It may sound like common sense, but pricing your home appropriately is one of the most critical factors in a thriving rental investment. What we describe as the appropriate price is the price your property will rent for in 30 days to a well-qualified renter. There are other ways to describe this price, but to be successful long-term in investment real estate you need to learn to minimize your vacancy and keep your investment protected by working diligently to place quality tenants.
This guide will go over some of the most common mistakes we see rental owners make regarding the pricing of their properties and the potential consequences based on the initial pricing. There are exceptions to every rule, but following these principles can point you down the right path for a successful career in real estate investment. After going over the scenarios, we will also go over the process in which we measure and can quantify based on market feedback if the current price for the home is conducive to placing a quality renter in the house within a 30-day timeframe.
1. Return on Investment
It is essential to establish the goal we are trying to achieve by going through this process. For most rental owners, producing the highest return on investment is the main priority, so let’s start there.
For us, there are two ways of looking at this return on investment: short and long timeframes. When looking at a short timeframe, achieving the highest rental price can make sense, especially if you are currently living in the home and are flexible when you can move out. Giving 60-90 days to find someone to pay the highest price can be more easily accomplished without a vacancy. Once you have moved out of the home, you will be re-renting the house in a specific timeframe to the next set of renters. This exposes one of the biggest killers of return on investment out there: vacancy. One month of vacancy kills 1/12 of the monetary return for the property over the year.
Let’s look at an example. If your property rents for $2,000 per month, going vacant for one month obviously costs $2,000. If that property could have avoided going vacant for that month by starting the price of the home at $1,900, instead of $2,000, your savings would be $2,000 minus the $100 dollar difference per month times 12 months ($100 x 12 = $1,200), so $2,000 – $1,200 = $800, and that $800 could have been earned instead of lost.
We will go into several other factors that also tie into appropriately pricing the home, but vacancy is the one that hurts the most. There is a renter out there that could be occupying the home, and this can be ensured by pricing appropriately.
2. Finding Quality Renters
There are actually many ways to think about this subject. Let’s take a look at how pricing can affect finding quality renters from the start. Of course, it is our goal to get the highest price for you, and help you achieve your goals, but there are a few ways to go about this. One train of thought is that the higher the home is priced in comparison to the market, the higher the quality of tenants. This may be achieved because the theory is that only top quality tenants can pay the higher price. We have actually noticed the opposite over time, and below is an idea of what we have found.
We see the pricing of a property to be a bit like a teeter-totter. With the price on one side, and the quality of the tenants on the other. With this simple analogy, let us compare a few examples.
Pricing too high can lead to problem tenants
First, let’s go as high in price as possible and see what happens to the tenant side. It’s a teeter totter, so the tenant goes down. We have found this to be true for a few reasons: when you are at the top of the pricing for a property, the pool of potential tenants will be smaller.
There are many housing options out there, and having a high price in comparison to other homes in the area may restrict you to less qualified applicants. They don’t have as many choices and are willing to pay the higher price to live in that specific area. This notion feeds into itself as when the pricing is at the highest level, the property owner will be receiving fewer applications, making the less qualified applicants seem more attractive based on the scarcity of other applications. Less qualified applicants can be harder to manage, have less robust rent payment and income histories, and can be a higher risk for damage to the property. Another aspect of this scenario is that when properties are overpriced, they tend to sit vacant on the market for longer periods.
More affordable pricing leads to better renters
Now let us look at the other side of the story. Lowering the rent side all the way down, the renter quality is on the top now. Lower priced properties generate a lot of interest, and with lots of attention comes plenty of quality renters that know a good deal when they see one. In this situation, we receive qualified applicants quickly and can negotiate the best terms. There is little to no vacancy in this scenario as well.
So obviously, you don’t want to charge too little or too much for your property, so what do you do?
Your property manager will be your guide through this process, as they have done it many times before, and can look at both sides of the equation to help you find the best renters at the best price. A healthy balance here will lead to a healthy deposit in your bank account.
3. Best Time of the Month to Find a Potential Renter
One crucial factor to think about when you are renting your property is factoring vacancy rate into your return. One critical junction of rental price vs. vacancy is in determining if your property may go vacant for a month based on the date of the current month in which you are renting.
This can help you decide if your rental price is correct and will help you establish the strength of your negotiating position with prospective renters. Below are some primary metrics for the number of potential renters on the market looking for a property as of the 1st of the following month:
- 1st – 12th: 90% of renters are looking for a move in the 1st of the following month
- 12th – 20th: approximately 50% of renters are looking for the 1st of next month to move in
- 20th – 30th: 10% – 15% of renters are looking to move in the first of the following month
This is another reason to price your home appropriately when the renting process begins. If this is the first time renting the house, this can be a reason to start the marketing for your property approximately 30 – 40 days from the date you are looking to have renters move in. A vast majority of properties that go up for rental start marketing around the beginning of the month. If you miss the opportunity capture a renter for the following month based on overpricing at the onset of the month and then start to reduce the price to encourage potential applicants, you end up fighting against the decreasing percentage of interested parties on the market.