5 Reasons To Consider A Month-To-Month Rental Agreement

Key Takeaways:

• What is a month-to-month lease?

• When to use a month-to-month lease

• Month-to-month lease pros

• Month-to-month lease cons

While a significant step, in and of itself, buying a rental property is just the first decision of many crucial choices passive income investors will be confronted with over the course of their careers. Of the decisions rental property owners will be confronted with, however, few are as important as the duration of their leases. In particular, what’s the ideal length for a lease? More often than not, investors will prioritize long-term lease agreements. However, investors shouldn’t be quick to write off the benefits of a month-to-month rental agreement. While not as traditional as their lengthier counterparts, month-to-month leases warrant some consideration.

What Is A Month-To-Month Rental Agreement?

A month-to-month rental agreement is exactly what it sounds like: a lease that isn’t renewed at the end of one month of tenancy. As a lease, the contract will lay out the rules for the tenancy, not the least of which include:

• Security Deposit Requirements

• Late Fees And Penalties

• Lease Duration

• Renewal Clause

• Rent

• The Name(s) Of The Tenant(s), Landlord, And Property Managers

• Tenant Privileges

• Late Fees And Penalties

• Insurance Requirements

• Pet Policy

• Property Damage Clause

All things considered, a month-to-month rental agreement is the same as a traditional lease, only it covers a period of 30 days.

When To Use A Month-To-Month Rental Agreement

Most landlords would prefer their tenants to sign long-term leases. After all, many of the greatest risks associated with owning a rental property can be mitigated with longer lease agreements. The longer a tenant agrees to reside in a rental unit, the less likely the owner will have to deal with turnover, vacancies, and negative cash flow. Perhaps even more importantly, it can be much easier to own a rental property that isn’t constantly turning tenants over.

Despite all of the reasons to favor-long-term contracts, there are times when a month-to-month rental agreement makes sense. In particular, investors will want to consider using a month-to-month rental contract under the following scenarios:

• Following The Expiration Of The Original Lease: A basic month-to-month rental agreement will come in handy once the original lease expires. If, for example, the tenants don’t want to sign a long-term contract but aren’t in a hurry to move, a short-term lease could keep them around a little longer. The tenants get to continue living in the unit with the freedom to leave, and the investor collects another month of rent.

• High Rental Potential: Investors will want to regularly deploy month-to-month rental agreements in neighborhoods with a lot of demand and potential. In an expanding economy, exercising month-to-month leases could result in more cash flow each month. All of the turnover will result in more work, but the rising rents each month could be worthwhile.

• Vacation Rentals: Destination properties can benefit from month-to-month contracts because of their seasonal demand. Properties in an area with year-round demand could host a new group or family each month, capitalizing heavily on the months with the most demand. There’s no reason an investor couldn’t charge more in times of high demand, which is made possible by shorter contracts.

• Student Housing: Due to the short-term nature of student schedules, strategically located rental properties could benefit immensely from month-to-month rental agreements. With most students expected to head home for summer, it only makes sense to offer shorter contracts in areas around universities.

Pros Of A Month-To-Month Rental Agreement

On the surface, most investors may be inclined to ignore the benefits offered by month-to-month rental agreements. One of the most basic principles of rental property investing is avoiding turnover. Still, there are some benefits to shorter leases, not the least of which include:

• Higher Rental Income

• Flexibility

• No Penalties

• Address Problem Tenants

• Keep Good Tenants

Higher Rental Income

Rental rates are almost always directly correlated to the duration of the lease. If for nothing else, the length of the lease agreement will determine how much risk the landlord is exposed to. Longer leases, for example, traditionally coincide with lower rental rates. The longer a tenant agrees to reside in a property, the lower the risk of vacancy and turnover becomes. Consequently, month-to-month rental agreements increase landlords’ exposure to risk. Shorter terms imply more turnover and an increased likelihood of vacancy. As a result, investors will offset the increased risk with higher rates.

