Setting Market Rent (Phase 1B)
Learning how to appropriately price your rental is one of the most important skills a self-managing landlord can develop to drive financial success. If you price the rental too high, you risk extended vacancies leading to lost revenue and increased carrying costs. Price the rental too low, and you are leaving hard-earned profit on the table. The goal is to price your rentals at current market rent.
Current Market Rent and the 5% Rule
At a basic level, current market rent is the optimal price to attract a qualified tenant within a reasonable amount of time. What exactly is a reasonable amount of time? According to real estate investor and self-managing landlord, John T. Reed, your goal is to always have 5% vacancy. Assuming there are no other factors such as poor marketing, if your vacancy rate is greater than 5%, your rentals are priced too high. If your vacancy rate is less than 5% or you have a waitlist, your rentals are priced too low. According to Reed, a waitlist is not a good thing. It means you are foregoing profit.
It’s important to note that these guidelines were in reference to multi-family units. Unless you have a large portfolio of single-family homes, this rule of thumb should be modified. According to the 5% rule, a single-family home should be rented within 2.6 weeks. That is an aggressive timeframe. To amend the 5% rule for small single-family home portfolios, we will target a range. The chosen rental price should produce a qualified tenant within two to four weeks. Anything less than two weeks, the rental was likely underpriced. Over four weeks, your asking rent is too high.
You may be saying to yourself, “This is great, I want to choose the rent amount to produce a signed lease within two to four weeks, but how the heck do I know what number to choose?”
Pricing Your Rental
There are many online tools that will calculate a probable market rent for you. Some of these include:
Also, you should locate rental comps in your area by searching rental listing sites like Zillow, Redfin, Apartments.com and even Facebook Marketplace in some markets. Remember, these are just data points. If Zillow says you should charge $2,000 a month for your 3-bedroom, 2-bath rental and Randy the out-of-town landlord is asking $2,200 a month for his 3-bedroom, 2-bath home, but it has been vacant for three months, the current market rent is likely somewhere below both of those prices. You need to use your knowledge of the local market and any recent changes that could be driving rents up or down to determine your price. If your listing is not receiving interest after two weeks and you are certain it’s not a marketing problem, you likely need to lower your asking price regardless of what other sources are saying. Also, don’t hesitate to call other landlords or property managers in the area to ask what they are seeing in terms of current market rent. The longer you manage your own rental properties, your confidence and ability to set appropriate market rents will increase.
Common mistakes self-managing landlords make when setting rent:
Refusing to lower rent
Markets are driven by supply and demand, and the rental market is no different. There are economic factors that can occasionally drive the price of rentals down instead of up. Landlords who refuse to accept that they may have to ask less for the next lease than the previous lease will lose money.
Pricing based on your costs instead of the market
Some landlords want to set rent based on their costs: mortgage, insurance, taxes. The reality is that if your mortgage is $1,200, and current market rent is $1,150 for that property, pricing your rental at $1,200 will cost you more money due to extended vacancies. Hopefully, you are never in that situation because the economics of the rental don’t make sense and selling the property is likely a better option unless the property is in a high appreciation area and you are able to cover the negative cash flow in the meantime.
Reluctance to raise rents
If the market will bear, which it will in most circumstances, a landlord should increase rent every year. Yes! Every year. There are a few exceptions (see mistake #1), but this is generally true. The increase does not have to be substantial, but a $20 increase every year over five years is easier for a tenant to stomach than raising $100 all at once.
Setting market rent can be intimidating at first, but with research and experience, you will become an expert in your market.
Disclaimer: The information in this article is for educational purposes only and should not be taken as legal or financial advice. For specific legal questions, consult a qualified attorney. For help managing your rental in compliance with state and federal law, reach out to a professional property manager.