Instead of the typical know your market, calculate expenses, and maximize profits article on pricing rentals, this post will focus more on greed and its alternative, which is stress reduction via common sense.
When pricing rentals, a landlord’s thought process sometimes begins with “I have the nicest house in the area.”
There’s nothing wrong with that—it’s something to be proud of. But the thoughts that follow are key to either maximizing stability or potentially adding a great deal of stress to your life.
The wrong follow-up is “therefore I can charge the highest rent.”
Instead, you should be asking “how do I get the best tenant?”
The answer to that question is always “charge the market rate or lower,” regardless of how much you just spent on those awesome bathroom upgrades.
While this may seem counterintuitive, it serves a vital function in that it adds a tier of high-quality applicants that otherwise wouldn’t have considered your property.
These are prospects who know they will be among a property manager’s top choices, and don’t need to settle for an overpriced home. Even if they do choose to settle, you can bet they’ve got an eye out for a better deal. In other words, they’ll be leaving at the end of the lease, and it won’t be due to their own instability.
Considering a tenant to be “high quality” goes beyond their FICO scores and verifiable income. It includes previous housing, employment history, a background check, and the simple fact that they chose the best deal. This means they are more likely to stay in the long term, which will greatly increase your chances of avoiding one of the biggest expenses (and hassles) a landlord faces, which is vacancy.
Pricing Rentals with Bob and Sally
Every property is unique, but there is always the danger of pricing yours into the red. For an example scenario, I’ll use two identical 3/2 single family homes in the same neighborhood, both with a market rate of $2,500/month. Let’s assume both are nicely upgraded and in a good school district. While this example may be slightly exaggerated, it illustrates that there really is a sweet spot.
Landlord Bob charges $2,600/month for his home. It takes a while, but he finds a tenant who seems acceptable on paper—with good (but not stellar) credit scores, several job and residence changes in the last five years but without periods of unemployment, enough current income to qualify, and no problem coming up with the deposit. This was Bob’s highest-quality applicant.
Landlord Sally charges $2,400 for her home. Bob’s new tenant had also put in an application, but she soon finds another tenant with excellent credit scores, sufficient income, and single entries for employment and housing spanning five years. In other words, someone who would easily qualify to buy their own property if they had enough money for the down payment (an increasingly common problem these days).
The key takeaway from this scenario is that Sally’s new tenant likely didn’t even bother applying for Bob’s rental, and certainly wouldn’t choose it over Sally’s if they had.
Now we’ll add a few years to the scenario. Bob’s tenant manages to stay employed, but following his usual pattern, moves out when the lease ends in a year. Bob didn’t necessarily intend to raise the rent, but takes the opportunity to do just that and bumps it to $2,650. After it sits vacant for a month, he finds another mediocre tenant.
Sally raises the rent on her existing tenant by the same amount (after all, rates are up everywhere), who remains in the house because they’re still getting a great deal.
If we assume Bob has two tenants staying for one year each, no adverse incidents such as damage or eviction, and an additional two months of vacancy, Bob’s gross revenue is $63,000 over those 26 months—not including cleaning and marketing costs.
Sally, on the other hand, could well have a full 26 months with the same tenant. Including two annual rent increases, her gross income is $63,200 over the same 26-month period.
That’s pretty much a wash, but it’s difficult to put a price on the stress reduction in Sally’s life. Meanwhile, Bob contends with large gaps in his income stream, more frequent marketing and cleaning, and a higher risk of problematic and potentially very expensive tenants.
While this strategy is obviously not guaranteed to eliminate vacancies or problem tenants, and may even be impossible in the short term due to expenses, pricing rentals right can swing the odds in your favor.
