Renting at below-market rates is a common problem among new real estate investors. How do you know what constitutes a fair rent rate? And what if that rate leads to vacancies or losses? Setting the right rent rate is a skill that requires practice. There are many things to consider in your analysis: property features, number of bedrooms, market trends, policies and more.
Understanding your market and your renters is the first step toward setting an appropriate rent rate. Here are five things to consider when setting a fair rent rate for your properties:
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Your property’s characteristics and features are one of the first things to consider when setting a fair rent rate.
To start, make a list of comparable properties in the area. Comparability is key. It won’t help to compare the rates of your 850-square-foot one-bedroom unit to a nearby 600-square-foot one, even if they’re in approximately the same neighborhood.
What’s more, prospective renters in different areas will have other priorities and preferences for features and amenities. For example, renters in a blizzard-prone city will likely pay more for covered parking than renters of a similar property in North Carolina.
In addition to size, other factors to consider include the property’s age, condition, number of bedrooms, in-unit and community amenities and location. Weigh each of these factors against each other. For instance, an older property might get away with charging the same rates as a newer one across town if it’s located in a prime spot next to a university or shopping complex.
Market trends and occupancy rates
Next, analyze market trends and occupancy rates. What are the average prices in your property’s neighborhood? How about your city? Falling too far outside the boundaries set by local trends in either direction will decrease your profit margin.
Occupancy rate is the ratio of rented units to available or vacant ones. Compare the average occupancy rates in your neighborhood, city and region. If you own multi-family units or multiple properties, how do your rates compare?
If your occupancy rate is higher than local averages, you’re probably undercharging and could benefit from a more aggressive rent approach. On the other hand, if your occupancy rate is much lower (i.e., you have a lot more vacancies), your strategy might be too aggressive — either rent is too high or something else is driving renters away, such as restrictive policies or bad reviews.
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Lower and upper bounds
Next, set a minimum and maximum rent rate. These limits will keep your expectations and policies aligned, even if your actual rent rate fluctuates over time.
When setting a minimum rent rate, don’t just consider mortgage payments and the monthly expenses of running your properties. You also need funds in reserve for emergencies (such as maintenance issues, disasters, market downturns, etc.) and a surplus on top of that — your profit margin.
Even if your profit margin starts low, you’ll at least know your properties are generating revenue— however small it may be at first. Setting a floor for your rent rate helps you know that you’ll make some kind of profit.
Setting an upper limit — a maximum rent rate for your properties — is also important. You still need to be able to attract renters instead of deterring them with unreasonable prices.
Unless you’re marketing exclusive, luxury properties, target reliable renters who will pay for quality and safety so long as the cost isn’t exorbitant.
What to do if you’re undercharging (renting at below-market rates)
Many landlords find themselves in this position: Your units are filled, but your business is still struggling. A market analysis reveals you’re renting at below-market rates.
There are several reasons why you might be in this situation:
You have a vacancy problem. Maybe there was a downturn in the market, leading to fewer renters in the area, and/or renters can’t afford higher rates.
You have an eviction problem. If you had previously been delivering lots of rent demand notices, you might have lowered rent to keep your current tenants and restore uninterrupted cash flow.
The previous buyer transferred tenancies to you at below-market rates. This is a common occurrence: A buyer allows you to take on their current tenancies, but their rates were never increased.
You have too many month-to-month tenants. Yearly renters expect small rent increases upon renewals. You might have forgotten to do the same for long-term month-to-month tenancies.
Rent in the area has experienced growth independent of your properties. But for some reason, your property isn’t keeping up.
Action step: If you’re undercharging for rent, get your rent to market level as soon as possible. Renting at below-market rates does no favors to your business, even if it is more comfortable for your current tenants. Remaining at below-market rates for a long time is not sustainable. Your costs will add up, and you won’t be able to compete with neighboring properties. It’s better to raise your rent, letting go of some tenants if necessary or making reasonable improvements to justify the increase.
Related: How to Get the Most Out of Your Rental Property Investments
What to do if you’re overcharging (renting at above-market rates)
Some landlords have the opposite problem: renting at above-market rates or overcharging.
Here are some possible reasons you might be overcharging:
You overcompensated when market rates were high. If rent was increasing in your city, you might have raised yours to exceed the rates around you.
You’ve had an influx of new costs to cover. You raised rent out of necessity to pay the bills. New costs could include mortgage payments, improvements or an unexpected lawsuit. Maybe a disaster occurred that wasn’t covered by your insurance, or maybe you weren’t insured at all.
Action Step: While it might be tempting to hike up the rent when you’re in a sticky financial situation, remember that vacancies will not help you cover your costs or reestablish cash flow. Tenants paying at-market rates are better than no tenants. Try to stagger rent increases and start with small, regular ones each year. Real estate investment site SparkRental recommends that landlords avoid raising rent by more than 5% per year.Setting a fair rent rate for your properties should be a top priority whenever you acquire a new property. And once you set it, regularly reevaluate it. Leaving your rate steady for years at a time is how many landlords find themselves in one of the undercharging or overcharging scenarios described above. Keep an eye on your rent rate to ensure both fairness for your renters and profit for yourself.
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