Just like numerous other economic factors, rental rates fluctuate over time. Theoretically, they can go up and down. Practically, they only go up over time. That means if you don’t ever change your property’s rent rate, you’re eventually going to be undercutting yourself and charging a number that’s well below the going market rate.
If you’re in a situation where you’re charging less than the market rate, you have options. However, if you want to increase the rate and bring it up to the standard in your area, make sure you’re smart about how you do it.
Otherwise, your decision could lead to some unintended consequences.
How to Know if You’re Charging Below-Market Rent
If you want a very quick (but often inaccurate) estimate of how much you should be charging for rent, you can run the One Percent Rule in your head. This method says that the monthly rent should be equal to roughly one percent of the property’s current value. On a $150,000 property, that comes out to roughly $1,500 in rent. However, don’t take this “rule” as gospel truth. For example, just because you have a rental property that’s worth $400,000, doesn’t mean you can charge $4,000 (in most markets, at least).
Thankfully, there are better ways to get a feel for the going rate in your area. Here are a few:
- Local real estate agents. Real estate agents tend to have a good feel for how much properties rent for in certain neighborhoods. They have access to the MLS and often have close relationships with property management companies. Ask a couple of agents in your network for rent projections on your property and they should be able to get you some pretty accurate figures.
- Zillow. Another option is to spend time on a site like Zillow. Not only can you browse current rental listings in your area – which is a great way to know how much other landlords are charging for similar properties – but you can also use their internal rent estimator tool. (While not entirely accurate, it’s usually not too far off.)
- Rentometer. If you’ve never used Rentometer, definitely take a look. This is a pretty amazing tool that lets you put in your property’s details and compare rent to other similar properties. When running calculations, the tool uses a combination of real-time data and different mathematical models to let you know if you’re charging too little, just right, or too much.
These are just a few of the methods you can use. Quite honestly, the more research you do, the better. By grabbing values from different places, you can sort of average them all out and get a pretty good feel for how much you can charge.
Understanding Your Options
If you find out that you’re currently undercharging on rent with your current tenants, you have a couple of options:
- Do Nothing (Keep the Same Rate). Let’s say you’re currently charging $1,200 for rent. You’ve been charging this rate for the past three years and have a great tenant who pays on time, takes care of your property, and has expressed interest in renewing her lease for another 12-24 months. After doing your research, you know that the new going rate is somewhere around $1,500 per month for a property like yours. Yes, you could raise the rate, but is it worth it?
Legally, you probably can’t bump the rate up 25 percent on an existing tenant. More than likely, you’d have to go to $1,300 first. That begs the question, is an extra $100 per month worth rocking the boat and potentially losing an excellent tenant? That’s something you’ll have to decide.
- Increase the Rent. Sometimes raising the rent is the most logical decision. After all, you’re running a business/investment here – not a charity program or affordable housing project. You have every right to charge the going market rate.
At the end of the day, you have to do what’s best for you and your investment. However, there are some “rules of thumb” that you’ll want to keep in mind as you decide how much to charge for rent.
First off, you need to know the minimum rate you can charge – your break-even point, if you will. This is the bottom line number that covers your operating expenses, mortgage, etc. Charging anything below this will cause you to lose money.
Secondly, you need to know the maximum fair market rent rate. In other words, what’s the upper end of the current market? This is the number that will allow you to generate the highest cash flow and best profit margins.
Generally speaking, you want to be somewhere in between these numbers. You don’t want to charge the minimum (because you won’t make anything). And you probably don’t want to charge the maximum either (as it will suppress demand and make it difficult to find a good tenant). The answer is somewhere in between.
Tips for Increasing Rent
If you decide to increase the rent in order to bring it into alignment with current market rates, make sure you have a plan. Here are some tips for raising rates without losing your tenants:
- Do your research. Never increase rent without first doing research (as highlighted above). Not only will this help you avoid breaking any laws, but it’ll give you the confidence needed to set a fair rate.
- Do it incrementally. Every state has limits on how much you can increase rent during a certain period of time. Make sure you’re only increasing rates incrementally. This prevents you from overwhelming tenants and unintentionally forcing them out.
- Don’t ask/negotiate. You’re a business. Businesses don’t negotiate with their customers. Avoid negotiating or asking if a tenant thinks an increase would be fair. If you’ve done your research, trust your math and stick with it.
- Have a process. If you own several properties, increasing rents is something you’ll have to do fairly frequently. Come up with a formal process that you can easily follow. This may include a template for sending a notification, a method for informing (certified mail is a good choice), etc.
Green Residential: Houston Property Management
At Green Residential, we do more than just manage Houston rental properties. We work closely with real estate investors and landlords to ensure they’re maximizing cash flow and protecting their properties in less time and with less stress.
Want to learn more? Click here to get your free property analysis!