Fair Market Rent – What is it and what should be considered fair?
I recently started investing in real-estate last year. I was able to refinance the property that I was in and then turn around and buy the wifes dream house. Well, the dream she was having at that time anyway. We moved out and I went to work on the old one. After 6 weeks of spit, polish, and adding a third bedroom I started advertising.
The number of phone calls was amazing to say the least. The area that the rental is in is generally a blue collar neighborhood in the suburbs of Kansas City, Missouri. The problem that I wrestled with was what was a fair and attainable rent. I had a mentor I could question but the problem with that was hes a little eccentric and although he has been in the business for several years hes just one of those birds that sings a different tune.
I have seen several different methods for figuring rent on property. First Ive heard was the rent should be 1% of the homes appraised value. The second was the rent should be at least 130% of the mortgage payment. One I have found here on the boards is 10% of the sale price a year in profit. That last one seems a little stiff to me.
I started out with HUDs Rent Reasonableness Survey and gave points for condition, amenities, location and such. After it was all said and done on the survey the rent should be about $925 depending on the subjective questions like quality and condition. I thought that was a little high. A property just up the street though was being advertised for $800, was basically the same floor plan but didnt come with a basement and had no stove. To insure I was able to get it rented, I under cut them by making my rent $825.
The property is a three bedroom, finished basement, nice fenced back yard, deck, all kitchen appliances, central air with an outbuilding. The property appraises for 75,000 to which my lean on it is 45,000. Total mortgage payment being $365 gives me a pretty good income of $460 off of it.
Now I am in year two. I am looking at another property but for all purposes this is actually my first attempt. Although I am renting one, I lived in it prior and was really familiar with the area and problems with the property. My next purchase will not come with such familiarity. What Im finding is another wrestling argument for what a property should produce.
So, what say you all. Is there a good formula for estimating the rent on a property without randomly picking a number between 700-900 dollars? Just because the poor schmoo across the street is renting his for $450 does that mean Im going to have a hard time with $750?
It all comes down to me having the pre-approval letter in my hand, a few properties that I have an eye on, and the anxiety that Im not going to be able to get it rented. If I had a stronger feeling for what kind of rent I should get I think that would help some of the anxiety.
Thoughts?
Zippatuh
[ Edited by Zippatuh on Date 02/06/2003 ][ Edited by Zippatuh on Date 02/06/2003 ]
When I analyze a property I use the 1% of FMV figure. This gives me a good idea of whether the property will break even or cash flow. Then I contact my property management folks and get their assesment. If the numbers don't work, I look for the next property.
For example, I got a lead on a house for $149,000. I did a rough analysis to get an idea of what numbers I would need for rent, etc. Then I contacted the PM and she told me the current rental rate in this area is 1050-1250. Now, unless you put a lot down on the property, this is a no brainer - move on!
Ho...
Zippatuh,
You really seem to have two questions. The first question is what is fair market rent? Fair market rent is whatever an unpressured, informed renter is ready and willing to pay. While various factors influence market rent, competitive rents for comparable properties will be the determinant. To determine market rent for a property you are considering, look in the classifieds for other rental properties in the neighborhood. Call a couple of property management companies and ask what rent you might expect if you were to put that property under their management. This will give you an idea of what the market will bear. Whatever the market will bear is "fair".
Your other question seems to be: "How much cash flow is good enough"?
I use the 125% rule. Multiply your debt service (principle and interest) by 125%. This is the amount of money I want to see left over from the rent income after all the day-to-day operating expenses are paid.
Operating expenses include property taxes, insurance, vacancy loss, association fees, management fees, leasing fees, advertising, legal fees, repair, maintenance and upkeep, utilities if provided by the landlord, and a replacement reserve fund. Subtracting these operating expenses from the expected rent tells me what operating income I have to work with.
If the operating income is at least 125% of the amount I need to make my loan payment (without escrows), then the cash flow is good enough for me. Less than 125% and I usually look for another deal. More than 125% is just gravy.[ Edited by DaveT on Date 02/06/2003 ]
Those were great questions and answers. Gave me a better feel for what the general community uses for rent calculations from the real world...
Just had to comment...
you can also use gross rent multipliers which takes market value of homes and their rent amt. and gives you one number. i.e.-$120,000 (mkt. value of rental home) divided by $l000 (rent) =GRM of 120. I like the quick rule of thumb advice but when you get down to a more detailed research you see what the market will bear in the area through comps.
Zippatuh
Truly in your area rents really go by what the market will allow.
You will truly find your best rent market at the following sites for your area
http://www.nlihc.org/oor98/mo.html
http://stlouis.missouri.org/citygov/nst/2002llcrpt.htm
http://www.universallivingwage.org/states_fmr_tables/MO_FMR2002.htm
I simply use the Sunday paper; I prefer the KC Star http://www.kansascity.com/mld/kansascity/
[addsig]
Thanks everyone for your comments.
JohnMichael, outstanding web links.
Zippatuh
[ Edited by Zippatuh on Date 02/07/2003 ]
Quote:you can also use gross rent multipliers which takes market value of homes and their rent amt. and gives you one number. i.e.-$120,000 (mkt. value of rental home) divided by $l000 (rent) =GRM of 120. land01,
In your example, the GRM = 10, when you divide the annual gross rent ($12000) into the purchase price ($120K).
Generally speaking, this rule of thumb is more effective in considering the value of a property with current tenants with set rents. As a general rule of thumb, a GRM of 6 or less will generate a positive cash flow, while a GRM of 7 or more will be a negative cash flow property. A GRM between 6 and 7 means that you need to do a more detailed cash flow analysis to determine profitability
Supply and Demand....
As a fellow number puncher I want to KNOW how much the rents will be, but ultimatly it will be the supply and demand of the properties and the tenants that establish the price. This will fluxuate. Put yourself (as much as you can) in the mindset of a tenant and go and look at what's being rented and how much they're asking for it. The times in my life when I've been looking for an apartment to live in for myself (...and I hope I never have to do that again) I've gotten a very good feel for the market after looking at apartments for one day. You'll find what type of place demands what types of rents in that area.
I'm always amazed at the amount of information that a tenant volunteers when you knock on their door, tell them you're looking for an apartment in the neighborhood, and ask them some questions. THEY know the area well. Good Luck