As a beginner investor, you are probably wondering how to calculate rental rate, one of the key determinants of profit in real estate investing.
Table of Contents
- What Is Rental Rate in Real Estate?
- What Metrics to Consider When You Calculate the Rental Rate
- How to Calculate Rental Rate
- Mashvisor’s Rental Rate Calculator
Learning how to price your rental property right is important. Buying and owning an income property does not automatically earn you a good rental income and return on investment.
Fixing a high rental price is not the solution, as it will affect the demand for your rental and leave you with a high vacancy rate. At the same time, setting up a low rate is not a wise move either. It means you might be leaving money on the table in exchange for a decent occupancy rate.
Thus, you should choose a rental rate that strikes the right balance between rental income and occupancy rate. The two metrics are the main factors when calculating the rate of return on real estate investment properties. So, in order to secure a positive cash flow property with a good return on investment, you need to learn how to calculate rental rate the right way.
In this article, we will show beginner investors what rental rate means and how it is calculated traditionally. We will look at the difference between setting up rental prices for long term rentals and short term – Airbnb – rentals. Then, we’ll discuss how the Mashvisor investment property and Airbnb calculator can help investors set up rental rates more accurately and more efficiently.
So after reading this article, you can stop asking yourself, “How much should I charge for rent?” and start earning money in real estate.
What Is Rental Rate in Real Estate?
The rental rate in real estate investing is the amount of money that you charge renters for occupying your property for a specific period of time.
Rental Rate for Long Term Rental Properties
With traditional rentals, the rental rate is usually set up on a monthly basis and is made available in the lease agreement signed between the landlord and the tenant. It is also known as rent.
In many states across the US housing market, there are rent control policies in place, which specify how often and by how much landlords can raise rent. Moreover, they stipulate how long in advance you need to inform your tenants of an upcoming rent increase. Rent control is mostly needed in markets with high rental rates, where tenants are left vulnerable.
Even if there are no strict rent control laws in your local market, you cannot simply raise and adjust the rent of a long term rental property as you deem necessary. For one, you risk losing your tenants if you surprise them with a rate that’s no longer affordable for them or not competitive in the area.
The lack of flexibility in adjusting the rental rate based on changes in demand and other factors is one of the disadvantages of investing in traditional rental properties.
Rental Rate for Short Term Rental Properties
With short term rentals—or vacation rentals—on the other hand, you usually set up the asking price on a daily or nightly basis. It is known as the Airbnb daily rate. It is the amount of money you ask guests to pay for staying on your property for a day.
The Airbnb daily rate multiplied by the Airbnb occupancy rate that you are able to generate brings your monthly Airbnb income.
One of the greatest things about buying a vacation rental property is that you can adopt a flexible pricing mechanism. So, you can ask for a different rental rate for each day of the week, week of the month, month of the year, etc. You are free to do so to accommodate fluctuations in demand based on seasonality.
In other words, you can raise the Airbnb daily rate during weekends, holidays, and popular events in the area to take advantage of the increased interest in short term rentals. Then, you can lower your daily rate in the off-season to attract some hesitant guests and still generate positive cash flow.
This flexibility is one of the reasons why Airbnb properties for sale tend to turn into more profitable real estate investment opportunities than their traditional counterparts.
What Determines the Rental Rate?
There are a number of factors that determine the rental rate appropriate for an income property. The factors differ slightly between traditional and vacation rental property investments.
The most important factor for both real estate investment strategies is location. The market where your property is situated dictates the rent that you can ask for it, whether on a monthly or daily basis. Some markets simply charge higher rental rates than others because of higher demand, living standards, price levels, etc.
So, if you’re wondering why rent is so expensive in Georgia, California, or Florida, it is because of the nature of the market, the economic factors, and the renters.
Investment Property Type and Features
The second key factor is your property, its type, size, and most prominent features. The bigger and more luxurious your rental is, the higher rate you can ask for it. Similarly, houses with a swimming pool, an outdoor gym, and a veranda can be rented out for more.
If you aim to maximize your rental rate, you should investigate what properties and amenities are most demanded in your local market.
Supply and Demand
Yet another thing to consider when you calculate the rental rate of your income property is the local supply and demand.
On the supply side: How many rentals are there in the area? Are they all occupied? Do they face prolonged vacancies?
On the demand side: Do local residents tend to rent or own? Is the population growing? How is the job market expected to perform in the coming months? If you own a short term rental property, seasonality also affects demand. So, you need to figure out the peak season and the off-season for your specific location.
