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Renting below market rates is a common problem among new real estate investors. How do you know what constitutes a fair rental rate? And if that rate generates vacancies or losses? Setting the right rental rate is a skill that takes practice. There are many things to consider in your analysis: property features, number of rooms, market trends, policies, and more.
Understanding your market and your tenants is the first step in setting an appropriate rental rate. Here are five things to consider when setting a fair rental rate for your properties:
Related: 7 Common Mistakes Made by New Real Estate Investors
The features and characteristics of your property are one of the first things to consider when setting a fair rental rate.
To get started, make a list of comparable properties in the area. Comparability is key. It won’t help to compare rates for your 850-square-foot one-bedroom unit with a nearby 600-square-foot one, even if they’re in roughly the same neighborhood.
Additionally, prospective tenants in different areas will have different priorities and preferences for features and amenities. For example, renters in a snowstorm-prone city will likely pay more for covered parking than renters in a similar property in North Carolina.
In addition to size, other factors to consider include the property’s age, condition, number of bedrooms, unit and community amenities, and location. Weigh each of these factors against each other. For example, an older property could get away with charging the same rates as a newer one across town if it’s located in a prime location 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 the neighborhood for your property? How about your city? Falling too far outside the limits set by local trends in either direction will decrease your profit margin.
The occupancy rate is the relationship between the units rented and those available or vacant. 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 rental approach. On the other hand, if your occupancy rate is much lower (meaning you have a lot more vacancies), your strategy might be too aggressive: rent is too high, or something else is driving tenants away, like restrictive policies or bad reviews. . .
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lower and upper limits
Next, set a minimum and maximum rental rate. These limits will keep your expectations and policies in line, even if your actual rental rate fluctuates over time.
When setting a minimum rental rate, don’t just consider your mortgage payments and monthly operating expenses for your properties. You also need funds in reserve for emergencies (such as maintenance issues, disasters, market crashes, etc.) and a surplus on top of that: your profit margin.
Even if your profit margin starts out low, at least you know your properties are generating income, however small they may be at first. Setting a floor for your rental rate helps you know you’ll make some sort of profit.
It is also important to set an upper limit, a maximum rental rate for your properties. You still need to be able to attract tenants instead of deterring them with unreasonable prices.
Unless you’re marketing upscale luxury properties, aim for reliable tenants who pay for quality and security as long as the cost isn’t exorbitant.
What to do if you are undercharging (renting below market rates)
Many homeowners find themselves in this position: their units are full, but their business is still struggling. A market analysis reveals that you are renting at below market prices.
There are several reasons why you could be in this situation:
You have a vacancy problem. Perhaps there was a downturn in the market, resulting in fewer tenants in the area and/or tenants unable to afford higher rates.
You have an eviction problem. If you had previously been serving a lot of rent demand notices, you may have lowered your rent to keep your current tenants and restore uninterrupted cash flow.
The previous buyer transferred the leases to you at below market rates. This is a common occurrence: A buyer lets you take over their current leases, but their rates never went up.
You have too many tenants month to month. Annual renters expect small rent increases at renewals. You may have forgotten to do the same for month-to-month long-term rentals.
Rent in the area has experienced growth independent of its properties. But for some reason, your property is not being kept up to date.
action step: If you are charging less for rent, bring it down to market level as soon as possible. Renting at below-market rates is bad for your business, even if it is more comfortable for your current tenants. Staying at below-market rates for long is not sustainable. Your costs will add up and you won’t be able to compete with neighboring properties. It is better to raise the rent, fire some tenants if necessary, or make reasonable improvements to justify the increase.
Related: How to Get the Most Out of Your Rental Property Investments
What to do if you are overcharging (renting above market rates)
Some landlords have the opposite problem: renting above market rates or overcharging.
Here are some possible reasons why you might be overcharging:
You overcompensated when market rates were high. If rent was going up in your town, yours may have gone up to beat the rates around you.
It has had an influx of new costs to cover. You raised the rent out of necessity to pay the bills. New costs could include mortgage payments, improvements, or an unexpected lawsuit. Perhaps a disaster occurred that was not covered by your insurance, or perhaps you were not insured at all.
Action Step: While it can be tempting to raise your rent when you’re in a tight financial spot, remember that vacancies won’t help you cover your costs or restore cash flow. Tenants paying market rates are better than no tenants. Try to stagger your rent increases and start with small, regular increases each year. Real estate investment site SparkRental recommends that landlords avoid increasing rent by more than 5% per year.
Setting a fair rental rate for your properties should be a top priority every time you purchase a new property. And once you establish it, re-evaluate it regularly. Leaving your rate stable for years is the number of homeowners who find themselves in one of the under- or over-collection scenarios described above. Keep an eye on your rental rate to ensure both equity for your tenants and profit for yourself.