(Note: The terms “fixed” and “annual” leases are used interchangeably. Both refer to traditional 12-month, fixed leases in the context of this article.)
Twelve-month, fixed-term leases have long been the standard structure for residential rentals, but they aren’t the only option. Month-to-month (M2M) leases are popular with many tenants looking for flexibility and temporary rental solutions. They’re exactly what they sound like they are—a one-month rental agreement, which can be renewed or terminated upon expiration. As shorter lease terms become more appealing to today’s renters, month-to-month leases are certainly worth your consideration as a landlord. This article examines the benefits and drawbacks of offering an M2M structure, so you can make the best decision for your rentals.
Month-to-month (M2M) leases are popular with many tenants looking for flexibility and temporary rental solutions.
Flexibility: Landlords can take advantage of a month-to-month lease’s flexibility just as their tenants can, especially when deciding to sell a rental property. While it’s certainly possible to sell a tenant-occupied property, you’ll find that it’s a much smoother process when the unit is vacant. Selling during a fixed-term lease means that you’ll most likely have to work around tenants’ busy schedule and right to quiet enjoyment of their living quarters for a matter of months, not weeks, when organizing showings. An M2M lease enables you to obtain more quickly the freedom of showing or renovating your property as you see fit.
M2M leases also give landlords a better opportunity to move into their rental and convert it into a primary residence as a result. Doing so may have tax implications, but it’s always an option for landlords looking to sell, downsize or have for personal use.
Non-Renewability: Screening and vetting your tenants is always necessary, but it’s not always perfect. The reality is that not all tenants will be ideal fits, and sometimes it’s just as important to discharge them as it is to keep them. Instead of committing to a tenant for the remainder of the year, a month-to-month lease enables you to end the tenancy by the end of the next month. This is especially beneficial when tenants are in direct violation of their lease, and waiting out the remainder of the M2M term is a simpler option than taking on the costs that are necessary for an eviction. Even if your tenant isn’t in violation of the lease, you may still want to find a better fit for that unit. An M2M lease makes it possible to find another renter quickly rather than wait out the remainder of a fixed-term lease when there are no grounds for eviction.
Adjustable Rent: If you own a property in a growing market, you’re able to capitalize much faster than you would with an annual lease. That’s because you’re able to react and adjust your rates at the end of your existing month-to-month lease term, instead of hoping that such growth is sustainable for 11 more months.
Of course, landlords can’t keep constantly raising rents left and right. There are limitations on the timing, the communication and, in areas enforcing rent control, the amount by which rent is increased. Many of these limitations vary by state, but there are some commonalities. Generally, states require landlords to give a written notice at least 30 days in advance for rent increases. Always check local laws before making rent increases (or changes to any other aspect of your lease, for that matter), and ensure that your rates are still in line with the market for your area. If done properly, M2M rentals can be very profitable in growing, high-demand locations.
Ease of Long-Term Conversions: If you have a quality tenant renewing month-to-month leases, it can be extremely simple and beneficial to convert to a fixed-term lease upon its expiration. The tenant must be willing to do so, too, but it’s a win-win for both parties if everyone agrees to make the switch. Landlords get the security of an occupied unit for the year, and the tenant can lock in a consistent rent payment over that time. In this way, an M2M lease also serves as a vetting process. If tenants have proven themselves reliable after the first two or three months, you can feel much better about offering them a fixed, 12-month lease.
If you have a quality tenant renewing month-to-month leases, it can be extremely simple and beneficial to convert to a fixed-term lease upon its expiration.
On the flip side, an M2M lease can be used on the tail end of an annual lease to retain quality tenants. This would apply to tenants who need an extension but who aren’t able commit to an entire year. This is another win-win situation — your tenants know they’ll have a roof over their head, and you get to retain a proven renter (and his or her cash flow) for a little while longer.
