Rental pricing and how to set the price of their rentals is naturally one of the first questions asked by owners.
They often have some idea – which, unsurprisingly, may lean towards the optimistic end of the spectrum. Independent pricing sources are available to provide pricing guidance and counter any internal bias. But there also are some general guidelines you can calculate yourself based on size, which are very important to understand regarding total rental yields.
Pricing is important both directly and indirectly. Directly as rental income, and indirectly in that it determines occupancy – or vacancy – and lease-up times. High pricing may result in higher volatility of rent payments and lower total revenues due to longer lease-up times or increased vacancy.
Pricing also affects the pool of applicants. The higher the price, the smaller the pool of applicants. Using a common 3x rent-to-income approach diminishes the pool quickly as you move into the upper echelons of household income. For example, rent of $3,000 per month would require an annual household income of $108,000 – which equates to roughly the 70th percentile of household income in the Portland/Vancouver MSA. Said another way, only 30 percent of the population would qualify to rent your unit based upon income. Other exclusions (such as no pets) may quickly reduce that pool further. Rental-pool size is a larger subject, but you get the idea.
As housing increases in size, pricing can be difficult to estimate due to diminishing returns. While the difference tenants are willing to pay for 200 more square feet may be significant as square footage increases from 800 to 1,000 square feet, the extra they are willing to pay as it increases from 2,000 to 2,200 may be significantly less. The diminishing-return trend can be calculated by plotting available rentals and their asking prices.
Rental pricing per square foot
The following graph illustrates the declining price-per-square-foot as the rental size increases. This graph includes all properties currently listed for rent on Zillow in West Linn, OR (as of December 14, 2019). The price per square foot is shown on the vertical axis and the total square foot of the unit on the horizontal. For example, a 1,400-square-foot house may rent for $1.50 per square foot ($2,100 per month) while a 2,500 square foot house will rent for $1.10 per square foot ($2,750 per month).
There is a distinct trend of diminishing income per square foot as size increases. The breadth of pricing at a given square footage may stem from various factors, including location of rental, quality, included amenities, pet acceptance, and simple pricing errors.
As you may imagine, type of rental (single- or multi-family) affects the slope of the rental-income curve. The following charts illustrate single- and multi-family separately. The range of square footage for multi-family units is more compact than SFR.
Interestingly, the slopes of the trendlines for both single and multi-family units decrease at very similar rates. The decline in average rent as size increases is as follows for this group of rentals:
3.3¢ per 100 square feet
33¢ per 1,000 square feet
2.9¢ per 100 square feet
29¢ per 1,000 square feet
At first glance those may seem like small numbers but extrapolating into annual rents for long-term properties the results can be highly significant. The yield differential between a 1,500 square foot rental and a 2,000 square foot unit is very significant – especially when you factor in the additional costs of purchasing, operating, and maintaining the larger homes – think roofs, window counts, flooring, yard maintenance, etc.
Third party pricing guides are very helpful in providing an unbiased (albeit unseen) estimate of your property. And absent notable differentiators such as location or amenities, are likely reasonably accurate. Rentometer (www.rentometer.com) and RentRange (www.rentrange.com) are 2 sites worth a visit. And again, Zillow will automatically provide an amount that will be seen by all visitors. The combination of these 3 estimates will provide you with a default rental amount.
Keep in mind that renters will likely also see estimates – particularly on Zillow – and may assume that your higher price is out of line with the market. Owners must counter that price anchoring effect with photos and a compelling description that justifies a higher rent variance. On a side note, while I love Craigslist please exercise caution when using it for anything rental related including rent pricing. Most rental horror stories begin with “I saw an ad on Craigslist…”
Using these third-party pricing sources will you give several data points as a backdrop for your pricing decision. Understanding the diminishing return trends in pricing will also help to guide your pricing – and investment decisions. Good luck!
About the author:
Steve Geidl is a licensed Property Manager and Residential General Contractor living in West Linn, Oregon. He can be reached at firstname.lastname@example.org.