slumlords,” I think you should consider a couple of things.

First, if you invest in a Total Stock Market Fund like most of us, you are already investing in these sorts of investments. I'm sorry. Just because you're up there viewing it all from 30,000 feet doesn't mean that there aren't people down on the ground having to move out of YOUR mobile home parks when they can no longer pay the rent. Sun Communities Inc. (Ticker SUI) owns 661 mobile home parks across 39 states and in Puerto Rico. Yup, you own those mobile home parks just like I do. I assure you they “kick out” an unfortunate mobile home owner at least every week (if not every work day) to keep their investors (i.e., you) happy. If you don't want to overweight it in your portfolio by buying a fund that specifically invests in these properties or buying one yourself, that's fine. But don't kid yourself that your hands are somehow clean.

Second, if you're reading this, there is a good chance you work in healthcare, an industry notorious for opaque pricing practices and pushing countless people into bankruptcy. Very few people declare bankruptcy because they can't make the rent, but it happens to more than half a million people a year due to medical debt. Mote meet beam. Stones and glass houses and all that. Yes, we all do some work for which we are not paid (especially those of us to whom EMTALA applies), but my group sends self-pay patients a bill, and I bet yours does, too. If they don't pay, they are hounded by bill collectors, and their credit is ruined.

Is There No Middle Ground?

Like most things in life, the truth is probably in the middle somewhere. There are clearly terrible people out there who do dirty business deals all the time with profit as the only motive and care not a bit for the end customer. Some of them clearly work in the low-income housing space (such as mobile home parks). Here's an example from a piece that NPR did not long ago. Planet Money talked about how some of the private equity trends we've seen in medicine are also being seen in the mobile home park space.

Mobile homeowners are particularly sticky compared to other renters, because it is particularly expensive to move a mobile home to another park. If you can't make rent, you certainly can't afford to move. Despite that, it's still both moral and ethical to charge a mobile home owner market rent for their spot. In fact, it is the best practice in the long run for all involved. Businesses do not need to be run SOLELY to maximize profit so long as the owners have other goals for the business to accomplish. But still, no margin, no mission.

Is Everyone Cut Out to Invest in Real Estate Directly?

If you like the returns and tax benefits of real estate but you hate the idea of having to tell a tenant they need to pay more, collecting rent, or initiating eviction proceedings, you do have a few options. You can hire a manager to do it for you. You can invest through private syndications and funds. You can even just buy a Total Stock Market Fund. If you are a people-pleaser, being a direct real estate investor may not be for you.

That's OK. You're probably in the majority. One reason the returns of doing direct real estate well are so good is because it's hard work. Part of that hard work is being on the front line and having to see what happens when bad things happen to a family and they can no longer make rent. This is just one reason I don't personally invest directly anymore. I'm too much of a people-pleaser. It's also why I hired somebody else to sell the ads at WCI. Sometimes you don't want to know how the sausage is made.

More information here:

Real Estate Investing 101

Landlords Should Not Be Expected to Solve the Affordable Housing Crisis by Themselves

What is particularly unfair is to expect landlords to somehow solve the affordable housing crisis by themselves by charging below-market rent. If society wants to somehow subsidize housing costs, we all need to contribute—not just a subsegment of the population. Grocery stores get money from the government (i.e., the taxpayers) when they accept food stamps. It should be the same for landlords. Better yet, encourage the building of new housing.

If you'd like to invest in private real estate, check out our partners in this space.

If you're interested in learning more about how to invest in real estate both directly and passively, consider taking our brand new No Hype Real Estate Investing Course. It's on sale through September 26 for $400 off.

What do you think? Do you think it is ethical to invest in low-income housing, such as mobile home parks? Why or why not? What practices should you adopt in doing so? What do you think are the best solutions to the affordable housing crisis? What role do landlords have in solving it? Comment below!

The post Why Landlords Should Charge Market Rent (and Why the Affordable Housing Crisis Is Not a Landlord Problem) appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: The White Coat Investor
Title: Why Landlords Should Charge Market Rent (and Why the Affordable Housing Crisis Is Not a Landlord Problem)
Sourced From: www.whitecoatinvestor.com/charge-market-rent/
Published Date: Wed, 14 Sep 2022 06:30:37 +0000

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