Determining your rent rate is the first step toward filling your vacancies and generating revenue from your properties.
However, the decision shouldn’t be based on one factor alone.
There are many factors to consider when setting your rent rate, such as property condition, fair market value, local trends, and others. Research is key to setting an appropriate rate, especially if you’re investing for the first time in a new location.
Set the rate too high, and you won’t attract enough applicants to fill your units. Set the rate too low, and you risk a situation where your expenses outweigh your income.
How do you know if your rate is fair, yet still enough to generate positive cash flow?
Here are five tips for choosing an appropriate rent rate for your properties.
#1 Find Comparable Properties
A successful landlord chooses a rate that is profitable while remaining competitive with comparable properties.
Your first step in setting a rate should be to locate and research comparable properties in the city and neighborhood.
It’s important to compare properties like your own. For instance, if you’re trying to rent a 2-bedroom townhouse apartment on the west side of Cleveland, find out what 2-bedroom apartments are renting for in other parts of the city. What features do they offer, and what is the corresponding increase in rent?
The first place to go when looking for an idea of what your rent rate should be nearby, comparable rentals.
#2 Assess Local Rent Trends
It’s also critical to consider and assess local rent trends.
In addition to the average rent price in your city, consider how rent has trended in the past few years. Are rent rates declining as fewer people want to rent in the area? Or are rates increasing due to job prospects, population movement, or another reason?
Knowing and evaluating these trends will help you form an accurate picture of what the rental environment will be like in two, five, or ten years from now. Ideally, you want your properties to be sustainable in the long-term.
#3 Consider the 2% Rule
The 2% rule is a popular rule of thumb for new landlords. It essentially states that monthly rent should be around 1-2% of the property’s total value.
The 2% rule can be a good baseline to get perspective about what your unit should be worth. However, it cannot be substituted for the real work of researching and evaluating rent trends and comparable properties.
Another reason why it’s not smart to only use the 2% rule is that rent rates do not always rise and fall proportionally with property prices. If rates are inflated in an area, or your property has key features outside of its monetary value you can leverage (e.g., location, proximity to a good school system, etc.), then the 2% rule likely won’t be an accurate measure of a good rent price.
#4 Set a Minimum Rate
If you’re a landlord investing without a lot of capital, your top priority should be to make sure you can pay all your expenses: utilities, property management, repairs, etc.
For this reason, it’s best to determine a minimum rent rate before moving any further.
At minimum, you need enough rental income to cover your expenses. Ideally, you should set your rate at least a little higher than this number to establish positive cash flow.
#5 Determine the Rent to Value Ratio
Finally, a good strategy for choosing a rent rate is to calculate the rent to value ratio.
The rent to value ratio represents the ratio of rent to your property’s worth in a given location. It’s a simple calculation: take a tentative monthly rent rate and divide it by the property’s purchase price or value.
The higher the rent to value ratio, the better you’ll fair and the more income you’ll generate.
Calculating rent to value is a good way to decide if a potential rate you’re considering is a fair price for what you paid for the property. However, remember that the ratio doesn’t factor in any variable ongoing expenses of the property, such as landlord insurance or renovations.
Conclusion
Rent pricing can be one of the first challenging decisions in your real estate journey. However, by understanding these five considerations, as well as others like seasonality, you can be sure to set a fair rent rate that will ensure profit in the coming years.