Last but not least, the rental rate should be affected by the price of the property. The more expensive your investment property is, the more rent you should ask for it. Indeed, there is a specific rule in real estate investing that sets what percentage of the purchase price the rental rate should be, and we will discuss this shortly.
What Metrics to Consider When You Calculate the Rental Rate
While knowing how to calculate the rental rate for your investment property is a must in real estate investing, it is not enough to guarantee positive results. You need to take into consideration a number of other metrics when conducting investment property analysis before buying a property.
The metrics include:
Rental Property Expenses
As a first-time landlord, you might be downplaying the importance of rental costs for the bottom line of your business. But they include quite a few things that pile up and might significantly affect your cash flow and overall profitability.
The recurring expenses associated with running a rental property business include but are not limited to:
- Monthly mortgage payments if you take a mortgage loan rather than paying for your investment property in cash
- Property tax, rental income tax, and other taxes
- Property maintenance and repair costs
- Property upgrades like adding a dishwasher or even a hot tube
- Property insurance: Landlord’s insurance is about 25% more expensive than that of a homeowner, and the rate might go even higher when insuring an Airbnb property.
- Utilities (electricity, gas, water, internet, etc.) and supplies (toiletries, towels, sheets, coffee, tea, etc.) for short term rentals
- Cleaning supplies and/or fees if operating an Airbnb business
- Property management fees if you opt to hire a professional rental property manager
- Travel related to your rental business. Traveling back and forth to your property might end up costing you a hefty amount of money if you invest out of state.
When calculating the rental expenses of your property, don’t forget to consider the financing costs. Unless you buy your property fully in cash, you will likely need to repay the loan amount on a monthly basis. This holds true whether you take a conventional mortgage loan, an FHA loan, a VA loan, a hard money loan, or a private money loan.
Thus, the mortgage payment should be deducted from the gross rental income as it affects how much money you make from your real estate investment. Indeed, most landlords and Airbnb hosts realize that the loan repayment ends up being the largest recurring expense.
Related: 6 Types of Investment Property Loans
One other thing you need to remember when dealing with rental expenses is that many of them are tax-deductible, whether you own a long term or a short term rental property.
When filing your taxes, you can deduct the following items:
- Mortgage interest
- Property tax
- Operating expenses, such as cleaning fees, accounting fees, legal fees, travel expenses, home office expenses, property management fees, etc.
It’s important to take full advantage of the real estate tax benefits as they might make the difference between running a money-making and a money-losing business.
How much can I rent my house for? Many first-time real estate investors make the grave mistake of setting a rental price that’s too high for the rental market, negatively impacting their gross rental income.
It is because the total rental income is calculated by multiplying the rental rate by the occupancy rate. The latter is the time of the month/year for which you are able to rent out your investment property and keep it occupied.
It is good to have an idea of what rental income you expect. It should be realistic for the type of investment property that you own and the real estate market where it is located.
A few things to keep in mind in this regard are:
- Traditional renting usually earns less per month than renting out on Airbnb, but vacation rental homes experience a higher vacancy rate (more on that below). So, long term rental properties provide a more stable source of income, albeit at a lower rate.
- The location, type, and size of the rental property impact the rental rate a lot. It is not enough to know that a friend on the other side of town makes $2,000 a month. You need to do a rental market analysis and compare your rental property to similar properties in the neighborhood to optimize your rental income.
- Owning a rental property can bring you substantial income, but you should not compare it to working full-time. So, do not just set a rental amount to substitute your job. Your rental income might be lower – or higher – than your monthly salary.
The occupancy rate metric in rental property analysis shows the proportion of time for which your property is rented out – or occupied – compared to the time for which it is available for renting.
In long term rental property investing, it is the share of months in a year when you have tenants. In short term rental property investing, on the other hand, the Airbnb occupancy rate refers to the share of nights booked versus all available nights on your booking calendar.
The rental occupancy rate is never 100%, and this is why it is an important element of how to calculate rental rate. Even if you set up the most optimal rental rate for your property, you won’t be able to maximize your revenue and return on investment with low occupancy.
There are two most effective ways how to push up the occupancy of your rental. The first is to choose the best rental price to attract more tenants or guests than competitors in the local housing market. If you’re not able to keep your property occupied for most of the time with your current monthly/daily rate, it’s worth considering lowering it a bit to increase occupancy.
