Rent estimates in 5 steps: How savvy landlords set asking rents

Rent Estimates in 5 Steps: How Savvy Landlords Set Asking Rents
by Brad Cartier, posted in Investment Strategy

Arriving at an accurate rent estimate for your vacant unit or expiring lease is a mixture of art and science. Choosing the right asking rent for your Craigslist ad or Zillow Rental Manager listing isn’t just about leasing your unit at the highest possible rent. It’s also a key decision that impacts your overall rental property valuation, your tenant’s likelihood of staying, and potentially even your ability to refinance the property.

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Setting the rent below market can attract less desirable tenants, reduce your net cash flow, and reduce the value of your investment property. An asking rent that’s clearly above market can lead to prolonged vacancies, increased marketing expenses, and high tenant turnover.

In this article, we’ll look at how successful landlords arrive at an accurate market rent estimate before listing their vacancy or renewing a tenant. We’ll also examine some best practices to help you maximize rental income without enduring more vacancy than necessary. It’s sometimes a fine line, but play your cards right and you can often have the best of both worlds: a reliable tenant paying full market rent with minimal vacancy.

Rent estimate: Why finding the right asking rent matters

Many landlords make the mistake of not paying enough attention to comparable properties and market trends when they set their asking rents. As discussed above, there are several reasons why getting the market rent estimate correct before you list your unit matters.

Choosing an asking rent that is too low can set you back years if the tenant decides to stick around and you can’t reset the rent to market at a later date. Depending on your local regulations, raising rents on a current tenant can sometimes be challenging, expensive, or even illegal. In areas with rent stabilization measures, if you set the initial rent at $800, but then realize market rents are really $1,100, it may take you years to catch up with market rents through minimal allowable rent increases.

Even in places where rent control is a foreign concept, a 10-20% rent increase on an existing tenant can be enough to show them the door even if they were paying well below market. Tenants (and landlords) have been known to take things personally from time to time!

Let’s quickly consider the example of a multifamily investment property with total market rents of $3000 per month. Setting the asking rents at a total of $2900 instead of full market may not seem like such a big deal. After all, that $100 difference is only about 3%.

Small rent decrease = big erosion of value

What’s perhaps less obvious is that this $100 difference in monthly rent could decrease the property value by $20,000. Let’s use the cap rate formula to see how:

  • Cap rate = NOI / Market value

Now, assume that in our market rental properties generally trade at a 6% cap rate. How does discounting the rent by $100 per month affect the property value?

  • NOI / Cap rate = Market value
  • $1200 ($100 per month x 12 months) / .06 or 6% = $20,000 market value difference

So, a seemingly minor rent reduction of 3% translates to a $20,000 loss in potential property value. That will pay for more than a few high-caliber rent estimates!

More reasons to get your rent estimate right

  • Setting the rent right attracts better tenants who will pay on time. A potential tenant that needs a below market deal to afford the unit may have less buffer for unexpected expenses or a loss of income.
  • Making an accurate asking rent estimate delivers needed cash flow to pay your operating expenses and mortgage with minimal unit downtime.
  • Advertising a fair market rent can help you reduce overall vacancy and increase income. If asking for too much rent leads to only a single additional month of vacancy, that’s an annualized 8% top line hit to expected income.
  • Cash flow, net operating income, property value, and profit are maximized when you lease your units at a market-clearing rent.

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Calculating a market rent estimate in 5 easy steps

Now that we know why setting the right market rent estimate is so important, let’s discuss the five easy steps we recommend using to calculate an accurate rent estimate:

#1 Research the neighborhood

Things that make a neighborhood good for renters include ease of transportation, perceived safety, ease of access to key amenities like shopping, dining, and well-rated schools, and the quality of nearby businesses.

#2 Review rental listing comps

Conduct a survey of asking rents for currently available units of comparable quality in the neighborhood. Ask yourself:

  • How do the various locations compare to yours?
  • What is the average size in square feet?
  • How many bedrooms and bathrooms does each comparable have?
  • What is the normal size of the front and back yard? Is there private outdoor space at all?
  • Are there extra amenities like a swimming pool, garage, fireplace, upgraded kitchen and bathrooms, etc.?
  • Are pets allowed? Are utilities included in the rent? Is there an extra fee for parking?

#3 Determine the market rent trends per square foot

Once you know what the average size of comparable rental properties in your area are, or better yet the actual size of specific units, calculate the average market rent per square foot:

  • $1,500 per month x 12 months = $18,000 / 1,200 square feet = $15 per square foot per year or $1.25 per square foot per month

#4 Make adjustments for amenities and features

Amenities fall into two categories:

  • Property and unit amenities such as a yard, swimming pool, parking and/or included appliances like a dishwasher and/or washer and dryer..
  • Community or neighborhood amenities such as off-street parking, a playground or greenbelt area, or HOA gym or other common areas.

#5 Analyze potential future competition

All rental properties will have short-term vacancy at one time or another, because tenants come and go. As a rule of thumb, an area with a vacancy rate of 10% or less is fairly tight and may indicate an ability to push rents a bit.

However, an area with a high vacancy rate, or where there are a large number of homes or apartments under construction, could be in danger of soon having more supply than demand. When this happens, you may find yourself competing against new projects that are offering significant incentives to lure tenants away from existing supply.

15 factors that affect a rent estimate

As a general rule, landlords should focus on maximizing current income and property value when determining the proper asking rent. This may or may not include listing your unit at the highest rent possible. In our opinion, the 15 most important factors that affect a rent estimate are:

  1. Type of home – single-family vs. multifamily
  2. Location of home – near a school, high-end grocery or park vs. a busy highway. Also consider the neighborhood features – distance to shopping and entertainment, public transportation, schools and churches, safety and security of the area, and the walk score of the neighborhood.
  3. Local rent regulations including rent stabilization ordinances, eviction protections, limits on rent increases, etc.
  4. Size of home – based on square footage, size of front and backyards, and room sizes
  5. Number of bedrooms
  6. Number of bathrooms
  7. Seasonality – how property demand varies based on time of year
  8. Appliances – age and quality, including in-unit washer and dryer
  9. Amenities – updated fixtures, natural light, newer heating and air conditioning, extra storage, swimming pool, and BBQ
  10. Outside space – backyard, patio, terrace or balcony
  11.  Furnished vs. partial or unfurnished
  12.  Utilities included such as water, sewer and trash, electric or internet
  13.  Pets allowed – including additional rent or deposit for a pet
  14.  Parking – on-street vs. carport or garage
  15. Length of lease – month-to-month vs. six months vs annual lease agreement

Where to find market rent comparables

When you look for rent comparables, what you’re really doing is researching the competition. If a qualified tenant has a choice between two local properties, they’ll often choose the one that offers the best value. It’s important to be competitive on asking rents while paying attention to differences in amenities, unit size, and the relative advantages of various locations.

Online sources for rent comparables

Offline sources for property rent comparables

  • Fellow landlords
  • Real estate agents
  • Property management companies
  • Local rental associations and investment clubs

Making the right rent determination

When you set your asking rent in line with the market, you’re likely to enjoy consistent and strong cash flow, lower tenant turnover, and higher overall property values. Plus, you’ll likely be able to pay off your mortgage quicker than expected or have more free cash flow to invest in new opportunities. Either way, you’ll be one step closer to financial freedom.

To quickly recap, setting the right asking rent for your unit or single-family rental property includes:

  • Researching the neighborhood
  • Reviewing comparable rental properties in similarly desirable locations
  • Determining the market rent per square foot
  • Adjusting the rent amount for amenities and features popular with tenants
  • Adjusting for potential future competition