Whenever someone tries to rent out their property for the first time, what to charge for rent is the big question. Friends and family will happily indulge us with fantastic sums no one will actually pay. If you’ve shown your apartment to prospective tenants, you’ll realize how inscrutable they can be. Many novice landlords have worried about overpricing a unit and having it sit vacant or underpricing a unit and losing out on rent money.
How The Property Rental Market Is Different From Other Markets
People shop for rental real estate differently than they shop for other things. Someone will go shopping for a new laptop with an initial budget of $500. After looking at different models with different features, they’ll justify buying a $1300 model. Some landlords hope for similar behavior, however, it just never happens that a decent tenant will wander along and massively overpay for a property. The only time this ever happens is if someone from out of town is renting the property remotely, and this has its own challenges.
I thought about this for a while, and I think I understand why the market is different. Housing is, for most people, their biggest expense. Typically they will figure out what they can afford – perhaps 30% of their income – then they will go shopping with this budget. Unlike the laptop example above, they can’t afford to impulsively decide to spend 3 times as much on rent – they don’t earn enough to cover this! Instead, they’ll look at a number of properties that are renting at their price point and pick the nicest one.
This simple heuristic on the buyers’ part leads to an incredibly efficient market. If a property is under-priced, it will look very nice compared to the competition and will get snatched up quickly. If a property is over-priced, it will look bad compared to the competition and no one will ever choose to rent there.
I’ve often thought this is a great strategy for buying. Determine a fixed budget, then get vendors to offer you their best deal at that exact price.
I’ve suggested this as a decent graduate research topic in economics, but have been told it’s already been done.
How To Use This As a Landlord
As a landlord, you can use the aggregate behavior of renters to figure out whether or not your rent is correct. Basically, if you have your unit priced properly half the people who come to see it will apply to rent there. If less than half are applying, it’s priced too high. If more than half are applying, it’s priced too low.
Rather than refuse to rent to someone who applies or trying to raise their rent, I would suggest starting a bit above what you think the rent should be. Do a showing. If less than half the people who see it apply to rent there, drop the rent and advertise it again. Keep doing this until you reach the half application point – or it’s rented.
If more than half apply, rent to the best of the bunch, but next time you’re setting your rent be more aggressive.
If you are very picky with tenants and reject many of the people who apply to rent from you, you may want to deliberately offer a unit at an under-market price so that you can get more applicants.
How To Come Up With First Guess
If you have no idea even the ballpark of your rent, there are a couple of ways to get yourself in the right range. If the unit has been rented before, try renting it for a little more than the previous rent – or a lot more if the previous tenant was there for a long time. If it’s a brand new property and you don’t know anything at all, look at rents for similar properties in the same neighborhood. You can see these on Craigslist or whatever the standard marketplace is for rentals in your area.
The beauty of this approach is it will work for any property, even if it’s dissimilar for other properties in the area.
Why It’s Important To Get The Rent Price Right
If a unit is overpriced and sits vacant, this is obviously a massive amount of lost money. Not overpricing your unit prevents this.
If a unit is underpriced, you’re losing money in the short term because you could be getting more rent. You’re also losing money in the long term. Most rental properties are valued as a multiple of their income. If you’re bringing in more rent, it makes the property more valuable. This can be a significant difference in the value of a property.
I released a book on Amazon about “Getting Started As A Small Scale Landlord”. It treats this as a part-time job you can give yourself, rather than a get-rich-quick scheme. If you enjoyed this post, I think you’d dig it.
If you’re a landlord, how have you set rent prices for your units in the past? Are you confident you’ve gotten the rental prices correct?