The second is to up your real estate marketing game. You can list your property on multiple rental websites or build your own website to promote your listing. Also, you can share your listing on social media and use your own network of friends and acquaintances.
The vacancy rate of your rental property is the opposite of the occupancy rate. It is the vacant nights/months as a share of all nights/months available, depending on whether you run a vacation rental or traditional rental business.
The vacancy rate shows the share of time for which you are not earning a rental income, so you want to keep it to a minimum. The longer your property stays unoccupied, the less money you will make from it. Seeing your rental vacant for too long is the fastest way to end up with a negative cash flow real estate investment. So, you should focus your efforts on preventing such an unfavorable situation.
The average vacancy rate stands at about 5%-6% for long term rental properties, while it is around 45-50% for Airbnb investments. However, they are just nationwide averages, while individual rates vary widely from one property to another. Vacancy is determined by the same factor as occupancy: mostly, the rental rate and the marketing strategy.
The best way to minimize the time when your property remains unoccupied is to perform neighborhood analysis to see what rental rates your competitors are using. If you charge significantly more than that for a similar property, you can expect to find it hard to attract tenants.
We will talk about the importance of rental comparables and real estate market analysis in a bit.
When you consider how to calculate the rental rate, you should not ignore the cash flow metric. It is a very basic—yet crucially important—measure in real estate investing. The cash flow shows the difference between the money coming into your pocket and going out of your pocket, associated with your rental property business.
In other words, it’s the difference between your gross rental income (the rental amount you charge) and the rental cost (all rental property expenses) discussed above.
The cash flow is so significant for a number of reasons. First and foremost, it shows directly whether you are making money or losing money from your income property.
If your property is generating negative cash flow, it means that it’s making you lose money. It means that the rental rate is not enough to cover all expenses, and you are at a minus at the end of the month. Alternatively, if it’s bringing you positive cash flow, it’s making money for you.
Some beginner investors make the major mistake of buying a negative cash flow rental property with the hopes of being able to turn it around. However, when analyzing long term and short term rentals for sale, you should always go for a positive cash flow one.
Another reason why cash flow is key is that it’s present in all metrics for return on investment in real estate in one form or another. We will get to this soon.
The cap rate is one way to measure the expected annual return on investment. It is calculated as the ratio between the net operating income (annual rental income minus expenses) and the current market value of the property. It shows the rate of return on a rental property you can expect each year.
The capitalization rate is a beneficial metric in real estate investing because it is easy to calculate. So, it constitutes a straightforward way to see if your rental rate will be sufficient to generate a good return on your income property.
However, the cap rate formula comes with one major drawback: It does not factor in the method of financing. Whether you buy a property in cash or take a loan does not affect it; in reality, this decision impacts your investment outcomes.
Cash on Cash Return
Another popular metric on how to calculate return in real estate is the cash on cash return. The formula constitutes the ratio between the annual before-tax cash flow divided by the total cash invested.
While the CoC return is more complicated to calculate than the cap rate, it is also a more comprehensive measure as it takes into account the financing method. Thus, it gives a more realistic picture of how the rental income affects the rate of return.
How to Calculate Rental Rate
There are a few different ways how to calculate the rental rate that you should charge for your investment property. Each of these methods might yield slightly different results as it relies on varying factors and assumptions.
1% Rule in Real Estate
The 1% rule is an easy-to-follow rule of thumb in the real estate investing industry. It states that the gross rental income which a property generates should be equivalent to 1% of the sales price in order to buy a positive cash flow rental property for sale. The rule can be applied to both long term and short term rental properties.
While the 1% rule in real estate is a good estimate of what rental rate you should set up, it does not give enough details. It is not clear exactly what profit you will be able to generate. Moreover, it doesn’t specify if this rate is competitive in the local rental market or not.
For traditional rental properties, many investors tend to use the Rent Zestimate. This is an estimate, provided by Zillow, of the rate that landlords should be able to charge for a certain property based on prevailing rates in the area.
While it seems like a shortcut that beginner real estate investors can take, online Zillow reviews suggest that Zestimates are not usually accurate and realistic. Thus, savvy landlords must look for a more reliable way to calculate the potential revenue from their income property.
The most favored strategy on how to estimate the rental rate of a specific property is through the use of rental comps. Rental comps refer to comparable rental listings in the area, i.e., rentals that are of the same type and size and with similar features and amenities. Importantly, they must be located within a couple of miles of the property you’re analyzing.
