It seems pretty straight forward, the higher you charge for something the more money you expect to make on it. Whether it's a retail product or a service the first instinct most of us have is to charge the most we can for what we're selling. Although there is some truth to that, in most services and in real estate that is not always the case.
In this article we'll be exploring how setting your rent too high can actually make you less money... yes, you read it right... LESS money!
Let's look at a scenario where you analyze a rental to determine what it's market rent should be prior to listing it. You search current rental listings on Zillow, search on Craigslist and even seek the opinion of your well-off real estate Uncle, all in the search for that 'perfect' rental price. Bingo! you got it, you have a 3 bedroom rental that you are sure will rent for top dollar between $1,850 and $1,950 a month. But wait what if you're off just by a bit? The rental market is not very forgiving and a price difference of a merely $25 one way or the other can be enough to bring on the hordes or drive away all but the cobwebs hanging by the front door. Should you list high, should you list low?
In rentals sometimes the lowest rental price far outweighs the highest in the long term through consistency and a little word with a big impact... "Vacancy", or lack thereof to be more accurate. It's true that you should always be maximizing your rental to it's fullest potential by keeping rents steady and updated with the market, this not only brings in more cash-flow for you but, it can gain you many benefits when it comes time to refinance.
However, if you're pricing your rental to the max it can make a big impact in the length of your vacancy.. and vacancy equals loss of cash-flow. If it takes 6 weeks to find a tenant at a rent price of $1,950 vs. 2 weeks to find a tenant at a rent price of $1,850 - Is it worth the increased vacancy that the "higher" rent will bring? Let's take a closer look at the numbers, so you see exactly what I'm talking about.
Listing of $1,950 monthly rent
Gross rents collected: $23,400/yr. (Potential Gross Income)
Six weeks vacancy: - $2,860
Gross rents collected less vacancy: $20,540/yr. (Effective Gross Income)
Listing of $1,850 monthly rent
Gross rents collected: $22,200/yr.
Two weeks vacancy: - $863
Gross rents collected less vacancy: $21,337/yr. (Effective Gross Income)
Winner: $1,850 - Lower Rent
A listing priced on the higher end within your market rent bracket will see significantly less demand than one still within market rent but on the lower end... shocking right? We all know that but, what most don't account for is the length in vacancy and the translation into loss of cash-flow that decrease in demand brings. In this common scenario a lower rental listing priced for demand will actually net you higher cash-flow!
Of course there are many, many, many and dare I say it... many other factors that will dictate what you receive in cash-flow but, pricing your listing correctly from the start will set you on the right path from the beginning and save you some heartache in the long run. So what are some of these other factors?
Well property management for one. If you are hiring a good property management company to manage your properties they will typically charge anywhere between 10-12% for a standard management package based on collected rents. I'll say it again... based on collected rents. So in addition to taking the loss of increased vacancy that a higher rent price will bring, you will also be paying more for your management. If the company charges a flat fee instead and is responsible for finding you a tenant, you'll see that loss translate into even higher vacancy since they have no incentive to find you a tenant quickly.
Wait, I'll make less with rents pushed to the max and wind up paying more on management fees? You got it.
So Higher Rents are Bad?
Let's not get carried way now. You should be pricing your rental within market rates but, the focus should be on the right rent 'bracket' instead of the highest rent price. Think in terms of the perfect rent range instead of the perfect pin-point rent price, demand is fluid and it shifts up and down depending on the competition, the time of year, your property type, etc. etc. and so your market rent bracket should reflect that.
If you determine your rent bracket to be between $1,850-$1,950 based on a market analysis, all that is really telling you is that your rental will most likely rent within that range. Sure your rental will certainly rent for $1,950, that is what the analysis is telling you after all but, how long will it sit vacant before you find a tenant? Although a higher rent price is alluring, depending on the factors listed it may not make sense to list at the top of your range and could actually wind up costing you big money in the long run.
"Although a higher rent price is alluring... it may not make sense to list at the top of your rent range and could actually wind up costing you big money in the long run."
How to Price your Rental Properly
First thing's first, you need to find out the market rent range for your rental. From there you have to look at the time of year and other factors that will affect demand. Another important factor is the time of the month your rental is going to be listed, if your listing coincides with the 1st of the month - when most renters are looking to start their lease - then you have a good shot at demanding a higher rent price, although keep in mind that your best renters are 6 weeks away - more on this in another article.
You should aim to maximize your rent price to its fullest but, not too aggressive otherwise you will turn away potential tenants and will increase your vacancy. Regardless, whatever you do, stick to your tried and true rental screening criteria. Vacancy may hurt but, ignoring your screening criteria and placing the wrong tenant in your investment will come back to bite you. Take your time and use your rental analysis as a tool to help you determine rent price rather than a rent price 'crystal ball'. Factor in the non-numerical factors such as time of year, upsides and downsides of your property and target audience - stay in tune with the market and before you know you will have your property rented with a happy quality tenant while still retaining maximum cash-flow.
About Ricardo Reis
Ricardo is a member of G3 Management & Investments and a real estate professional. He has been a successful property manager and real estate investor for over 10 years.