How to Set Rent for an Investment Property


Has your investment property been listed for too long with no interest from prospective tenants? Or perhaps you have the opposite problem – when you market your vacant property you immediately receive dozens of phone calls and the prospective tenants are almost falling over themselves to view the property and sign a lease. These are both signs of improperly set rent.

In this article we will attempt to demystify the process of selecting the correct rental asking price for your investment property.

Market Study

The first step in setting rental prices is to conduct a market study. We work from big to small, looking first at the Tulsa metro area and working down to the individual neighborhood. What we are looking for is recent comparable rental rates for properties that are very similar to yours (neighborhood, number of bedrooms, number of bathrooms, square footage, amenities, year built).

Common sources to find rental prices include websites like Craigslist, Zillow, Trulia, Rentals.com, the local newspaper, or simply by calling the number on a “For Rent” sign in the same neighborhood and asking what the rental price is. Remember that these sources of information will only provide the “asking price” and not the actual negotiated rental rate in the lease. The actual negotiated rental rate (referred to as a “comp” or “comparable”) is the best indicator of the market rent.

The best way to determine “comparable” market rents is to work with a qualified property manager who can use the additional tools that he or she will have including his or her own database of lease rates, the multiple listing system (MLS), and especially his or her experience with the area that your property is located in.

Let’s assume for the moment your property is located in a neighborhood where all of the homes were built within the same 5-year period, are mostly 3 bedroom, 2 bath with 2 car garages, and all are within 300 square feet of your property. Rental rates in this neighborhood will likely be fairly consistent and it will be easier to determine the market rent rate for your property by finding a few comparable recently rented properties.

However, if your rental property is located in a diverse neighborhood with large differences amongst the properties, it will be more challenging to determine market rent and will probably be necessary to look at other nearby neighborhoods to find accurate comparables.

Adjusting Comparables

Once several recent (within 6 months is usually acceptable) comparables have been located, it is necessary to adjust the comparables to determine what the “market rent” for your property. Adjustments are made for differences between the comparable and your property. Let’s take an example with 3 properties of similar construction in your neighborhood:

Your Property:

– Built in 2002

– 3 bedroom + office, 2 bath, 2 car garage

– 1800 Square Feet

– Has been a rental since 2008, no refurbishments since then

 

Comparable Rental 1:

– Built in 2002

– 4 bedroom, 2 ½ bath, 2 car garage

– 1950 Square Feet

– Recently rented for $1300 / month on a 1 year lease

 

Comparable Rental 2:

– Built in 1995

– 3 bedroom, 2 bath, 2 car garage

– 1400 Square Feet

– Recently rented for $1050 / month on a 1 year lease

 

Comparable Rental 3:

– Built in 2010

– Same floor plan as your property

– Was owner occupied until recently, carpet and paint are like new

– Recently rented for $1300 / month on a 1 year lease

Based on these comparables, where would you set the rent?

If you looked at comparable number 3 and thought “My property is exactly the same, therefore it should rent for $1300 / month”, you would be making a common mistake. Each comparable should be adjusted for any differences that make it more or less attractive than your property. In the case of comparable 3, it is 8 years newer and is in like-new condition.

Here is how these hypothetical comparables might be adjusted to arrive at the market rental rate:

Comp 1:

– Has additional bedroom, additional half bath, and is 150 Sq Ft larger (- $125 / mo)

– Does not have an office (+$25)

– Adjusted Rental Rate of Comparable: $1200 / mo

 

Comp 2:

– Does not have an office and is 400 Sq Ft smaller (+$125)

– Adjusted Rental Rate of Comparable: $1175 / mo

 

Comp 3:

– Is 8 years newer and is like-new (-$75)

– Adjusted Rental Rate of Comparable: $1225 / mo

 

Average adjusted rental rate of comparables: $1200 / mo

Voila! We are finished!

But wait a minute….. Let’s talk about setting rent in relation to “market rents”

Owners commonly ask the question “What’s the highest rent that my property can get?” It seems logical that extracting the highest rental price from your investment property will lead to the most income.

We think the question that you should be asking yourself is:

“What is the highest rental price that will still attract a sizeable pool of prospective tenants while encouraging the eventual tenant to stay multiple years?”

Vacancies are the number one rate of return killer on investment properties. A typical vacancy period costs an investor several thousand dollars in lost rental income, mortgage payments, touch up painting, yard maintenance, utilities, etc.

Your goal should be setting a rental rate that is in line with market rents but encourages the tenant to stay for multiple years in order to minimize vacancies.

Our philosophy is to set the rents ever so slightly below market rents. Why?

Setting rent even $25 per month below market rent is a powerful incentive for tenants to renew leases at the end of the term. We also believe tenants are more inclined to take good care of the property when they feel like they’re being treated fairly. $25 per month is money well spent to avoid a several thousand-dollar vacancy.

What about automatic rent increases in the lease?

Many leases include a clause that raises rent by 5% or so if the tenant decides to renew after the initial term. Do you like it when prices go up for no good reason? Neither do we. We think automatic rent increases in leases are a bad idea. What if local market rents go down? The tenant will shop around at the end of the lease, and when he or she discovers that their rent is about to be $75 / mo higher than other similar properties, they will probably move.

Our philosophy is to raise rents only when there is a good reason to do so: when market rents in the area have increased significantly. If you do decide to raise the rents on an existing tenant, only raise it enough to bring it near current market rent and have comparable rental data available to show the tenant that you are treating them fairly.

Your pocketbook will thank you in the long run.

Summary:

Setting correct rental rates is an important part of being a landlord. The process doesn’t have to be confusing, but it does take time and effort to get it right. Setting rent can be a bit counter-intuitive. Vacancies create large expenses, so try to minimize them by setting fair rents after conducting a comparable analysis.

A reputable property manager can make the process easier by using their experience and information that isn’t accessible to the public like MLS and their own database of comparable rental prices.

If you would like professional help with the leasing and management of your rental home in Tulsa, we are here to help. Contact us at 918-665-0212 and ask how we can make your Tulsa investment property “hassle free”.

Regards,

Nate

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