Flexibility

A month-to-month rental agreement will award passive income investors with more flexibility than standard lease options. Whereas most leases will last anywhere from 12 to 18 months, the truncated nature of month-to-month rental agreements eliminates the need to wait prolonged periods of time in order to initiate an alternative exit strategy. Instead of waiting upwards of a few years for a lease to run out, investors with month-to-month rental agreements can exercise other options much sooner. The resulting flexibility may grant investors the ability to:

• Switch to a more seasonal approach that favors vacation rentals.

• Increase rental rates and welcome in new tenants.

• Sell the property.

• Conduct any intrusive rehab projects.

• Update the property to better suite a new generation of renters.

• Alter the original exit strategy to meet long-term goals.

No Penalties

There is no penalty for terminating a month-to-month lease as long as the tenant is given proper notification. In fact, most month-to-month lease agreements are drafted for the sole purpose of an impending termination; both sides are already aware the lease will be terminated sooner rather than later. As a result, there’s no termination penalty for either side if the proper protocol is followed. Long-term leases, however, may coincide with significant penalties if broken before the agreed-upon timeline.

Address Problem Tenants

Month-to-month lease agreements allow landlords to turn over tenants at a faster pace than long-term leases. While more turnover may sound counterintuitive to what investors are trying to accomplish, the idea of moving on from poor tenants is very attractive. Therefore, if current tenants are less than optimal, a month-to-month lease agreement gives investors the ability to move on; doing so may simultaneously mitigate risk and allow investors to bring in better tenants who don’t threaten potential cash flow operations.

Keep Good Tenants

In addition to allowing landlords to move on from problem tenants, a month-to-month rental agreement may also help keep good tenants. If, for example, otherwise great tenants don’t want to sign a long-term lease, the mere option of a month-to-month rental agreement could prevent them from looking elsewhere, at least for a short period of time. Landlords unwilling to offer a short-term lease may risk losing great tenants sooner rather than later. At the very least, a short-term lease grants both landlords and tenants optionality.

Cons Of A Month-To-Month Rental Agreement

In addition to understanding the benefits of a month-to-month rental agreement, landlords must also familiarize themselves with the downside of offering such a short lease option. Here’s a look at some of the biggest risks associated with short-term leases:

• Cost Of Turnover

• Loss Of Income

• Rent Instability

Cost Of Turnover

While turnover can be a welcomed process for some investors looking to move on from less-than-ideal tenants, it can be costly. In addition to losing out on income in the form of rent, investors must immediately market the property for tenancy. As soon as the tenant is gone, it becomes the landlord’s responsibility to replace them with someone else. Doing so will require a marketing strategy and a budget.

Loss Of Income

Again, turnover becomes much more likely in the event a landlord initiates a month-to-month rental agreement. With leases lasting as little as a month, a landlord will inevitably need to search for new tenants. That said, the search is only a portion of the cost landlords will incur. In addition to implementing a marketing strategy, investors will also lose out on the cash flow from the previous tenant; not only that, but the mortgage obligation remains. Instead of using someone else’s money to pay down the mortgage, investors will need to tap into their own savings. Therefore, instead of making a profit each month, the landlord will actually have to pay out of their own pocket, making vacancies that much more costly.

Rent Instability

Long-term tenants typically present landlords with stable, predictable incomes. Short-term tenants, on the other hand, offer landlords anything but stable cash flow. When leases are constantly in flux, so too are payment dates. Keeping up with fluctuating payments can be an obstacle in and of itself. Without a steady income stream, everything from balancing a checkbook to making mortgage payments becomes that much more difficult.

Summary

A month-to-month rental agreement isn’t usually at the top of any investor’s list of priorities. In fact, most investors try their hardest to avoid short-term leases. It is worth noting, however, that month-to-month agreements have their place. While they aren’t always the preferred option, they can be incredibly beneficial when deployed at the right time. Therefore, instead of simply ignoring them altogether, investors familiar with short-term leases can give themselves a significant advantage at the most opportune time.

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