You found a property where the numbers work at current rents, but you noticed something: the tenants are paying $200 to $400 below what comparable units are getting. The seller mentions the tenants have been there for years. Your mind starts racing with the upside potential.
This scenario is common, and it creates one of the most frequent analysis mistakes I see from newer investors. The gap between current rents and market rents looks like free money. Sometimes it is. Sometimes it costs you the deal.
Why Below-Market Leases Exist
Before you can analyze the opportunity, you need to understand why the rents are low in the first place. The reason matters more than the gap itself.
Long-Term Tenant Relationships
Many landlords prioritize stability over maximizing rent. A tenant who has been in place for 8 years, pays on time, and never calls with complaints is worth something. These landlords often give small annual increases (2% to 3%) rather than adjusting to market every year. Over time, especially in appreciating markets, this creates a significant gap.
Fear of Vacancy
Some landlords, particularly those who self-manage and have had bad tenant experiences, undercharge because they are terrified of turnover. They would rather collect $1,100 per month reliably than risk two months of vacancy trying to get $1,400.
Out-of-Touch Ownership
Absentee landlords or inherited properties often have rents set years ago and never adjusted. I have seen properties where rents had not changed in a decade. The owner either did not know the market or did not want to deal with the conversation.
Section 8 or Subsidized Tenants
Payment standards for housing vouchers sometimes lag behind market rents, especially in rapidly appreciating areas. These tenants might be at the maximum the housing authority will pay, but that maximum is below what the open market would bear.
The Two-Scenario Analysis Framework
When I analyze a property with below-market rents, I run two completely separate analyses:
Scenario 1: Current Rent Analysis
This is your baseline. Assume nothing changes. The tenants stay, the rents stay, and you operate the property exactly as the current owner does. Calculate your cash flow, cash-on-cash return, and DSCR based on what the property actually produces today.
This matters because this is your floor. If the deal does not work at current rents, you are betting on your ability to execute a rent increase strategy. Sometimes that is the right bet. But you need to know you are making it.
Scenario 2: Pro Forma Market Rent Analysis
This is your ceiling. Assume you eventually get all units to market rent. But be honest about what "market" actually means for this specific property.
Market rent is not the highest rent you can find in the zip code. It is what a comparable unit in similar condition would rent for today.
If the subject property has original 1990s appliances and no updates, you cannot compare it to the renovated unit down the street getting $1,600. Your market might be $1,350.
Calculating the Realistic Upside
Here is how I think about the math on a property with below-market rents:
| Unit | Current Rent | Market Rent | Monthly Gap | Annual Gap |
|---|---|---|---|---|
| Unit A | $1,050 | $1,300 | $250 | $3,000 |
| Unit B | $1,100 | $1,300 | $200 | $2,400 |
| Unit C | $1,200 | $1,300 | $100 | $1,200 |
| Unit D | $1,150 | $1,300 | $150 | $1,800 |
| **Total** | **$4,500** | **$5,200** | **$700** | **$8,400** |
On paper, that is $8,400 per year in additional income. At a 6% cap rate, that represents roughly $140,000 in additional property value. Exciting, right?
But here is what that math ignores:
The Timeline Problem
Most lease agreements require you to honor existing lease terms. If a tenant signed a 12-month lease three months ago, you have nine months before you can legally change anything.
Even after lease expiration, many jurisdictions require notice periods for rent increases (30, 60, or 90 days). And if you have month-to-month tenants, you still need to weigh the human element.
Mapping Your Rent Increase Timeline
I create a simple timeline for every property with below-market rents:
| Unit | Lease Expires | Notice Required | Earliest Increase | Months from Close |
|---|---|---|---|---|
| Unit A | Month-to-month | 60 days | Month 3 | 3 |
| Unit B | August 2026 | 60 days | October 2026 | 10 |
| Unit C | March 2026 | 60 days | May 2026 | 5 |
| Unit D | December 2026 | 60 days | February 2027 | 14 |
This shows me that full market rent is 14 months away at minimum. My first-year cash flow projections need to account for this reality.
