Setting the rental value can be a tricky process. It is an art and a science combined, with many factors to consider. Even when a property manager and/or owner carefully derive a rental price, it is subject to change if rejected by prospective tenants.
Supply and demand
A major underlying factor determines rent – supply and demand. Generally, if the supply is low, the demand is high and conversely, if demand is low, the supply will be high.
For example, if there is one other property of similar size and amenities in the neighborhood for rent, this substantiates a competitive price. However, if the same neighborhood has twelve other properties for rent, it puts a different light on the rental value, even if your property has a few more amenities. Asking for top dollar and competing against numerous properties does not make economic sense, particularly if the property remains on the market for several months. This will definitely affect the return on investment (ROI).
Real estate is immobile, but people are mobile. When rent is too high in one area, people are willing to move and commute a greater distance. This is particularly apparent around large cities or areas where rents have become extremely high. A prime example of this is the Phoenix, AZ market – many people are willing or forced to travel great distances to affordable housing in outlying areas because city rentals are too high, and they can rent larger properties, with more amenities, for less.
Rental housing is also a stratified market. Low, medium, and high rents have different vacancy factors. For example, properties that command a higher rent are in the income range of people who generally will purchase a home, therefore, there are normally fewer numbers of people who rent. This does not mean a higher valued property will not rent – people rent for many reasons, but there are different ratio values for different economic levels, and lower income properties normally have the higher numbers.
It is also necessary to use comparable properties in the current rental market. This usually means similar size, amenities, and neighborhood desirability. Specific items to consider are square footage, lot size, bedroom and bathroom count, appliances, heating and air, parking, RV Access, etc. Every area contains neighborhoods that are more “desirable” and usually based on low crime, better schools, community activity, etc.
What not to use when setting rent
Do not use rental values contained in an appraisal. Generally, they collect these figures for meeting loan requirements. Although the property value is in the right ballpark, appraisers use rental values for properties already rented. The pitfall here is that the property may have been under rental market value at the time or at a higher rent that is not obtainable today. When buying, check the “current rental market,” how long the properties have been on the market and what has “recently” rented.
Do not base the rent on purchase price or justifying the investment. The price of the property and the current rental market are separate issues. Perhaps at the time of purchase, rents or expectations were higher. Rental markets can swing just like the stock market, up and down.
Remove your emotions when renting a property. For example, if the property was a personal residence, personal memories can distort the true picture of the rental value. Think of the property as an investment in today’s rental market.
Common sense must prevail
It does not pay to sit on an empty property with the attitude, “I am holding out for higher rent.” Run the numbers – long vacancies create more financial damage than adjusting the price and renting the property with the least amount of time possible. Work with the rental market and achieve success.