Friday, July 25, 2014

Calculating the right rent for your investment property.

Owning rental property is one of the soundest investments you could make, to the extent that 90% of millionaires have income-producing property in their portfolio.  But making day-to-day decisions to manage those properties can be challenging if your not properly informed.  There is no greater decision than what rent to charge a new tenant.

If you read all the books on real estate investing, they cite a general rule as industry standard: To calculate rent, take 1.1% of the home’s value.  That means if your rental property is worth $100,000, the rent should be $1,100.  If it’s a $200,000 rental house, the rent will be $2,200. 

Universal axioms like that are dangerous when you’re talking about real estate because there are no “one size fits all” solutions.  For instance, good luck getting 1.1% in California, where the median home price is much higher than the rest of the country.  The good news about owning property in California is that our appreciation rates are much higher than the rest of the country during healthy markets – as we’ve seen with nearly 25% appreciation since 2012 in the Sacramento area.  Also, whether you’re renting a house, a halfplex or duplex, condominium, or apartment in a building you own has a huge impact on what rental price is appropriate. 

Assuming that you have a single-family residence or halfplex or one side of a duplex (not a condo or apartment) in a decent neighborhood in the Sacramento region, how do you price your rent?

First off, let me cover the three priorities of any landlord to frame the conversation.

In reality, you have three goals as a landlord, in this order:

1. Avoid vacancies.
2. Get a renter who pays on time and doesn’t trash your unit.
3. Get a renter who stays long term.

A renter who stays long term and pays on time helps minimize time, energy, and money-consuming transitions, where 90% of your work as a landlord will occur.  Of course you want someone who takes reasonably good care of the property so your fix-up costs (above their damage deposit) will be minimal. 

And vacancies?  Those are the enemy of the landlord – the monkey wrench that throws all of your calculations on profit out of whack.  Point blank: vacancies kill landlord profits. 

The reason I bring this up is because too often, landlords try to charge the highest monthly rent they can manage, thinking it’s good business to boost their monthly income as high as they can “get away with.”  But in reality, charging rent that’s above fair market value is detrimental to their business model.  Why?  They’ll have a smaller pool of applicants (who may have shaky credentials,) the tenants will move out more frequently or cause more problems, and it will take longer to rent the unit – all factors that contribute to a high vacancy rate.

Imagine that we have a house in a neighborhood where most similar properties rent for $1,200 a month.  At that price it’s easy to find good renters so let’s say the unit will have a paying tenant 12 months a year.  That equals $14,400 a year in rental income.  But if the landlord gets a little greedy and tries to charge $1,300 a month in rent it takes longer to find a tenant or they move out before the year is up.  If it’s occupied 11 months out of the year at $1,300, that comes to $14,300 a year profit.  If it’s vacant for two months, the total profit is only $13,000.  It doesn’t seem like much, but any benefit of trying to squeeze an extra $100 a month in rent is wiped out by even one month’s vacancy.

So as we determine a price for your rental property, we have those three goals in mind. What we want to offer is a rental price that is fair, a win-win for both the tenant and the landlord.  I even like to price my rentals slightly below market value because I attract far more applicants.  I can take my pick of those with the best credit score, income, stable jobs, etc. and I end up earning far more profit by eliminating vacancies, evictions, maintenance, etc. 

Here are the steps in determining the rental price that’s best for you:

1. Compare apples to apples.
When researching what other similar homes are going for, make sure you look in the same neighborhood and at the same type of property.  Don’t compare a condominium to a house, a unit in Granite Bay to one in Citrus Heights, etc.

2. Look into Craig’s List and other websites.
Do your homework online by looking into Craigslist and other websites that advertise rental properties.  This will give you a good sense of what other landlords are charging – your competition – and what options a renter has.  You’ll come up with an accurate range – low, average, and high rental prices. 

3. Talk to neighbors.
Knock on a few doors, announcing your intention to rent the property and inquiring what rents are going for in the neighborhood.  You may be surprised at the answers!

4. Add or subtract for amenities.
Honestly assess what your property has to offer.  If you have new appliances, new carpet, and a hot tub, you may be able to charge slightly more than a unit with old amenities in worse condition.  But you still shouldn’t get too happy adding extra money to fair market rent just because your property is in good condition – that’s almost a necessity.  It will help you attract more and better applicants, but definitely subtract off the rental price if your property is outdated or needs work.

5. Test the market.
As you put your house up for rent and start advertising, listen carefully to what the market tells you.  If you get no calls or interest, your price is way too high.  If you get a few people looking but none want to rent it, they’re finding better and cheaper properties to rent.  The more interest you generate, the closer you are to the fair market value price.  

6. Have a set schedule of price reductions every week or two.  That way, you’ll know you tested the market so you’re not leaving any money on the table, but you’ll get it rented soon without those dreaded vacancies.

7. Talk to a property manager.

The most efficient way to make these rental headaches disappear is to hire a property management firm.  A well-established company like Vienna Property Management in the Sacramento area has an intimate knowledge of rental prices, a pool of tenants looking, and all the marketing channels you need.  If you think big picture, their help will free up your time and energy and eliminate vacancies, evictions, etc. – saving you money overall even with their small fees.

If you need any help or would like some advice about pricing your rental property, give Vienna Property Management a call (916-520-1712) or email.  They're great people and do a wonderful job turning rental properties into cash flowing smart investments!

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