To use this method, an investor needs to locate a few rental comps, investigate the exact degree of similarity between them and their property, and check what rents they charge. The rents of the comparables form a range within which the rental rate of the analyzed property should lie.
The most significant benefit of using rental comps is the accuracy and competitiveness of your estimate. You’ll be able to set up a rate that is reasonable for the local area, which means that vacancy will be minimized, occupancy will be maximized, and profit will be optimized. The strategy works for both traditional and Airbnb properties.
However, such an approach means that you need to conduct detailed rental market analysis, which can take a lot of time for someone with little experience in the field. Unless you have proven real estate and rental data sources, it will be difficult—if not impossible—to yield good results.
You can also apply reverse engineering to arrive at the optimal rental rate for your property. Let’s look at an example.
Let’s assume the following numbers for a long term rental:
- Desired net rental income = $500
- Property tax = $100
- Insurance = $75
- Maintenance = $50
- Average vacancy rate for rental comps in your area = 5%
- Financing costs = $500
Total recurring expenses = $100 + $75 + $50 + $500 = $725 per month
You need $725 a month to cover the operating costs of your investment property. But that’s not all. You need to add the desired profit on the rental property.
Let’s assume you expect to make $500 per month, so you need to charge at least $1,225.
But the estimated vacancy rate means that 5% of the time, you would not be earning rental income. So, you need to add 5% to the rental rate to cover vacancies.
$1,225 x1.05 = $1,286
It means that you should charge at least $1,286 per month for your traditional rental property. However, this simple reverse engineering approach does not tell you whether it is a realistic rate in the local market. If $1,286 is significantly above the average rental rate in your market, you will see a higher vacancy.
So, what’s the best way how to calculate the optimal rental rate for a property?
Mashvisor Rental Rate Calculator
In 2023, real estate investors who stay away from traditional methods of analysis and use the power of AI, big data, and machine learning instead will enjoy higher chances of succeeding. The rental market and industry are too dynamic and competitive to waste time and energy on manual data collection and calculations.
Thus, the best way to find out the rental rate that you should charge for a property is with the use of the Mashvisor rental property calculator.
There are two main ways in which you can benefit from our real estate investing app in this regard:
Finding the Optimal Rent
You can use the investment property calculator available on the Mashvisor platform to instantly check what monthly rental income you can expect from a property. In addition to analyzing the properties available on our marketplace, you can also investigate off market properties by entering the property address.
Our comprehensive rental property analysis shows you the rental rate you can expect based on the historical and current performance of rental comps in the area. It means that they are highly accurate and reliable, which is the most important characteristic of good traditional and Airbnb analytics.
Moreover, you get immediate access to other key metrics, such as startup costs, recurring expenses, mortgage loan information, occupancy rates, cash flow, and return on investment.
One of the best features of the Mashvisor app is that all numbers are customizable. It means you can adjust them to your specific situation.
If you strongly believe you can charge more for your property because you plan major renovations and upgrades, you can raise the rental income. All numbers will be automatically recomputed to show you how the new rent will affect your cap rate and cash on cash return.
Locating Properties for Sale With Your Expected Rental Income
Sometimes, beginner real estate investors are clueless where to start to find profitable opportunities. If that’s the case with you, you can still use the Mashvisor platform to search for traditional and vacation rentals for sale with your expected rental rate.
All you need to do is to choose your location, financing method, property type, and expected traditional or Airbnb income. Afterward, the Mashvisor investment property search engine will provide you with a complete list of MLS listings, as well as off market properties matching your exact requirements.
For each of the properties, you can access the same level of detailed investment potential analysis as described above. With just a few clicks of a button, you can find listings for sale that are guaranteed to bring you a good rental rate and an excellent rate of return.
Final Words on Rental Rate
The rental rate that you charge for your income property is the most important factor for the success of your investment undertaking for all the reasons explained above. Now, you know not only what the concept means but also how to calculate the rate you should ask for as a landlord or Airbnb host.
The good news for inventors is that you don’t need to gather data manually and use Excel spreadsheets that are prone to human error.
You can use the Mashvisor rental property calculator to search for money-making investment properties for sale and calculate the expected rental income of various listings. It will help you save time and effort while also making better-informed and more confident investing decisions.
To find traditional and Airbnb rental properties with the best rental rates across the US market, sign up for a 7-day free trial of Mashvisor now.