Rental Pricing or Pricing Rentals?

“We have the best view in the city!”

“But you have to see our backyard.”

“It’s got a wine fridge and there are outdoor areas with the front and back balcony.”

“It’s walkable to so many great Asian Restaurants.”?

I have the opportunity to talk to 50+ people each week about their rental properties in the Chicago MSA. As you might imagine, there are quite a variety of property types and personality types I run into. As you also might imagine, it gives me great [albeit largely anecdotal] insight to the way mom and pop investors talk and think about their rental properties.?

Today I want to talk about the hottest of all topics when it comes to your rental property–HOW MUCH RENT CAN I CHARGE! Or in some cases–AM I GOING TO BE ABLE TO COVER THE MORTGAGE!?

I’ll be honest with you, I completely made up the quotes at the top when I started writing this. However, my imagination is built on the overall sentiment that I hear from MOST landlords when we have this conversation. It’s NATURAL to want to sell people on your property. I expect you to be confident in your investment! If not, maybe it doesn’t make sense to rent it in the first place (P.S. if you need a brokerage I know a great one!).?

What I really want to talk about is not rent prices, but rather an overall philosophy on pricing rentals. There are a million perspectives on this, but Alex Hormozi says to group things into threes.

SO, I’ll give you three primary reasons why I think you’ll make more money aiming for the middle of the market–maybe even BELOW market. And, I’ll list them here first so you can read them and then go back to scrolling the other socials if this letter is too dry and poorly written for you.?

1. Lower rent = Less vacancy?
2. Lower rent = Decreased turnover
3. Lower rent = Higher quality tenants

Part 1: Lower Rent = Less Vacancy?

Most people care about dollars. If you are not currently including lost rent due to vacancy when underwriting a deal, start now!?

Pricing below market

Perception:

• Less Money
• Worse Tenants
• My uncle who owns rentals will be pissed at me?

Reality

• More Money
• Better Tenants
• Uncle can take a hike, he should support you?

So how do I make more money charging lower rents??

Vacancy. If you price at or below market the likelihood of a tenant move-in in less than 20 days is dramatically higher. At GC Realty we have placed just shy of 900 tenants in the past two years. Between February and September our average list date to move in date is 19.7 days.?

Now, I’m obviously not biased and I recognize we have the best leasing team in the United States (probably on Earth). However, one of the secret sauces for us is simply listing the units at reasonable rent prices.?

If our clients are convincing enough about their [wine fridge], yes we will be flexible. That flexibility is where we get the data to understand what’s driving up the 19.7 number (hint: it's over DOUBLE the vacancy days when people push above market pricing).?

This is where the math comes into play. I’m going to use round numbers so I don’t have to slide down on my iphone.

Let’s say you have a property that will rent for $3000 per month, $100 per day. If it sits on the market for 20 days, this means you lost $2000 to vacancy (potential rental income). If it sits for 40 days (i.e. double), you lose $4000 to vacancy!?

This is the important part: Those 20 additional days or $2000 additional lost dollars divided by 12 months (the lease term) equals ~$165.?

This means if the market price for your property is $3000 and you get it rented in 20 days, you will make MORE THIS YEAR than the person who listed it at $3165, a rent that’s 6% higher. If you consider this marginal then a) keep reading, and b) then you wouldn’t have groveled with the suggested market rate to begin with!

Part 2: Lower Rent = Decreased Turnover

We have cognitive dissonance when it comes to pricing rentals. If it were ME searching for a rental property; No way I would overpay! If it were us deciding whether or not to renew, of course we’re going to find the best property for our dollar–rent is our biggest expense!?

Let’s look at it through the turnover lens. The expiration of the lease is approaching and you originally priced 6%-10% above market. Your tenant sees the notification that the lease is up soon so it’s top of mind.

Because it’s top of mind, they imagine, even flirt with the idea of what it would be like to live elsewhere. They pop on [Zillow] and say, “Whoa! We could get this place a few blocks away for $200 less per month.” –or– “Look at this place, for the same price we could have in-unit laundry and a parking spot.”?

It’s simple and our tenants are very human. The likelihood of TURNOVER increases if the resident can get more for their dollar elsewhere.?

Okay, who cares? Let’s put it back on the market and get even MORE!!

I will use some ballpark numbers for illustration. Assuming they were a model tenant (ha!),?

• Cost to clean the place up, touch up paint, change locks, etc.: $1500-$5000.?
• Lost rent due to vacancy (If you’re in the same headspace about maxing rent price): $100 x 40 days.?
• If you hire a leasing agent you'll have leasing commissions.?

At this point, you're in the ballpark of $5k-$10k in REAL COSTS to get a new resident placed. And, if we go back to our very special ‘divide it by 12’ equation from earlier; That is $400-$900 per month. So, unless you are now going to charge 25% more for rent, avoiding turnover is your best friend.?

A good rule of thumb is to aim for 3 tenants over 10 years. If you can divide those real turnover costs by 36 months, rather than 12, the numbers start to become much more reasonable.

Part 3: Lower Rent = Higher Quality Tenants

When something of quality is affordable, demand goes through the roof. But, when you feel like you’ve bought something expensive, your expectations go through the roof.?

Applications–There is certainly a lot that goes into finding a high quality tenant. However, like anything else it’s a numbers game!?

Perception:

• Higher than market rent = weed out bad applicants
• Higher than market rent = higher quality product
• Higher than market rent = higher quality tenant?

Reality:

• Higher than market rent = LESS applicants
• Higher than market rent = LESS value for the tenant's dollar
• Higher than market rent = HIGHER expectations

If we step back into the shoes of the tenant and think about looking for a place to live, we can assume that we’d gravitate towards what gives us the best value for our dollar. If there are multiple similar properties but one of them costs more than all the others, we’re probably not going to apply to that one.?

Competition ensues because as Murphy's Law would have it, a bunch of other people are also looking for a place to live!?

All of us apply to the same few properties and put our best foot forward, some of us even offer OVER the listed price because we understand there is competition for this property.?

As a result, the landlords with the reasonably priced rentals receive a bunch of applications and get their pick of the litter. They cherry pick the single most qualified resident.?

On the other hand, the landlord with the higher priced rental has a choice to make; Should I accept this single application even though they aren’t great or should I wait it out??

When you price below or at the middle of the market the likelihood of multiple applications is higher. The more applications you receive, the more opportunities you have to pick a great tenant.?

Expectations–The second half of this is resident expectations.?

Now that you have priced the property reasonably, received a slew of applications, and selected the highest quality applicant from the group. It’s time for them to move in.?

They feel like they are getting a STEAL! They are pleased they get the opportunity to move into a high quality property at a reasonable price. When the topic of rent comes up they say, “Can you believe I’m only paying [x] for this place!”?

In general, they don’t start with the impression that ‘landlord = bad.’ This type of tenant is less likely to call about minor work orders, they are more likely to handle things on their own, and most importantly, they are more likely to respect the property.?

Conclusion

If you made the plunge into the real estate investment world, you have earned the right to price your rental property in whatever way you choose. There are certainly times when I am wrong about this and a great tenant is found at the top of the market that respects the property and stays for years because of the balcony with the view.

Much of the information I shared here is based around large averages, rather than black and white best practices.

All of this begs the question; So how do I know what market rent is!

Hint! --> Check out the free rental analysis calculator here

-or-

Call me!

Thanks for your time.

-Shea