What Rent Increases Actually Cost
Raising rents is not free. When you push a long-term tenant to market rate, several things can happen:
They Accept the Increase
Best case. You get higher rent starting next month. This is more likely when:
They Leave
Now you have turnover costs:
For a unit renting at $1,300 per month, a turnover might cost:
If you were trying to capture a $200 per month increase ($2,400 per year), you just lost more than a year of upside.
They Leave and the Unit Needs Work
This is the hidden risk. Long-term tenants often mask deferred maintenance. When they leave, you discover the bathroom needs re-grouting, the carpet is destroyed, or the HVAC has been limping along.
I once bought a duplex where the downstairs tenant had been there 11 years paying $825 (market was $1,100). When I raised rent to $1,025, she left. The unit needed $4,200 in work before I could re-rent it. The stove was original to the house. The bathroom fan did not work. There was water damage under the sink.
That $275 per month increase? It took 18 months to break even.
A Complete Worked Example
Let me walk through a real analysis framework:
Property Details:
Current Rent Analysis:
Net Operating Income = Gross Rent - Operating Expenses
At current rents, this deal barely breaks even. The DSCR is 1.05, which most lenders would consider too thin.
Pro Forma Market Rent Analysis:
Now the deal works. But you are betting $85,000 on your ability to execute $9,600 in annual rent increases.
Blended Realistic Analysis:
I prefer to model a realistic Year 1:
This is closer to reality. You might have a slightly negative first year while you execute the rent increase strategy, then strong returns in Year 2 and beyond.
Tenant Quality Versus Rent Optimization
This is where I have a strong opinion: I prefer a slightly below-market tenant who is stable over a market-rate tenant I have to find.
The math supports this more than people realize. A tenant paying $100 below market who stays three years costs you $3,600 in "lost" rent. A tenant paying market rate who leaves after one year (industry average is 18 months) might cost you $3,000 to $4,000 in turnover.
The break-even point depends on your turnover costs and local market conditions. But the conventional wisdom of "always push to market rent" ignores real operational costs.
Red Flags in Below-Market Situations
Not all below-market scenarios are opportunities. Watch for these warning signs:
Rents Are Below Market for a Reason
Sometimes units rent below market because they are worse than the market. Location issues (busy street, bad parking, noise), condition issues (outdated, poorly maintained), or layout issues (awkward floor plan) can explain the gap better than landlord complacency.
I always ask: "Would I rent this unit for market rate?" If not, your pro forma is fantasy.
The Seller Tried and Failed
Ask the seller if they have attempted rent increases. If they tried to raise rents and tenants left, or they got pushback and backed down, that tells you something about the local market dynamics.
Tenants Have Leverage
In rent-controlled jurisdictions or areas with strong tenant protections, your ability to raise rents may be legally limited. Research local regulations before assuming you can adjust to market.
The Rent Roll Deep Dive
Before closing on any property with below-market rents, I want to see:
The rent roll tells a story. A tenant paying $900 who moved in six years ago and has never been late is different from a tenant paying $900 who moved in last month because no one else would rent at that rate.
Running Your Numbers
Underwriting properties with below-market rents requires running multiple scenarios. You need to understand your floor (current rents), your ceiling (market rents), and your realistic path between them.
Be skeptical of deals that only work at pro forma rents. Be especially skeptical if the rent gap is large (over 20%) and the path to market rent is unclear.
The Single Family Rental Calculator lets you model different rent scenarios and see how cash flow changes over your hold period. Run the numbers at current rents first. If the deal works there, the upside is gravy. If it only works at pro forma, make sure you understand exactly what has to happen for those rents to become reality.
For more data on what market rents actually look like in different areas, HUD publishes Fair Market Rent data that can serve as a baseline for your analysis.
The best below-market rent deals are the ones where you understand exactly why the rents are low and have a clear, executable plan to address it. The worst are the ones where you assume the upside without pricing in the risk.