Raising rents is a sensitive issue with real estate owners and tenants alike. For tenants, of course, it’s understandable; no tenant likes the idea of having to pay more rent for a unit tomorrow they’ve been living in for less rent yesterday.

The problem for some property owners (at least for small property owners) is that they become over friendly with the tenants, and the idea of having to increase the rent on nice tenants is tough. For others, it’s simply the fear that raising rents might cause the tenants to move out and in turn generate unwanted vacancies.

The real estate investor, however, must keep in mind that owning rental property is a business, and raising rents comes with the territory. After all, your cash-on-cash return and the ultimate value of your building depend on the amount of rents you collect. So raising rents (when a rent increase is in order) is needful, whether you are sensitive to the idea of looking like Scrooge or not.

Here are a couple of ideas a landlord can implement that might help.

1. Know what the competition is doing. You probably won’t lose tenants with a nominal rent increase when it’s in line with the rental market rate in your area. Tenants generally aren’t willing to suffer the stress and cost of relocating when it means paying the same rent down the street from you.
2. Be consistent with your rent increases. Whether you raise rents annually or semi-annually, regular modest increases are more easily understood and taken in stride than irregular massive increases. Most working people do understand cost of living adjustments. Just be sure to raise rents about the same time during the year; consistency will reduce friction generally caused by the element of surprise.
3. Consider doing something extra for the tenants. When you feel the need to take some of the sting out of the rent increase, you might want to offset it by steam cleaning the carpets, washing the outside windows, or making some other upgrade to the unit that might be in order anyway. If you really want to show the tenant what a wonderfu landlord you are, you might even consider giving them a gift certificate to the local Starbucks.
4. Think about posting the rent on your “For Rent” signs. When exisiting tenants see what a new tenant will have to pay for the same unit they currently rent for less (assuming they are paying less, even after the increase), they are less apt to object and might even go to bed that night appreciative about the good deal they are getting.

Of course, these are only suggestions to help you cope with having to raise rents; it’s not rocket science. Perhaps you even have a couple of ideas of your own.

The important thing is to remember that owning real estate investment property is a business, and as a landlord you must not ignore raising rents to make your investment profitable. It has nothing to do with the greediness of Scrooge.

Okay, you’ve been looking at a real estate investment property for some time and are about to write an offer.

You’ve driven by the property and like it’s curb appeal, and you like the fact that there appears to be little deferred maintenance. Plus, you’re fond of the neighborhood because it’s highly residential and yet close to buslines and shopping areas. Moreover, given the overall condition of the tenants’ cars, you’re encouraged about the quality of tenants who might be renting there.

Most importantly, you’ve reviewed the annual property operating data (APOD) and other income and expense statements and you like the bottom line. You’re attracted to a great rental income, low vacancy rate, and annual operating expenses in the range of a reasonable percentage of GSI. According to your calculations, after your mortgage payment the property will indeed produce a very favorable positive annual cash flow.

In other words, this rental income property is just the investment opportunity you’ve been looking for. Or is it?

Obviously your offer will include the typical walk-thru and professional property inspections to validate the property’s condition. And closer examination of a current rent roll, tax, utility, and other records will shed light on the rents and operating expenses. But what about the property’s performance? How can you be sure that the property has been able to generate the kind of numbers suggested by the data you’ve been presented? Perhaps the favorable numbers are an apparition without a past reality.

One sure-fire way to know is for you to ask to see the seller’s tax return (Schedule E). Why? Because the owner’s Schedule E is what the owner has actually reported to the IRS about the property’s performance. And given that it’s unlikely that an owner will claim inflated income or too little expense on a tax return, it becomes an illuminating source of information about the property apart from the statement of cash flow you were given during the sales presentation.

Of course don’t expect to get the Schedule E up front (the owner is not likely to submit tax return information without an acceptable offer). Just be sure that your offer includes a contigency provision for you to see and approve it. And don’t be shy to ask for the past several years of returns. If the seller objects, simply point out that a Schedule E tax return is not unrelated to the property and is a vital part of your normal due diligence and decision making.

The financial management rate of return (FMMR) was introduced to the world of real estate investing because it addresses the length of investment term and risk of investment issue. Although FMMR is regarded a better mirror of real-world investment situations than the modified internal rate of return (MIRR) (also known as the avarage rate of return model) and internal rate of return (IRR), it has not been widely adopted as a common form of investment analysis by real estate investors because it is more difficult to calculate.

In fact, very few real estate investment software programs include FMMR because it is difficult to calculate, and opt instead to use MIRR because Excel provides a built-in MIRR calculation that the software developer can simply plug-in with the click of a mouse. Therefore if you want to use FMMR in your investment analysis, you can calculate it manually with some financial calculators, or get it calculated for you automatically inside real estate investment software (just be sure that the software provides it).

Okay, let’s see how FMMR compares to MIRR and why it is a serious investment return that real estate investors should know about and consider using.

Whereas modified internal rate of return (MIRR) makes the assumption that all annual cash outflows (investments) are discounted to a present value at an average rate and all positive cash inflows are reinvested at that same rate, financial management rate of return (FMMR) specifies cash outflows and cash inflows at two different rates known as safe rate and reinvestment rate. The FMMR also differs from the MIRR in that FMMR makes the additional assumption that positive cash flows occuring immediately after negative cash flows will be used to cover that negative cash flow, whereas the MIRR simply discounts back all negative cash flows to the beginning of the holding period at an average rate.

Here’s the idea. Safe rate assumes that funds required to cover negative cash flows are earning interest at a rate easily attainable and can be withdrawn when needed at a moment’s notice (i.e., like from a day of disposit account). Thus, the name “safe;” the funds are safely available when you need them. Reinvestment rate reflects that rate one might expect to receive if the positive cash flows were invested in a similar intermediate or long-term investment with a comparable risk. As you would expect, safe rate is a lower rate than reinvestment rate because it is highly liquid (i.e., requires minimal risk), and reinvestment rate is higher than safe rate because it is not liquid (i.e., it concerns another investment, and thus higher-risk).

Here’s how it works. All negative cash flows are discounted back over the course of the holding period at the safe rate until they are fully covered by the positive cash flows, and then all the positive cash flows are compounded foreward over the course of the holding period at the reinvestment rate. The result is the financial management rate of return; the rate of return an investor might expect to receive on real estate projects of that length of term and reinvestment risk.

What does it mean? Simply put, the FMMR provides the best way to compare alternative investments on a par (”apples-to-apples”) basis and is a better mirror of real-world situations.

ProAPOD real estate investment software provides the financial management rate of return in a proforma income statement that can be previewed here.