Mortgage payments, property taxes, and ongoing maintenance – while landlords collect a hefty rental income from their tenants every month, they also have a lengthy list of outgoing expenses to manage their investment property. So how do you determine the right pricing for your rental property to garner the biggest return on investment?
Buying a new construction home as an investment property is a lucrative business: estimates suggest rent prices skyrocketed in the first half of 2022 across the U.S., to the tune of $2,495 a month on average. That’s a 13.4 percent increase compared to the same period last year.
FYI to potential investment property homebuyers: Californian cities (Los Angeles, San Diego, San Jose, and San Francisco) and locales in Florida (Miami, Fort Myers, and Sarasota) topped the list with rent prices ranging from $3,548 to $4,664!
On the flip side, monthly mortgage payments in the U.S. sat at roughly $1,912 as of September 2022, according to the National Association of Realtors.
But setting a competitive rental price requires more than just recouping your mortgage. You also need to take into account the current market rate in your neighborhood and other expenses to make sure you’ve hit the sweet spot.
Here’s a look at eight factors to take stock of to help you choose the right pricing for your new rental property.
Consider the “1% rule”
As a rule of thumb, industry experts recommend investors charge about one percent of their property’s purchase price for rent (including the cost incurred from major repairs and renovations if you aren’t buying a new home) to break even on the property. On that note, your monthly mortgage payments should be less than the one percent figure, too.
If, for example, you bought your investment property for $150,000, the one percent rule dictates you should – at the very least – charge a monthly rent of $1,500 while your mortgage payment should be less than $1,500.
Don’t Forget Your Fixed Costs
Bear in mind, the one percent rule is used as a general strategy. It doesn’t take into consideration the multitude of fixed costs landlords are on the hook for. The most common fixed costs you’re likely to incur include:
- Property taxes
- Homeowner’s insurance
- Homeowner’s association fees, if applicable
- Utilities, if you decide to provide them
- Routine maintenance and repairs
Wise landlords will factor these into their rental pricing. If your tenants have access to beautiful HOA amenities like a gym or outdoor parks, you might pass on the annual fee to them or work the cost into their monthly rent.
If you decide to provide utilities so your tenants have a single bill to manage, you ought to work these extra perks into their total rent as well.
All in all, tenant rent payments should comfortably cover your mortgage and fixed costs.
Know your Competition
You don’t want to undervalue your rental unit but you don’t want to overprice it either, driving away potential tenants – your job here is to strike the right balance.
You can do this by creating a comparative market analysis, or “comp,” which is focused on scoping out the competition and seeing what’s on offer in the current rental market.
Comps are usually conducted to help homeowners decide on how to price their homes for sale, but it’s an informative exercise for the rental market as well. To pull together a comp, pore over existing rental listings in your neighborhood and identify three or four similar to your investment property in size, condition, and features. Pay attention to how these rental units are priced and how long they’ve been on the market.
Doing your homework on rental prices will give you a solid grasp of what other landlords are charging for similar properties, and what they’re including in the price, such as parking, outdoor living space, or utilities and amenities.
Check Local, State, and Federal Rental Laws
Step into being a landlord with responsibility on your mind. While you have a bottom line to prioritize, you’ll need a solid understanding of landlord-tenant laws you must abide by in your jurisdiction. These laws include rent control measures.
Make sure the rent you’ve set doesn’t violate the legal limits on rental rates, and the security deposit you’re asking for is within the guidelines.
Landlords can’t unjustifiably raise the rent either, be it during the contract or lease renewal.
Seek Advice from a Real Estate Expert
If you’re a novice in the property investment space, get in touch with expert real estate agents and property managers who know all the ins and outs of the industry.
Show them your property investment’s specs, or better yet, consult with them before making a purchase to familiarize yourself with what kinds of homes and price points get the most traction from prospective tenants.
Their expertise can help guide you in your next steps.
Acknowledge your Property’s Strengths and Weaknesses
Is your investment property sparkling new with parking, security, and great transport links or is it a cozy fixer-upper without a dishwasher, washer and dryer, or other important features?
When you’re doing your comparison research, be honest with yourself to make sure you’re comparing like-for-like accommodations.
These days, the most popular features Americans are looking for include outdoor living spaces like a backyard, front patio or balcony, open-concept floorplans with modern kitchens, energy-efficient appliances, smart home technology, and plenty of storage space.
If you’re sitting on a dream property that’s stacked with these features, test the waters by bumping the rent price up slightly to see if you get any bites. Renters may be persuaded to pay more for these perks, including heated floors, a basement gym, or a den they can convert into an office.
Focus on the Reason Why You’re Renting Your Property
Is the mortgage on your investment property paid off or did you buy it to diversify your portfolio?
Some homeowners are renting their secondary homes for a bit of extra pocket money while others are relying on this passive income to pay off the mortgage and cover their own monthly living costs.
Keep this in mind when setting the rent price. If you have some wiggle room in your budget, your pricing may be incredibly competitive to gain a selection of great prospective tenants to choose from, higher rent retention, and a lower vacancy rate.
On the other hand, if your margins are slim, you’ll need to make sure your rent pricing covers your mortgage and fixed costs. Tread carefully if you fall into this category – try not to invest in a low-rent, unstable market.
You can also rationalize a higher rent by sweetening the deal: offer a furnished home or throw in small touches like an accent wall, patio set and barbecue, or luxury coffee machine tenants can use during their stay.
Be Flexible and Keep an Open Mind
While consumers buy investment properties to collect a “passive income,” you’d be surprised by how much work is involved in being a landlord.
You’ll need to prepare and price a home worth renting, find tenants you trust with your asset, then manage property repairs and maintenance while you stay on top of mortgage payments.
Pay attention to what’s going on in your locale – there could be a shortage of rentals available or a multinational company could set up a headquarters across the street, both providing you with a plum opportunity to charge more than what’s needed to cover your bases. Once you’ve gone through the process and found the perfect tenants, it’ll be worth your initial efforts as you build wealth and home equity through rental income!
Carmen Chai is an award-winning Canadian journalist who has lived and reported from major cities such as Vancouver, Toronto, London and Paris. For NewHomeSource, Carmen covers a variety of topics, including insurance, mortgages, and more.