How to Set Rent
Do you want to rent out an investment property, but are not sure how to price a rental? First, you have to find the perfect rental property, then you have to figure out what to charge. Let’s take a closer look.
Finding a Good Rental Property
The ideal rental property has the following characteristics:
- A great price-rent ratio
- Minimal maintenance
- Good cash flow
- Few vacancies
The price-rent ratio is determined by dividing the annual rent into the value of the property. For example, if you can collect $1,000 a month ($12,000 a year) on a property worth $200,000, the price-rent ratio is 16.67. The inverse is the rent yield, which is 6 percent. All things being equal, the higher the rent yield, the better the deal. However, sometimes all things are not equal. A tight housing market or high interest rates can affect the yield and may create a misleading impression. It’s best to consult with a local real estate agent to help understand how to interpret the rent yield in your neighborhood.
It doesn’t make sense to charge a rent that doesn’t cover your mortgage payments. The question becomes how much above the mortgage payment should you charge in rent? The rent-to-mortgage ratio, or debt coverage ratio, should clearly be greater than 1.0 if you want a positive cash flow. And that doesn’t even take into account your other costs, such as taxes, utilities, legal fees, maintenance, etc. So, you want to set your rent high enough so that you get a decent return on investment, say 8 to 15 percent. If you plan to rent out your property for just a few years before selling it, you can consider an adjustable rate mortgage, which is cheaper in the first few years.
How Much Rent to Charge?
You should charge rent equal to about 1 percent of your property’s value. We say “about” 1 percent because it’s OK to tweak the rent so that it lies between 0.8 percent and 1.1 percent. For example, if your property is worth $250,000, you might charge a monthly rent between $2,000 and $2,750. If your property is worth no more than $100,000, charge 1 percent or higher in order to cover your costs. On the other hand, if your property’s value exceeds $350,000, reduce the rent to 0.8 percent so that you can attract renters.
You also have to check out the rents on comparable properties in your neighborhood. Whether you like it or not, folks will tend to gravitate to the best values, so you can’t get too greedy. Check out websites like Zillow and Trulia to see what the rents are like in your area.
Selling Your Rental Property
You might decide it’s time to unload your rental property, for any number of reasons. Calculate the capitalization rate (“cap” rate), which is the net rental income divided by the selling price. The net rental income is the gross income (one year of rent income for all units combined). Subtract 5 percent to account for occasional vacancies. Next, subtract operating expenses, plus another 5 percent for maintenance/repairs. Divide the result by selling price you desire. You should figure on a cap rate between 4 to 10 percent, depending on market conditions, vacancy rate, the condition of the property, etc. Adjust your selling price accordingly.