COVID-19 has played havoc for landlords, particularly those invested in certain cities. San Francisco, New York, and Toronto are three examples where average rents have been depressed.
Average monthly rent and YoY change New York (above) and San Francisco (below)
Source: Zillow Weekly Market report
As a landlord, the average rent doesn't matter. Your P&L and cashflow matter. I've found myself in the situation three times this year having to ask myself: "Should I reduce the rent or leave the unit vacant until the market rebounds?"
Here's how I think about it:
- If I drop the price now to minimize vacancy, how much will I need to drop the price by?
- Once the price is lowered, how long will it take to increase rents to get back to where the market is?
- If I wait to decide, how much lower could the market go?
- If I leave it vacant, for how long will it remain vacant?
- If vacant, what's the benefit (no wear and tear) vs what's risk (break-ins, squatters)?
That's a lot of unknowns. To help me make a qualitative decision, I run a quantitative analysis comparing vacancy with a price drop over a two year period, modelled over five years.
In scenario 1 I assume vacancy might be for 2.5 months in the first year and a month in the second year in a three-unit house:
In scenario 2 I assume rents might be depressed by about 10% for a couple of years in the same multi-family house:
In these two scenarios there isn't much difference on the average metrics. Take a look at ROE or cash-on-cash return. Even the five year net income after interest ($132K) is about the same in both scenarios.
But cashflow is negative when you opt for vacancy. And that for me is a no-no (within reason). I can spend a lot of time modelling all sorts of scenarios. The reality is anything more than 18 months out is just guessing.
My edge is to recognize local market trends before other landlords. You can then 'lock in' rents with a contract before prices have fully bottomed out. Of course a contract isn't a guarantee of future rental income, but it helps. Especially if you can have a guarantor to the contract (someone who is contractually obliged to pay rent even if your tenant doesn't or can't).
In general, in a tanking market drop your rent quickly but not by too much. Avoid vacancy unless necessary. Don't be one of many landlords competing for the few remaining renters.
A guarantor is a free rental income insurance policy. Get one if you can.