Renting at a Premium: Because a month-to-month lease doesn’t provide the consistent cash flow or occupancy of an annual lease, many landlords charge a premium as a protectionary measure. Many tenants are willing to pay a slightly higher rate than an annual lease because it provides them flexibility as well. For instance, $500 per month with an M2M lease may seem more appealing to some tenants than being locked into $425 per month for an entire year. This is especially true if there is uncertainty with a tenant’s employment situation or the tenant is planning on moving again within the next few months.
Vacancy & Turnover: Finding new tenants isn’t a fun process. It takes a significant amount of time and might even be costlier than you think. The more units you have under a month-to-month lease structure, the more often you’ll need to take time searching for tenants, showing units and screening applicants. Even if you do rent certain M2M units at a premium, it may not be enough to offset the costs filling the vacancies once the lease expires. Making sure you have consistently occupied fixed-lease units in your portfolio is the best way to protect yourself before committing properties to an M2M structure. Additionally, fixed leases provide you a 12-month window for finding a new tenant. An M2M lease may give you as few as 30 days to find a new tenant before vacancy ensues.
Forecasting: For the most part, you know what to expect when you have tenants signed into fixed leases. Landlords know (contractually, at least) that they’ll collect X amount of rent for the year, with occupancy between dates Y and Z for each property. There’s quite a bit more uncertainty in a month-to-month situation. Until a tenant gives you a standard 30-day notice to terminate the lease (or you do so yourself), there’s no way to know for sure just how long that unit will be occupied. Even once a vacancy is refilled, that uncertainty returns with each tenant who follows.
The term lengths aren’t the only variable. Rental amounts also can change for each tenancy throughout the year. As a result, converting a good tenant to a fixed lease can be a big advantage when the opportunity presents itself. Forecasting only becomes more problematic as your portfolio of M2M leases increases. This could be an issue in situations such as expansion, where your annual projections can impact the financing of new properties significantly.
Adjustable Rent: Just as you can increase your rental rates in a hot market, you also may be forced to reduce them in a struggling market. Rent prices don’t decline as often as they increase, but as cyclical as real estate tends to be, you’re bound to experience these conditions at some point. For landlords using fixed leases, these rent decreases don’t make as much of an impact. Their tenants will owe them the same amount for 12 months. On the other hand, landlords overseeing month-to-month units have to reduce prices along with the market to stay competitive. In poor economic conditions, landlords may not be able to keep the units occupied if they are charging at a premium. So, landlords must deal with inconsistent occupancy in addition to increased turnover costs, and they are already working on a tight timeframe as they have a smaller window to find new tenants.
Landlords overseeing month-to-month units have to reduce prices along with the market to stay competitive.
Maintenance: Renters often expect landlords to fully furnish units designed for the short-term. Doing so can help you fill vacancies faster and justify a higher rate. However, the more your month-to-month rentals change hands, the more likely the rentals are to wear and tear quickly. You’ll have to spend more time doing maintenance checks after each tenant vacates, and furnished properties means potentially higher costs for repairs or replacements.
Pros & Cons of Month-to-Month Leases at a Glance
Many factors differentiate month-to-month leases from fixed-term leases besides their length. If you’re deciding whether M2M leases are a good fit for you and your tenants, here’s a quick recap of the pros and cons:
These end sooner, so you can sell, renovate or move into your units more quickly.
Vacancy & Turnover
M2M leases mean more time spent finding new tenants with a shorter window to do so.
You can choose not to renew after the next month instead of waiting a year or evicting a troublesome tenant.
Variable term lengths and rental amounts can lead to inaccurate financial projections.
You can capitalize more quickly on growing market prices.
Should rents decline, M2M units are more susceptible to reduced cash flow.
Ease of Long-Term Conversions
You can sign good M2M tenants to fixed, annual leases, or use an M2M lease after an annual lease to extend or retain good tenants.
More time will be spent doing maintenance after each tenancy. An expectation of furnished units means repairs could be costlier.
Renting at a Premium
You can take advantage of higher rates to counteract the lack of security on short-term rentals.
For more interesting articles on managing your properties, be sure to subscribe to our blog and Like us on Facebook. And don’t forget to share your thoughts in the comments!