Supply and Demand Determine Rent Amount
Okay, so, you are a landlord and want to maximize your investment. What do you do? Charge a price that is high enough to equate to a great return on investment, but one that is reasonable…that is the goal for every landlord, right?
But, does it matter what rent you choose to charge? Actually, yes!
Rent is, most of the time, determined by supply and demand. The supply and demand of rent is the same for all other products and services. Each landlord has the same number of apartments that they are able to rent. So how should they go about setting up their rent?
Since the number of apartments has no effect on the supply, they have to compete over the demand. Landlords have to make sure that they charge a rent that will attract tenants, keep them occupied, and maximize ROI.
To do this, you have to understand the rent and return calculator. What this does is it takes certain variables into account such as loan, operating cost, vacancy rate, property tax and other expenses. It will then let you know the net operating income, and should you want to increase it, you would be able to see how and by what percentage.
You should also try and have a good understanding of how a rent multiplier is calculated. What this is will let you know how the rent you set will effect the property and its income.
Positive Cash Flow Is Important With Rentals
An Example of a Good Rental Cash Flow
When I first started out as a landlord, I didn’t pay too much attention to the exact numbers. I really wish I had before I decided to buy my first house. While the first few houses I bought worked out fine, eventually I learned some hard lessons about good and bad rental cash flow and started to do some number crunching.
The first lesson was a simple one, but one I think a lot of newbie landlords don’t consider when they’re getting started–the costs of getting the property rented. I was spending 100-200 dollars to get the place rented out, and with only a 2% yield, it took me a while to get the positive cash flow to cover these extra start up costs.
I learned from this how important it is to pay attention to the expenses and get them low before you start. Instead of spending so much to get the place rented out, I was able to get a few apartments that were already full of renters from a rental office in the same complex, and lower my cash flow significantly.
How Much Rent Is Enough?
When it comes to renting out investments, there are no shortage of opinions. Some people will readily share their wisdom based on just about anyone’s investment. But unlike many other types of investments, the “market” is much smaller, and there are less properties to compare.
Sometimes, it can be really difficult to find a proper benchmark.
We decided to do some research to try and define a “reasonable” rent that could be considered a good investment.
It’s important to understand that there are different ways to define “good”. Some investors may just be interested in maximizing their return, while others might want to have the financial freedom to spend their time and energy doing something else.
Here’s what we discovered:
Establishing a baseline is the first step.
As a baseline, the most conservative investor should assume that any investment return should at least cover the cost of the property and the debt. So we looked at the average mortgage debt for a property of that type.
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How Much Rent Do You Need to Charge to Make a Good Investment?
With the many different things that can go into the decision to purchase and rent a property, it may not be clear how much rent you need to charge to make the investment worthwhile.
Often, when you get into real estate rental investments, there is more than just a property involved. There are other costs that have to be factored in as well.
So let’s start off by taking a look at some of the more obvious costs.
Rents are based on traditional debt instruments such as CDs and stocks. With rents, tenants pay your mortgage for you and you get passive income while enjoying the appreciation the market bestows upon your property.
If you were to sell your property for a reasonable gain, you would be making a profit minus transaction costs. However, you can’t sell a rental because the money you put into it is already gone, offset by a loan and interest payments.
Rentals are excellent for passive income and little appreciation. This may be a blessing for those who are looking for steady work and dividends or for those who don’t want to take risks on capital appreciation.
The seller is responsible for guaranteeing the property is fit to live in and for covering all the maintenance, property taxes, and insurance. This includes the property having adequate heating, cooling, plumbing, etc.
Can you pay the mortgage if a tenant can’t? What happens when your tenants don’t pay their rent? Is it all on you to fix it yourself or will they only compensate you for the cost of materials?
Will you receive compensation if the tenant leaves early?
Rents are NOT a substitute for due diligence and common sense. It is more of an alternative for people who either lack time or do not have the capital to invest in other tools such as CDs or stocks.