How to Charge the Right Amount of Rent
Unfortunately, many people think that monthly rent is based on what neighboring rentals are charging minus how much their own property’s mortgage payment is each month. They omit such crucial factors as maintenance and utility costs, taxes and payroll and all the other expenses that come with being a property investor and a landlord.
Apartments.com reports that, “Setting the right rental price for your property can be a tricky balancing act. Charge too much, and you risk driving away potential tenants or dealing with a vacant property for extended periods. Charge too little, and you might miss out on valuable income. Landlords and property managers, especially those new to the game, often wonder, ‘How much should I charge for rent?’ and ‘What’s the sweet spot for my location and type of property?’”
How do I know how much rent to charge my tenants?
“Determining how much to charge for rent requires careful decision-making,” advises HomeDepot.com. “You need to charge enough to cover your monthly expenses as well as provide an adequate return on your investment. But if you set rent too high, you risk pricing yourself out of the market.”
In other words, if you price your rental too high, your place could sit unoccupied. Too low, and you face the possibility of losing money on your investment.
According to HomeLight.com, “Landing on a fair market value for your rental property can be a big challenge, especially if you haven’t rented or set a rental price before. You don’t want to leave money on the table, but you also don’t want your rental sitting vacant because you’re charging too much.”
“A fair rental price for your property generally is the amount of rent that a person who is not related to you would be willing to pay,” notes the IRS. “The rent you charge is not a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property in your area.”
The U.S. Department of Housing and Urban Development (HUD) estimates fair market rents annually. Since they look at rents across the country, it’s a good place to start your research, but you’ll want to get a more localized view to see if rates in your area are the same or differ from HUD’s fair market rent estimations.
“For landlords who already own property, determining market rent will help you decide if you should increase your prices,” notes TransUnion. “Raising the rent above market rent can leave you with extended vacancies and you’ll need to cover the mortgage on an empty apartment for several months. For this reason, it’s best to do your research in advance.”
Determining market rent can also help you avoid charging too little for rent. Your own expenses, such as property taxes and employee salaries, increase each year, so you need to charge enough rent to maintain a positive cash flow. Raising the rent may be the right way to accomplish that. It’s something you’ll want to consider at each lease renewal.
Determining market rent
If you’re looking to make a new rental property investment, calculating market rent can help you decide if you’ll earn a reliable and profitable income from the property.
The simplest way to determine how much rent to charge for a property is the 1% Rule. This general guideline suggests that you charge around 1% (or within 0.8-1.1%) of your rental’s total market value as monthly rent payments. A property valued at $200,000, for instance, would rent for $2,000 a month, or within a range of $1,600-$2,200.
The 1% Rule should be used as a starting point for estimating rent, as many factors can influence the best rent for your property’s location.
For homes worth significantly less than the median U.S. value, you probably want to set a rental price closer to 1.1%. For homes worth more, 0.8% is perhaps a more realistic rent price.
According to HomeLight, if housing prices are up and the inventory is low, the demand for rentals also goes up. When housing prices are low, and there is more inventory, demand for rentals typically goes down.
Consider the housing market and the level of supply and demand in your area. If there is a high demand for rental homes, you can set the price a little higher, but if demand is low, a lower rental rate may make the home more appealing.
When someone is purchasing a multifamily property or a single-family home as an investment, they naturally want to know how much profit it is going to produce. To arrive at the answer to this question, it is necessary to know the potential rental income.
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Computing the NOI, the Cap Rate and the ROI.
When you manage or own a rental property, your success depends on renting the property at a rate that consistently earns you a profit. However, how do you know what rate to charge for providing cash flow to cover expenses that won’t outpace the rental market?
How does one know how much rent to charge? The answer lies in computing the Net Operating Income (NOI) and the Capitalization Rate (Cap Rate).
- NOI is the annual income generated by the property after subtracting all operating expenses. It reflects the financial health of the property and its efficiency in generating revenue.
- The Cap Rate estimates the investor’s potential return on investment (ROI) by comparing the NOI of similar properties. It provides a standard by which to measure the property’s potential as a profit center.
Setting the proper rental rate for your property is not the same as determining the property’s return on investment. A competitive rental rate often reflects your property’s value to potential renters in the area. An acceptable return on investment often depends on your own expectations for a property’s earnings.
This method offers a simple way to determine the return on investment (ROI) for your rental property.
- Determine the property’s annual income based on rent.
- Determine the property’s annual expenses such as mortgage payments, taxes, maintenance costs, etc.
- Subtract the expenses from the income to determine the property’s annual cashflow.
- Calculate your total investment in the property, which includes the down payment, closing costs, renovation costs and more.
- Determine the ROI by dividing the annual cashflow by the investment amount.
Many experts advise investors to seek an ROI of at least 5%. Often the best way to gauge a return on investment is to compare it to an alternative investment option, such as the stock market.
The conditions that determine the ideal rent
Local market conditions play a significant role in determining rental prices. If you are in a hot rental market, the available rental homes will be snapped up quickly, causing the stock of rentals to be low. If this is the case in your area, you may be able to charge more in rent. Be sure to check the market conditions as you determine your rent. On the flip side, if there’s higher vacancy than there is demand, you might need to lower your rent to be competitive against other properties.
