As a landlord, should you lock your tenants in for a longer term, or shorter lease terms to allow for rental increases? What's the optimum length of leases to ensure maximum income? Chris Rolls explains
So just how long should you lock a tenant in for when renting out your investment property. It's a question I get asked all too often, and the answer is... it all depends on your circumstances.
As a landlord, you'll need to weigh up the benefits of longer versus shorter leases - both strategies having advantages. So to determine what's best for you, there are a few simple questions you should ask yourself when setting the lease terms so that you can achieve the optimal lease period and ensure you maximise the returns you receive from your investment property.
1. Is the demand for rental property in your area high and is it likely to stay that way?
In most cities across Australia rental vacancies are at record lows and rents continue to increase. The question in these uncertain economic times is whether or not this will continue, or will the global economic crisis also affect the rental market.
The reason it's so important to know the level of demand for rental property prior to determining the length of the lease, is that demand affects the rental price you can achieve and the vacancy period. It's important to note that demand can also vary at different times of the year depending on individual market conditions, and can change quite considerably from month to month. In most major cities, demand for rental accommodation spikes in January and February.
What we're concerned with, in this instance, is long term demand. For example, if you sign a tenant up on a six-month lease, will demand still be strong in six months - allowing you to achieve a good rental increase and low vacancy following the re-renting of the property? Or if demand over the medium term is likely to drop, would it be a wiser move to lock in a tenant for two years?
As a general rule of thumb, if demand for rental accommodation is likely to be strong for the long term then there is less value in trying to lock tenants in on really long lease terms.
2. Do the tenancy laws allow you to put rent increases into your lease, and if so what restrictions are there?
Tenancy legislation differs from state to state, however most states allow for rental increases to be included in a tenancy agreement provided the rental increase amount and the commencement date of the increase is included.
You will find from time to time you may have some prospective tenants offering to sign a two-year lease. Obviously this is beneficial from their perspective as they are assured of a fixed rental price for two years. However, as the owner of the property, you may be assured a long term tenancy you but you may be missing out on a significant amount of money.
Despite what some real estate property managers will tell you, in most states you can and should add a rental increase into long term leases. For example, if you were going to rent a property on a fixed term lease for two years, and you wanted to include a rent increase after one year, you need to work out what would be a reasonable figure to increase the rent by, based on what the property would rent for if it became available in a year. In the current strong rental market this could be as much as 12%.
3. How important is a regular income stream from your property?
If you're an investor that is heavily geared (ie you have borrowed as much as possible and don't have a lot of spare money to pay your mortgages), then a regular income stream from your rental property is probably quite important. In this situation, having a long term lease in place would be to your advantage. It provides you with an almost certain figure of future cash flow.
However, be aware that the legal system is particularly lenient on residential tenants, and even provides a special Hardship Circumstance under which a tenant can get out of a fixed term lease by proving they are under significant financial hardship if they stay.
4. Are you planning to sell your property?
It's always hard to determine what's going to happen down the track, but one thing you need to be mindful of prior to entering into a long term lease with a group of tenants is whether you are likely to sell your property. Unlike commercial property where it is often an advantage to have tenants in place if you sell, having tenants on a fixed term lease in a residential property almost always makes it harder to sell. This is because it makes access difficult, the presentation is almost always negatively affected, and it makes the property less attractive to buyers who are purchasing a property to live in.
If you're planning to sell your property consider shorter leases
As an aside, be aware that new legislation recently introduced in Queensland that allows tenants to terminate a lease if the property is advertised for sale within the first two months of their tenancy.
5. What are the real costs in changing tenants?
One of the often overlooked factors of short leases is that there are often some hidden costs involved in regularly having one group of tenants move in and a second move out.
Other than an increase in total number of days vacant over the course of any year, consider as well that each time you advertise for a new set of tenants, if you self manage the property you have to go through the whole inspection process, application process, lease preparation, lease sign up, as well as conduct an exit/entry condition report and lodge a bond. These all take time and effort or will cost you a let fee if you have a property manager look after your property.
Additional hidden costs of high tenant turnover include the extra wear and tear on your property that occurs during move in/move out of tenants. The majority of preventable damage including broken windows, scratched floors and chipped and marked walls during this time. Additionally research has shown that tenants new to a property request more maintenance and repairs than those who have been residing in a property for a period of time.
All these costs add up in favour of longer term tenancies.
As you can see there is a lot to consider and the decision as to the length of the lease you enter into with your tenants will be determined by your personal circumstances.
At Rental Express we manage over a $1b of residential property across 234 suburbs in Brisbane and in most cases, longer term leases are better for the property owner as long as suitable lease increases are correctly inserted into the lease document. Longer leases result in lower costs, lower vacancy, less wear and tear on the property and more stable cash flow. The only down side is you need to plan in advance for rent increase and if you decide to sell the property.
The good news is that in this very tight rental market, most tenants prefer longer leases and are happy to have a rental increase built in as they then have the security and stability of knowing where they will be living. Additionally, moving is expensive, costing the average person around $2,000 to move house. So to some extent, longer leases are a win-win for everyone involved.
Chris Rolls is the managing director of Rental Express, Queensland's largest property management organisation. To get a free DVD on how to maximise the returns you get from your investment property, go to www.rentalexpress.com.au
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