An Investor’s Guide to Determining Fair Market Value for Rental Properties
No matter how long you have been a landlord, a sure way to fail is to disregard or be unaware of your property’s Fair Market Rental Value.
If you get it wrong, you risk vacancies or leaving money on the table. Nevertheless, you can maintain a profitable occupancy rate and fill your units with high-quality tenants if you get it right.
What is Fair Market Rental Value?
Fair Market Rental Value, often referred to as Fair Market Rent (FMR), depicts the amount you can expect a renter to pay per month within your specific area.
Rent prices constantly fluctuate because of supply and demand and the current market, but it is not uncommon to see prices rise or fall as much as 10% to 20% within the same year.
Typically, FMR gets determined by the U.S. Department of Housing and Urban Development (HUD). They release a formal guide annually for setting FMRs in late April or early May to propose what each area should expect to charge tenants monthly for the upcoming fiscal year, which runs from October 1st through September 30th.
HUD uses four data sources to release this formal guide: a specific section of the 1990 census that covers every urban and rural area in the nation, its annual American Housing Survey, a telephone survey of 50 to 60 metropolitan areas known as Random Digital Dialing (RDD), and a public comment process which gathers information provided by local housing authorities.
Every year, HUD will gather data on two-bedroom units using these four data sources and then use their findings as a baseline to determine the FMRs for one-bedroom units, three-bedroom units, and so on.
How to determine Fair Market Rental Value
While there are some online resources you can use to estimate your area's FMR, most landlords prefer to compare their properties to comparable properties, known as comps.
To make an accurate comparison, look at recently rented units in your neighborhood similar to yours.
In most cases, it is best to strive for three reliable comps and find the average of the three to calculate what a fair monthly rent would be for your property.
When searching for comps, it is advisable to consider if your unit offers the same features as those you compare it to since these features can affect the FMR of your property.
Some factors that affect the desirability and value of a unit include:
The ideal comp would perfectly match in size, location, and features, but since it is unlikely to find an identical match, try to find a few as close as possible.
When is it most important to consider FMR value?
Although you should always have an idea of what the Fair Market Rental value is in your area, there are four circumstances in which you must be aware of it:
When you know how to pinpoint a market’s rental value, you have the great advantage of forecasting the return you would earn from a potential investment.
Going into the buying process with a firm understanding of the area’s FMR allows you to adequately calculate its potential cash flow and your expected cash-on-cash return, which is the money you earn on the cash you invest into the property.
After purchasing a property, it can be easy to go overboard on renovations, but doing so is not always profitable.
To ensure that you are not investing more than the property can return, you should understand the FMR of your area before starting any renovations.
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Consider comps that resemble the property as-is and those with the renovations you intend to make. If there is a significant uptick in the monthly rent you can charge a tenant after completing the renovation, it might make sense to move forward.
It is vital to be aware of your Fair Market Rental Value when listing your unit for rent since marking it too low or too high could mean a loss of money.
Be mindful of prospective tenants who try to negotiate the rent to a lower price. It is not always an awful idea to negotiate with them, but ensure you are not bringing the price too low to the point it is no longer profitable.
For landlords who participate in?HUD’s Section 8 ?program, you may be subject to annual inspections and mandatory property updates, potentially reducing your profits
Also, it can be difficult to anticipate the rent you will collect monthly. You can sometimes charge more than market value, but you may also collect less rent than cash tenants.
A landlord typically raises the monthly rent to keep up with market rents every year, even if it is only by twenty or thirty dollars.
By increasing the rent every year, you help set the tenant’s expectations, protect yourself from leaving money on the table, and keep yourself from having to increase the rent in one lump sum in the future.
There are many aspects of managing a rental property that one can learn along the way, but without the fundamental skill of determining Fair Market Rental Value, your time as a landlord could be short-lived.
However, when you master it, you will never have a vacant unit and be well on your way to running a successful rental property business.
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