Setting prices is one of the biggest challenges for many business owners—and landlords are no different in that regard. Fortunately, you can take the guesswork out of pricing your rental property by considering four factors:
- Taxes and insurance
- Vacancy rate
- Debt Service Coverage Ratio (DSCR)
“Understanding your expenses on a property, the vacancy rate, and knowing the factors that go into your debt service coverage ratio can help you calculate a rent price that yields a strong profit,” says 5 Arch CEO Shawn Miller.
Calculating Your Debt Service Coverage Ratio
At the heart of calculating rent prices lies your Debt Service Coverage Ratio, which is a property’s annual net operating income (NOI), versus its monthly mortgage principal and interest payments. “Investors consider a rental with a 1.25 or higher DSCR as a strong performing property,” explains Miller.
Factor the Vacancy Rate into the NOI
The vacancy rate in any rental unit or an MDU factors into the NOI, reducing the net income by a percentage. “Calculating NOI accurately is a key step to knowing exactly how much to charge for a rental,” says Miller.
When calculating the vacancy rate, which is a percentage of the apartments left empty in any given unit, do not include apartments that are closed due to renovations or those being used as a public gathering space.
Taxes and Insurance
In addition to mortgage payments, you’ll have to add property taxes and insurance onto a property’s operating expenses. Consider ways you can keep the cost of insurance down by adding a security system, flood detection system, or smart lighting to deter burglars.
“It’s wise to form a strong relationship with an insurance broker in your area,” adds Miller. “You should find a firm you can trust, with brokers who will shop around for the best deals for you, knowing that you’ll continue to send business their way.”
Consider Marketing Costs and Other Business Expenses
Overall, the rental price must exceed your expenses, and allow for times of vacancy. Common expenses may include upkeep, payments to a property manager, and utilities (if they aren’t included). That’s basic math, and most investors understand this.
Do not forget rental costs that are not typically recurring—unexpected repairs, marketing and advertising costs, legal and accounting fees, and any other expenses associated with the business.
“Take these average monthly costs over time, split them between your rental units, and add that amount to the cost of each unit as part,” says Miller.
Assess Rentals in the Area
Regardless of your calculations, the rental price should not exceed the cost of similar properties in the area, or you will be left with a vacancy. “It is better to rent a property at a smaller profit than to have an empty unit,” Miller points out. After all, empty rentals are a security risk, a financial loss, and can even drive down overall property values in the neighborhood—the exact opposite of what an investor hopes to achieve.
“If you have done your homework before you purchased the unit, you should be able to turn a nice profit by pricing your rental close to the median of similar rentals in the area,” says Miller.
Location, Location, Location
Within a neighborhood location counts. Homes closer to schools, parks, shopping, and public transportation—especially in walkable communities—command a higher rental price than those on the outskirts.
When an apartment has a great location and is stocked with amenities, you may be able to charge more than the median price in the area, or even more than market value.
Some aspects that make a home or apartment more desirable:
- An updated kitchen with stainless steel appliances
- Level door entries
- Hardwood floors
- Clean, consistent transitions between hardwood floors and carpeted areas
Marketing: The Art and Science of Real Estate Rentals
If pricing rentals were as easy as calculating DSCR, anyone could make money as a landlord. But renting an apartment is as much art as science. When you apply solid marketing strategies and home staging to make an apartment more appealing, you may find a higher priced unit will move quickly. “It’s all about perceived value,” says Miller.
“And don’t worry if it takes some trial and error to price a rental home or apartment. That means you’ve learned something important. Filing that information will make it easier to price your next rental right,” he says.
On that note, as you begin to perfect the process, your rental property portfolio will grow, which requires you align yourself with a lender that offers rental property loans designed to support your exit strategy. Be on the lookout for flexible duration terms—three-year loans vs. 10-year loans, for instance. While there will be additional insurance, a mid-range tenured loan can mitigate risk while adding the optionality that can enable you to maximize your profits as the market and your investment needs change.
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