How To Determine How Much To Charge For Rent

Property Value Expected Value Formula

“How much do you charge for rent?”

Such a simple question, yet the answer influences so much!

  1. Give too high of an answer and the potential tenant might think it’s too expensive and look somewhere else before hearing more about the property.
  2. Go too low and you’ll lose out on money for repairs, and paying yourself, which could result in a less-than-desirable rental in a few years.
  3. Of course, charging at the low end of the market means resident turnover will be low and you’ll have time to save up for repairs when they move out.
  4. Being on the high end could potentially only attract people who are desperate and willing to pay anything – people you don’t really want to rent to.
  5. Or, being on the high end could give you an opportunity to afford to go beyond normal expectations: like regular carpet cleanings, new appliances, or a responsive handyman to make repairs quickly.

To figure out how much to charge for rent you need to determine two piece of information: First, the market rent. Second, how your rental compares to the market.

 

How To Determine Market Rent

This part is relatively easy once you know where to look online.

 

Zillow

Zillow is famous for daring to guess how much your property is worth with the “Zestimate”. They have super secret algorithms that compare your property’s stats (# of beds, # of baths, etc) against other recently sold properties. I’m guessing, because it’s super secret, but the closer in location, the more similar type of property, and the more recent the sale, the more influence it has on your value.

Real estate agents love to pick on it and claim that it’s not accurate, which probably was true at first, but less so as time continues. The problem is that if you ask an agent how much your property is worth, the answer is, “however much someone is willing to pay.” That’s not very helpful. To get a better answer, agents do a comparison analysis of recent sales (called “Comps” for short) which probably is more accurate, but Zillow is free and fast. It’s so easy for the buyer and seller to take a peak on Zillow, that a lot of people do it before even talking to an agent, and just like that, you’re both anchored with the same price. So the first set of people who see the same starting price both agree that Zillow is pretty accurate and agree on that price. Now Zillow has become a self-fulfilling prophecy and genuinely was more accurate than the agent. I wouldn’t say that Zillow is perfect, especially for non-cookie cutter properties, but its good enough.

Zillow Zestimate

Back to rents. Zillow also offers a Rent Zestimate. Visit the property’s page and it’ll be right next to the Zestimate. I actually don’t think it’s as accurate because they don’t have as much data to rely on, but I still think it’s within the acceptable range. You can check the accuracy of this yourself by comparing what Zillow says vs other sources. For example, if craiglist listings are always $25-$50 lower, then take that much off when looking at the Rent Zestimate. Again, Zillow is fast and free, so this is where I go for my first guess.

 

Rentometer

Then I head over to a very cool website called Rentometer. You put in your address, your guess for the rent amount (plug in the Zillow number at first, it doesn’t really matter), and the number of bedrooms. Click “Analyze My Rental” and watch the magic. Rentometer gets their estimate using another super secrete algorithm using bulk syndicated data, proprietary rental data surveys, and user generated listing & rental data. Here’s what you’ll see:

Rentometer Result

First, you’ll be presented with a little gauge that will tell you where your rate falls within a low-to-high range. Right below the gauge will be some stats that tell you the average rent in the immediate area. This is the number you want. You’ll also be presented with a map with pins that will tell you the specific rent data they’re using.

We’re 10 minutes into our research (if that) and you should have already started getting a feel for the market rate of similar properties. Now it’s time to validate.

 

Craigslist

When I wrote the Definitive Guide To Posting Housing Rentals on Craigslist, I stated that Craigslist was the #1 place people searched for rentals. So during the validation phase you want to do the same thing other potential tenants would do, and visit Craigslist to search for housing. Head over the the apts/housing section and start searching for similar properties. Then, and this is crazy, actually click on a few listings and read the description and look at the pictures.

Pro Tip: If you hold down the “ctrl” key (“command” key on a Mac) when you click a link, it’ll open the link in a new tab. So you can click on a bunch of links and have them all open while still keeping the search results open. Then you can click around to the different tabs to compare, do another search and get a different set of properties. Here’s a short video demo (which will automatically open in a new tab).

Back to Craigslist. As you’re looking at the rent price and viewing the actual listing, try to determine how similar it is to your property. Are the number of beds the same? The size? The location? How well maintained is it? Assuming your property is relatively normal, you’ll probably get a really good feel for both the low and high end of the market. You should also find that Zillow, Rentometer, and craigslist are all fairly similar. If so, great! You now know what the market rent is for similar properties. You can probably stop here on the market side and continue on to determine how much you’re going to charge.

 

HUD Fair Market Rents

The US Department of Housing and Urban Development also has an opinion of what market rent should be. Each year they perform mail and telephone surveys of local housing markets to obtain current rental housing information for their annual Fair Market Rent calculations. And it’s all available for free online. Head over to http://www.huduser.org/portal/datasets/fmr.html and you’ll see a list of all their reports. You’ll want the top choice, which is “Individual Area Final FY2015 FMR Documentation” in 2015. Click that link and follow the prompts. You’ll eventually chose your state and county. The very top of the results page has a table of average rent by bedroom.

