Philosophy on setting rental rates

10 Replies

We will be listing our first rental property in the next week or so.  I've spoken with two different PM's who have very different philosophies on setting rents.  

One says to stay away from the high end of the rent range.  Her thought process is that if you get the max rent and renters don't feel that they've gotten a good value, they'll "create value" in some other way  - namely more maintenance calls translating to higher expenses.  But if a tenant feels that they've gotten a good deal, they'll be low maintenance and more likely to stay longer term. This PM also doesn't believe in raising rent if you have a good tenant.  

The other PM suggests setting the initial rent above the high end of the range, and then gradually lowering it to hit the "sweet spot". 

I can see where both philosophies have merit, but I'm curious to know what others on BP think?  

As a property manager, I agree mostly with PM #1. However, I don't think that more maintenance calls will happen if the rent is higher. Things are either broken or not, regardless of the rent amount. 

I used to be PM #2, starting out at the high range for rent and continually lowering it. What I found out over the years is that you almost always have to lower it to market value eventually, and end up losing valuable rent money coming in because you have vacancies longer. Sometimes I did get tenants at the high end, but not that often.

I now just do my research and price it right in the first place. This has really decreased vacancies.

I aim for high, but realistic. Starting too high and gradually lowering until you find a sweet spot wastes valuable time and increases your vacancy. Charging too little leaves money on the table and I'm not convinced you get a better behaved tenant.

If I see a comparable that's been sitting on the market, I try to figure out whether my unit is as good, better or worse. If they're equally good, then the fact that the other unit is sitting tells me they're asking too much. It'd be silly for me to ask the same price and expect a different result so I'll price $50 or so lower. That's the sort of logic I use to help me shoot for high, but realistic.

I typically do small increases every year, $20-25, and have not seen any turnover as a result.

I do make sure to take care of repair requests promptly and professionally to hopefully avoid issues with perceived value / tenant satisfaction.

Owners commonly ask the question “What’s the highest rent that my property can get?” It seems logical that extracting the highest rental price from your investment property will lead to the most income.

We think the question that you should be asking yourself is:

“What is the highest rental price that will still attract a sizeable pool of prospective tenants while encouraging the eventual tenant to stay multiple years?”

Vacancies are the number one rate of return killer on investment properties. A typical vacancy period costs an investor several thousand dollars in lost rental income, mortgage payments, touch up painting, yard maintenance, utilities, etc.

Your goal should be setting a rental rate that is in line with market rents but encourages the tenant to stay for multiple years in order to minimize vacancies.

Our philosophy is to set the rents ever so slightly below market rents. Why?

Setting rent even $25 per month below market rent is a powerful incentive for tenants to renew leases at the end of the term. We also believe tenants are more inclined to take good care of the property when they feel like they’re being treated fairly. $25 per month is money well spent to avoid a several thousand dollar vacancy.

What about automatic rent increases in the lease?

Many leases include a clause that raises rent by 5% or so if the tenant decides to renew after the initial term. Do you like it when prices go up on a monthly bill for no good reason? Neither do we. We think automatic rent increases in leases are a bad idea. What if local market rents go down? The tenant will shop around at the end of the lease, and when he or she discovers that their rent is about to be $75 / mo higher than other similar properties, they will probably move.

Our philosophy is to raise rents only when there is a good reason to do so: when market rents in the area have increased significantly. If you do decide to raise the rents on an existing tenant, only raise it enough to bring it near current market rent and have comparable rental data available to show the tenant that you are treating them fairly.

Like any other business, provide value for your customer (tenants) and your business will prosper. Your pocketbook will thank you in the long run.

I think @Nate Garrett  has given a good rundown. The only place where I disagree is with automatic rent escalator clauses; I believe they must be used (and I set mine at 8%), but used within your discretion. When I say that, you have the discretion of making it a smaller or no increase for tenants that you like and wish to keep - you can raise it the full amount for those who are more trouble or that you want to move out. 

@Julie Kern  I very much agree with PM 1, and I am also a property manager.  I find that starting too high generally leads to a home sitting on the market too long and the listing getting "stale."  After someone has seen it on Zillow for two months, and they know they already passed it over (due to price), and they rarely go back to it after a price reduction.  They don't necessarily put price as the reason they skipped over it in the first place, just that they didn't choose it for some reason...so then the listing becomes invisible to them.  

There is one on my street that started at $2500/month, abut $400 overpriced.  I've watched it come further and further down, and it has been vacant for three months.  Now they are at $2200.  If they had just priced it at $2100 to begin with, they would have earned $6300, but instead, they have earned nothing during the vacancy.   

Wow, thanks everyone!  This is a huge help!  @Nate Garrett  - your post especially gave a great overview of setting rent rates.  

@Nate Garrett has given you some good advice. One caveat I would add is that in rent controlled environments there is no discretion to raise rents to market levels later on, so the prudent landlord goes for the small rent increases that are available each year (in my jurisdiction these are never any greater than 2.5%).

I think the advice about establishing what market rents are and then charging them is correct in general, however it can be a little more complicated than that. Sometimes the data on market prices is not all that clear. There may be a shortage of listings for units similar to yours. You may not come up with good comparators. At that point you have a choice: do you act conservatively and charge a lower rent, or do you push out in the pricing envelope and reach for a bit more? I have reached out and been wrong, but I have done it more times and been right. Being in a smaller market means there is sometimes not enough information for decision making. I recently upgraded rent on two units that had been set at around $1,100 up to $1,214. The units turned over, and I used the change in tenants to negotiate market rents for units that were in great condition and in a great building. Some of this is luck but most of it is having the right product. A lot of this will come with experience learned through managing your way through a lot of specific cases. After a while it starts to make more sense.

I'd say that local market conditions would influence this a lot. High demand and a lack of available rentals will help push the envelope. As Stephen said, data on market prices is not always clear.

In my little town, quality rentals are in very low supply, but landlords are leery of raising rents. We just rented a 2/1 SFH for 12.5% more than "the most you can get for a 2 br here." How? We asked more. I posted an ad for it on a yardsale page on Facebook, and 4 hours later we had our renter. They moved in this weekend and are thrilled to death to get it.

The next town over (just 9 miles away) has more rentals available, so we might have had a harder time finding a renter there, but I don't know.

We try to provide a better quality rental than others in town, and we will charge for it.

I like to price just under the comparable competition. I'd prefer to have several options when selecting from the applicants.

I am still fairly new at the game but from what I have seen, all of this is good advice.  It doesnt pay to market at the high end of your market unless you have the proper property and lease structure.  People pay for the amenities, providing lawn service to a nicer property rented to a younger professional (for example) may only cost you $100/mo. but let you market it at $120 or $150 more.

Another major part Ive found is proper marketing/information distribution.  I cannot believe how many ads Ive seen for other property that have one or two fuzzy pictures of the whole property in the ad.  I believe if you take pride in your properties, as I do, it should shine through in the ad.  I dont want to put "rose-colored glasses" on the ad but I do want to show them all that the space offers.  Make them feel like they are the quality of person you are looking for so they can be proud to live there and justify the higher rent.

I dont nearly have the track record many of the other fine investors on BP, so if I wrong please shut me down.

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