One major reason why many first-time landlords fail is that they don’t know how to price rental property correctly. For your residential rental property to generate positive cash flow, you have to ensure that your rental income is high enough to cover operating expenses and make a profit. However, this doesn’t mean that you should charge the highest possible price. Higher rental rates don’t always translate into higher returns.
Savvy real estate investors know that the appropriate price for a rental property should be based on the fair market rent. Whether you are aspiring to invest in rental properties or are an experienced investor with a huge portfolio of rental properties, it’s important that you understand how to accurately determine the fair market rent.
Read on to find out what exactly fair market rent is, why it’s important for determining how much to charge for rent, and how to calculate it.
What Is Fair Market Rent?
Fair market rent (FMR) is essentially the amount of money that a property in a specific real estate market would rent for at a given time. It is based on the amount that people would pay for a similar rental property in the same area. The rent prices of comparable rental properties will give you a good idea of the maximum rent you can reasonably charge for your rental.
FMR may be different from the current market rent, which is the rent that a property can obtain in a free and open market. Current market rent is dependent on local forces of supply and demand.
Related: Real Estate Market Value vs. Market Price: Learn the Difference
Why Is It Important to Determine the Fair Market Rent?
Determining FMR can be useful in the following situations:
Before Listing a Vacant Rental Property
Accurately pricing your rental property is key to being a successful landlord. Basing your rental price on fair market rent is important because it provides a balance between maximizing your rental income and ensuring that the property is continuously occupied by reliable tenants. With the right rental rate, you’ll be able to find a good tenant relatively quickly, keep them for longer, and earn a fairly good rental income.
If you charge too much above the FMR, your property is likely to sit vacant for longer. In the long run, you will lose money since you will be forced to cover the mortgage and other expenses for a number of months.
You should never charge well above the FMR unless there is a feature that makes your rental property considerably more valuable than comparables in the area. Even then, you may need to convince potential tenants why they should pay more for your rental property.
If you rent below fair market value, you may get a tenant relatively quickly. However, you’ll be leaving money on the table each month. If your rental prices are too low, it may be difficult to have a good monthly cash flow or break even.
Related: 7 Tips to Avoid a High Rental Vacancy Rate
When Adjusting Rent
It’s best to determine the FMR of your rental property before you list it for rent. However, if you are already a landlord, determining fair market rent can help you decide whether you should increase the rent (if you are charging too low) or reduce the rent (if you are charging too high) so as to maximize your monthly rental income and occupancy rates.
The value of a rental property can vary greatly over time. When this happens, you can agree with your tenants to adjust the rent based on the fair market rental value or set the appropriate rate in between tenants.
When Choosing a Rental Property to Buy
If you’re looking to buy a new rental property, knowing the fair market rent can help you in calculating the potential cash flow and return on investment. If the FMR of the rental property for sale doesn’t exceed its operating costs, then it may not be a profitable real estate investment.
When Renting to Section 8 Tenants
Fair market rents are usually estimated annually by the U.S. Department of Housing and Urban Development (HUD) to determine housing voucher amounts to issue to low-income individuals through the Section 8 program. Therefore, if you are renting to a section 8 tenant, it would be crucial to know the FMR.
What Factors Influence Fair Market Value?
The fair market rent of your rental property will be determined by a number of factors including:
- The desirability of the location (Good school zone, low crime rate, public transportation, etc.)
- Property size (square footage)
- Number of bedrooms and bathrooms
- Property type (apartment, duplex, single-family house, etc.)
- Amenities (recent upgrades, pool, great view, gym, central air conditioning, outdoor space, etc.)
- Property age
- The condition of the property
- Essential utilities included in the rent price (water, gas, or electricity)
Generally, the more desirable characteristics your rental has compared to other units in the area, the more rent it can command.
Related: What Are the Features of the Best Investment Property?
How to Calculate Fair Market Rent
HUD’s fair market rent estimations can be a good place to begin your research. However, they may not give you the correct fair rent price because the conditions in your specific neighborhood and your property may be different.
To find a more accurate estimate of the fair market rent of your rental property, you need to get a more localized view. Fair market rent is best determined by checking what other landlords are charging their tenants for comparable rental properties in the area. You should find out the rent for at least three similar properties currently rented out in the area and then find an average.
When doing your rental market analysis, you should take into consideration the factors stated above (location, size, property type, etc.). The more comparable the rental comps are to your investment property, the more accurate the fair market rent estimate will be.
If the comparables are occupied, it’s likely because they have reasonable rents that are close to the FMR. Ideally, determining their occupancy rate will help you know whether the rental rate is a little higher than the RMF, a little lower, or just about right. Vacant local rental listings can show you what rental prices are too high.
Remember, if your rental property has some unique features, they may justify a slightly higher rent than the FMR.
Finding Rental Comps
There are many ways you can find rental comps in your local real estate market including going around neighborhoods, asking local real estate agents or property managers that handle comparable properties, checking your local newspaper, etc. However, as a busy landlord, such methods can be time-consuming.
Fortunately, there’s real estate technology that can make your work much easier. The quickest and most efficient way to find reliable Airbnb and traditional rental comps in the US housing market is to use Mashvisor’s Investment Property Calculator.
Sign up for Mashvisor today to get your hands on readily available rental comps!
Related: How to Find Reliable Traditional and Airbnb Rental Comps
The Bottom Line
Understanding how to price rental property will go a long way to determine your success in the real estate business. Successful landlords usually base their rental prices on fair market value. Knowing how to determine the fair market rent in your area can mean the difference between long vacancies and renting your rental quickly to good tenants.