Are Investors Overestimating Rental Income Right Now?

Question

With DSCR and tighter margins becoming more important:

Are rent projections getting too optimistic in some markets?

Joe S. · Answer

Yes …. This has not just started though… in my opinion, most people lose money on rentals. There are a few exceptions that enjoy boasting, but they are the exceptions..

Stephen Delahoussaye · Answer

Managing 23 doors in Nashville so I see this play out in real time every month.

Short answer is yes, a lot of investors are overestimating rental income, but not always for the reasons people think. The biggest gap I see is not that rents are dropping. In Nashville they have actually been pretty stable in the areas I manage. The problem is that investors are underestimating the real cost of collecting that rent.

Here is what I mean. An investor runs the numbers and sees a property should rent for $1,800 a month. On paper that looks great. But they are not accounting for the one month of vacancy between tenants, the $3,000 to $4,000 make ready cost to turn the unit, the two weeks where the tenant paid late and you had to chase it, or the maintenance call at 10 PM on a Saturday that cost $350. All of that chips away at the actual income you take home.

The rent projection itself might be accurate. It is the net operating income projection that is usually way off. I tell owners all the time to budget 5% for vacancy, another 8 to 10% for maintenance and repairs, and assume at least one turnover every 18 to 24 months. When you run the numbers with those real costs baked in, a lot of deals that looked great on a spreadsheet suddenly look thin.

The investors who do well in this market are the ones who underwrite conservatively and then get surprised on the upside. The ones who get hurt are projecting best case scenarios and then scrambling when reality hits.

Linda, since you are a broker you are probably seeing this on the acquisition side too. Are the deals coming across your desk penciling out when you stress test the rent assumptions?

Jim Johnson · Answer

I think in some markets they definitely are — especially when people underwrite based on "best case" rent instead of durable rent.

What I've seen lately is a lot of projections assuming:• Perfect occupancy• Aggressive rent growth• Minimal concessions• Stable operating costsThat can work on paper but tighter margins expose assumptions pretty quickly.

For me, the bigger question is whether the property still performs reasonably well if rents soften a bit, vacancy stretches longer than expected or expenses trend higher. In this environment, resilience matters more than peak projections.

Stephen Delahoussaye · Answer

Linda, great question and the short answer from managing rentals in Nashville is yes, but the rent side is only half the problem.

On rent projections specifically, I am seeing two patterns here. First, new construction apartments are offering concessions that are pulling effective rents down in certain submarkets even though the asking rents look stable on paper. An investor underwriting a single family rental at $1,800 per month in an area where a brand new apartment complex is offering one month free at $1,750 is going to have a harder time than they expect. Second, the rent estimate tools tend to average across zip codes and miss the block by block variation. I have seen $200 per month differences between properties less than a mile apart just based on school zone boundaries.

But honestly the bigger issue I run into is expense underestimation. Investors will nail the rent number within 5% and then completely miss on insurance increases, property tax reassessments after purchase, or maintenance costs on aging housing stock. In Nashville specifically, insurance has jumped 15 to 20% on some rental properties over the past two years and property taxes get reassessed to the purchase price which can be a shock if you bought above the previous assessed value.

Jia Pan's approach of underwriting 5 to 10% below projected rent is smart, but I would add that you need to stress test the expense side just as aggressively. Run your numbers with insurance at 120% of current quotes and maintenance at $1,500 per unit per year minimum on anything built before 2000. If the deal still works after that, you have a real margin of safety.

Caleb Brown · Answer

It's very micro and each market is different. In my market some areas have a lack of rentals while others there is a higher supply. Generally the urban core you need to be conservative, A/B suburbs have higher demand.

Bryce Jamison · Answer

With the significant increase in apartment construction and homes available for rent in my area, I may be under estimating rents. On the plus side, I attract more renters, faster. On the down side, I may be leaving money on the table by not listing at a higher price. There's a balance, but overall I'd rather rent faster at a lower price than have longer vacancy. I also have the additional upside of being able to adjust rent to the market rate at lease renewal or when new tenants move in.

I spend a lot of time on Zillow looking at what's available for rent in my area. The listings getting lots of contacts and applications tend to be listed at lower than market value while the ones with few contacts and applicants are the opposite.

Are Investors Overestimating Rental Income Right Now?

Most Popular Reply