Prorated rent is a matter that every landlord comes across at least a few times in their investment career. So, what is prorated rent?
Owning a rental property requires that you understand the importance of your rental income. It is what determines the state of your cash flow (positive or negative). However, it is not always that you manage to rent your property the moment you purchase it or right after a tenant moves out. When a tenant moves in some time between rental terms, you will probably have to deal with prorated rent. Here is everything you need to know about it as a real estate investor.
Related: How Much Should I Charge for Rent?
What Is Prorated Rent?
Prorated rent occurs when a tenant moves into the property some time in between rental terms. For example, the tenant moves in on the 15th of the month when the rent is due on the 1st of each month. So, how does prorated rent work? Simply, the landlord has to calculate the rent for the 15 days the tenant stayed at the rental property as he/she will not owe you a full month’s rent. We will demonstrate the calculation later on, but before we do that, let’s view the pros and cons of this concept for first-time landlords.
The Pros and Cons of Prorated Rent for Landlords
The advantages of prorated rent for landlords are obvious. For one, it is a good way to keep your investment property occupied by tenants instead of having it vacant for even one day. In other words, let’s say the previous tenant moves out before the lease agreement is over. This will leave the rental property vacant for the remaining period. So, instead of having it empty, a landlord might have a tenant who is ready to move in before the end of that term. It is clearly more beneficial for the landlord to let the tenant move in between rental terms and simply prorate the rent. In this way, it’ll guarantee some cash flow. In essence, it is a creative way to make money in real estate when things don’t go the way you planned.
Related: 7 Tips to Avoid a High Rental Vacancy Rate
Now, one downside of prorated rent is the fact that the landlord loses a portion of the rental income for that specific rental term. Of course, this does affect his/her monthly cash flow from the rental property. However, if the landlord has to prorate rent to avoid complete vacancy, it is worthwhile to do so.
How to Calculate Prorated Rent
As a landlord, it is an absolute must that you learn how to prorate rent in case you encounter this situation. In this section, we’ll explain how to prorate rent, and then we’ll provide an example to demonstrate how it works exactly.
To calculate prorated rent, follow these steps:
- Determine your monthly rental rate. This is the amount of rent a tenant is expected to pay you at the beginning of each rental term.
- Divide that number by the number of days in one rental term (monthly, quarterly, annual terms). Make sure you take into account that the number of days is different from one month to another (whether it’s 30 or 31 days) when you are calculating daily rental rates.
- The result is the daily rental rate for your rental property investment.
- Multiply that number by the number of days the tenant actually occupied the rental property before the beginning of the new rental term.
Note: Do not forget that most landlords charge the first month’s rent in advance. Therefore, you might choose to do that first and then prorate the rent at the beginning of the new rental term. Also, it is best if you address the prorated rent in the lease agreement so that you have established all financial matters properly between you and your tenants.
John owns a rental property that is vacant and that he rents out for $1500 a month. He signs a lease agreement with a new tenant who says that he/she will move into the property on the 21st of the month. Let’s say the lease agreement starts in August which is 31 days. This means that the tenant will be occupying the rental property for 11 days of that specific monthly rental term. So, how does John prorate rent in this case?
This landlord would start by calculating the daily rental rate for his investment property:
Daily Rental Rate: $1500 / 31= $48.38 per day
Next, multiply 11 by the daily rate calculated above. In this case, it is:
Prorated Rent: 11*48.38 = $532.18
As simple as the calculation looks, it can have a major impact on your rental property cash flow. Although it is a good way to make money in real estate while preventing high occupancy rates, you must be careful with how you calculate prorated rent. Ensure you have done it accurately.
Related: What’s the Best Cash Flow Calculator for Rental Property?
Prorated Rent Laws
Well, it is crucial that whatever you do, you make sure it is according to the local laws and that you are not in any legal violation. Check your state’s laws regarding prorated rent and ensure that you calculate it accordingly. However, this doesn’t mean that the laws are strict regarding this matter. Most states’ laws do not require a landlord to prorate rent. But, many landlords choose to do so. All in all, you must check with your state’s laws before you proceed with prorating rent.
Proper real estate education is essential when you want to make money in the industry. Prorated rent is one matter you must be prepared for. Although it is not associated with high risks, it can still impact your rental business in various ways.
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