Firstly, when searching for properties to buy, investors often come across properties where the rentals are very low. The seller’s agent will generally tell you this is the case because the owner has rented out the property to the tenant for many years and because the tenant is a very good tenant, they hardly ever increased their rent. If you have never heard this line before, it means you are not searching enough for investment properties.

The problem is that many investors are afraid to increase the rent when they have a good tenant that pays on time and gives them no hassles. Though it is a good strategy to keep a good tenant, it is harmful to the bottom line if rents fall below market value. If you are an investor with an interest in making your investments return a fair value, not increasing rents is a bad practice.

Good service

To avoid this happening, make sure that you give a good service to your tenant and keep the property in good order at all times, rather than just never increase the rent.

Also make sure that you have clearly specified increases in your lease agreement and increase the rent when the lease agreement says you should. There is no reason to keep below market value rents with low yields other than your own fear losing tenants. This fear has no basis, because if the rental prices are market related, you will have new tenants if the previous tenant moves out.

The good news is however that most good tenants don’t move out as a result of fair increases. The reason is that they often know that they won’t find cheaper place somewhere else and they often have to factor in the cost of finding a property to rent, payments for ITC and other checks and the costs of moving. To move out every time the rent goes up will cost them more in terms of money and hassle than your yearly rental increase.

Costly pitfalls

Secondly, if you are new to property investing and you buy the property in the belief that the current rentals are below market value, watch out for two very significant and costly pitfalls.

The first one is the most painful: sometimes the rents have increased and are at market value. But if you don’t know how to evaluate market-related rentals in certain areas, you will believe the sellers' agents when they that the rents are low. After you purchase the property, you will try to increase the rents with no success. No one will want to rent from you.

Why? Because the rents are too high for the property and area. This often happens in low and mid-income areas, where the rentals are around the R1500 to R2500 and when the new investor sees such low rentals, they believe the agents that the rents are too low. The rents are capped to the maximum affordability of the people that will want to live in that area.

Ride out rental increases

This mistake is very costly, as the investor will have to ride out two to three years of rental increases at seven percent to 10% percent per annum to reach what the seller's agent claimed is reachable in the first place.

As an example, let's say there is a difference of R400 per month from the current rent to what the investor believed is market related. At a rental of R2000 with a 10 percent per annum increase that is a two-year waiting period. Of course this can be more, as one may not be able to increase rentals by 10 percent every year without losing tenants.

This may not seem much, but if you have to pay a bond and the interest rates increases, as it has in the last year, the rent will not cover that. Then add the levies and the investor has a cash flow shortfall. This minor miscalculation can add up to a big mistake.

Do your homework

In short, if you see low rents, do your research very carefully to determine the rent value in relation to the current market-related value. This will let you know whether the rent can be further increased at present. You can do such research through independent managing agents in the area, newspapers, internet listings, or if you know the areas very well you will probably have the knowledge of what is acceptable rentals and what is not.

The second thing to be aware of is that true lower market value rents with long standing tenants can have other associated problems.

If the seller has never increased the rental in many years and now you buy the property and want to increase rentals dramatically, you may find yourself without tenants at all, with rental increases simply beyond their budget.

This is not such a big problem if you don’t count on keeping those so-called “good long standing tenants”. If you are planning on changing them anyway, this is not an issue.

Evictions?

Lastly, you should be aware that if the rentals are truly low, long standing tenants might not want to move out when you increase the rents and you will have to deal with evictions. This is rare, but no laughing matter.

Some people simply lived in a place for so long, with such good rentals that they just don’t want to move nor pay a much higher rent. In this case, once the property is in your name you should meet the tenants and see what you can do for them, if you want to keep them, maybe make the increases slower, such as a small increase every three to six months, as opposed to a year, to help the budget management of the tenant to accommodate the full increase to market value. You may just be able to keep the good tenants and save yourself the eviction costs.

The moral of the story? Be careful of low rentals. The property may be a bargain because the rentals are not market related, but you have to approach this with research and caution. Once you are sure you know what you are doing, based on solid research, you may just find that you bought yourself a gem. Just make sure you do the research, so that you avoid buying a lemon.

This article was featured on iafrica.com: Costly buy-to-let property investing errors  

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