The size of the rental unit, its location, its age, and any applicable rent control laws or regulations are typically taken into account by landlords when determining your allowable rent.
Your rental price might also be affected by changes in local amenities or local job growth, such as when a new shopping center opens nearby or a big company moves into town and starts hiring. These factors can make your area more desirable, enabling you to increase your rent. Unfortunately, the opposite is also true. If local businesses are closing or jobs are leaving, your area might not be as desirable for renters as it was previously.
Consider the housing market and the level of supply and demand in your area. If there is a high demand for rental homes, you can set the price a little higher, but if demand is low, you may need to make the home more appealing with a lower rental rate.
Recent surveys show that renters are more willing to pay a higher dollar rent if the property is turnkey. Does it have the new floors, new countertops and new appliances that give it that new house feel? Properties with more amenities, such as in-unit smart appliances, fitness center or community swimming pools, can command higher rents than those with fewer amenities.
Checking out the competition
Learning the rents of competing apartment communities in your marketplace will give you a good idea of how much you will be able to charge your own tenants.
When determining how much rent should be for a property, one of the most important steps is to study your competition. Rent prices can vary wildly depending on location, square footage, the number of bedrooms and bathrooms and amenities, so be sure to compare apples to apples. Some of these competitive advantages apply to both single-family and multifamily properties.
Compare your properties to the competition based on these factors:
- Is the other property in the same neighborhood as yours? The quality of the neighborhood can have a strong influence over real estate values and rental rates. A rental in the heart of the city’s most popular neighborhood can demand more in rent than it could in a less desirable area.
- Does the other property have comparable square footage, number of bedrooms and bathrooms to yours? The size of a property will play a large role in determining your rent. If you have a 900-square-foot cottage, it won’t rent for the same amount as an 1,800-square-foot house, even if they are located next door to each other.
- You can often set a higher rental rate for new construction compared to old construction. If your home is historic or in a historic district, you could get more in rent. However, if your home is older and needs updating, its value could be diminished.
- Increase your property value with safety features such as parking lot lighting, security cameras or security fencing.
- Other features that can make one property preferable to another are ample parking and a location convenient to public transportation.
Once you know the rates of similar rentals in the area, it’s time to adjust your rent price based on the condition and offerings of your property. The state of your unit directly influences the rental price. Renovated and well-maintained units will naturally allow for higher prices. Amenities such as in-unit laundry, a pool or fitness center can also justify a premium rental price.
If the house down the block is renting for $3,000, but your property offers upgrades or recent renovations, such as new hardwood floors or a fully remodeled kitchen, you may be able to set your price higher.
Additional pricing considerations
Rent control is a government-mandated cap on the amount you can charge for rent. Look up the rent control laws for your city or state. Some states and municipalities also limit what property owners can charge for late fees or security deposits.
Rental properties have higher demand in warmer months. Rents can be set higher in April through June and at their highest in July and August. Consider setting lower rents in the fall and winter months, when demand is lower, with the lowest from Thanksgiving through New Year’s Day.
“When calculating rent for a multifamily property, some units in the same building may require different rates,” according to HomeDepot.com. They recommend you adjust the rent based on factors such as these:
- View: Apartments that overlook a green space are preferable to those that look out over parking lots or busy streets.
- Floor level: For buildings with elevators, units on higher floors are more desirable, offering better views and greater distance from potential street noise. With walk-ups, units above the third floor become less desirable.
- Size & amenities: Units with more square footage or additional rooms can be rented for more, as can units with features such as balconies or stainless steel appliances.
There is a wide variety of rental properties for people to choose from: single-family homes, multi-family buildings, condos, lofts, duplexes, ADUs and townhomes. The rent will vary depending on the type of home you have. For example, a single-family house will probably rent for more than a unit in a duplex.
Inflation and interest rates can affect your costs as a landlord, which in turn can influence your pricing strategy. Monitoring these factors is key to adjusting your rental prices periodically. A stagnant price in a rising market may indicate lost income potential.
Finally, increased interest rates might make it harder for renters to afford a mortgage, potentially lengthening the average tenant stay and boosting rental demand, which are additional factors to consider when determining rent.
Budget for Maintenance and Utilities
When you are figuring out how much to charge for rent, you can’t forget about the costs of maintenance and utilities. These are expenses you’ll need to cover as a landlord and they can significantly impact your bottom line.
So, how much should you budget for maintenance? Experts suggest maintenance will cost around 1% of your property’s value each year and recommend setting aside 50% of all rental income to budget for these expenses.
Utilities are another big consideration. These can vary widely depending on where your property is located and the size of the property. If you include a tenant’s utilities as a flat rate in their rent, try to estimate how much water, gas, electricity, and trash will cost over a year and adjust rent accordingly.
Conclusion
Determining the fair market rent for your property may not only mean less chance of vacancy and longer leases, but might increase the number of applicants competing to rent your property. The more applicants you have, the greater your chance of finding good tenants.
Setting the right rent price and conducting a thorough AAOA tenant background check on your prospective tenants are two of the best ways to ensure the highest possible profit as a landlord.
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