HUD Fair Market Rent Result

You can also geek out on all the information which describes the not-so-super secret algorithm they used to come up with these numbers.

 

Call and/or Visit Listings

By this time, you’ll notice that there isn’t a single market number, but a range. You should be able to fill in these blanks:

  1. In general, a <insert #> bedroom place should rent for about ________ .
  2. It could be as high as ________ , but that’s really only if ________ (probably because of size or newness, or some special feature).
  3. Given my property, somewhere between ________ and ________ is probably the right range.

If for some reason you still don’t feel comfortable answering those questions, continue on to the next logical step: call a bunch of listings and visit a few of them. If you’re first getting started, it’s a good idea to do this even if you can fill in those blanks. At the very least, it’ll help you figure out where your rental is better than others, and where it’s not as competitive. That’ll help you when potential tenants start asking you questions about your rental.

 

How To Determine Your Rent

OK. It’s been a journey. By now you should be able to easily avoid setting your rent too low or too high. Now it’s time to dial it in to that all important single number that will determine your income for at least the next year.

The easiest thing to do is pick a number that’s slightly under the average (when you bought the property, hopefully you used a similar number when evaluating if it’s a good deal). This has a few benefits:

  1. You don’t need to justify the price because tenants will see that’s it’s “reasonable” compared to other properties.
  2. Tenants tend to stay longer because when they look at alternatives, most of the “better” options will also be more expensive. This reduces your overall costs, which is good.
  3. You can be more hands-off because the tenants are living there for the cheaper price and are not looking for a bunch of goodies from you.

To look at it from an economic point of view, you’re assuming “perfect competition” in your market where your rental is just one of many standard rentals to choose from. Therefore, having a cheaper price and minimizing costs is the key to success. There is nothing wrong with this view, and there are many large property management companies that successfully manage the rentals this way. My goal right now is to expose you to the different ways to see the market and challenge you to consciously choose how you want to compete. Let’s dive into the 4 types of competitive markets.

Perfect Competition Monopolistic Competition Oligopoly Monopoly
Examples Agricultural products,such as corn, wheat, and soybeans Consumer goods, such as health and beauty products Auto manufacturers and wireless carriers Utilities
Number of suppliers A large number A large number A few suppliers One
Product Type Standardized Some differentiation Some differentiation Unique
Price influence None. The best way to compete is to minimize costs since you can’t charge more. Can charge a higher price if you can show yours is “better” than similar products. A lot, but must consider the reaction of the other suppliers. Total control
Difficulty for new suppliers Very low Very low A high barrier, because of location or resources available A high barrier, because of location or resources available

I had a professor who once said, “People often see monopolies as a bad thing because you’re now going to be regulated by the government (also a monopoly). But in reality, being a monopoly means you did such a good job of creating a unique product with a ton of value that nobody else could copy it, and you stayed so far ahead of your competition that you won. You’re not only the best, you’re now the only one because nobody is able to compete against you. Congratulations.”

As you can see in the table, the further to the right that you move, the more you’ll be able to charge for rent because your rental is different and one of a kind. (in a good way of course).

My challenge to you isn’t to price your rental as if you were a monopoly (which would be whatever you want), but to do the things that create monopolies: create such a massive amount of value for your residents that the amount you charge doesn’t matter as much.

Ask yourself: What can I do to make my rental special? You can make physical changes to your property (new carpet/paint/windows/etc). You can also add services (24/7 phone service: “text or call anytime”, a repair time frame guarantee). Get creative with this! Will you be paying utilities? Will you take care of the yard? Will you provide self address stamped envelops or an online payment option? What can you do better than the large management companies?

If you’re not sure, ask some of your friends who currently rent what they wish their current landlord did better.

If you provide services that are genuinely valuable, then tenants will be happy to pay more. They won’t pay above the high end of the market rates, but they’ll happily pay closer to high end rather than the middle or low end. Unlike the lower rent, you’ll need to explain why it’s higher, but the right tenant will find it valuable and will happily pay the higher price. They’ll also stay longer because of the extra benefits: “Sure, this other place is cheaper, but they don’t do _______ .” You will probably need to be more hands on, but you’ll be getting paid more, which should make it worth your time (it’s still a balancing act, of course).

As a side benefit, you’ve also raised the average market rate by a little bit. So the next time your unit is vacant and you want to speed up your gyroscopic cash flow, rents will be just ever so slightly higher because of you.

 

Bonus

If you’ve made it this far, you are serious about your real estate business. I’ve put together a free worksheet for you that walks you step-by-step though the process I just outlined. You will be able to systematically figure out how much to charge for rent that starts with a local market analysis and then drills down to your specific property. This is exactly what I use today.

If you want the worksheet to determine how to to charge for rent, get it right here. It’s free.

 

 

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