How to Optimize Your Rent Prices
November 1, 2010
What should your rents be? Might they be higher? What can you do to optimize them? What in the heck is “optimizing?” Part of your planning process for the coming year needs to be establishing rental rates that accomplish the goals you want for your net income. In order to get the rents where you want them, you need to do a rent survey: see another article on this site for techniques for doing that. Once you know what the area rents are, you can begin to think in terms of optimum rents. Establishing optimum rents involves several considerations.
Optimizing rents means you set your rents where they make you the most money. When optimizing, you create a balance between occupancy and rent amounts. It can be a tricky proposition and of course, as with anything in the rental business, is not an exact science. Some companies sell software that will help you optimize your rents. I think they will make money.
We will look at four considerations for how to get your rents right where they will make you the most money with the fewest headaches.
First, are you looking for 100% occupancy? If you accomplish full occupancy for an entire year, might you be actually cutting into your profits? For example, if you owned 50 units and were charging an average of $500 a month rent for each unit and at that rent maintained 100% occupancy, that would give you an Effective Gross Income (EGI) (Gross rents less $0 vacancy allowance) of $25,000 a month or $300,000 a year.
To optimize rents, the idea is to increase your EGI over $300,000. Suppose you did a rent survey and discovered that the average rent for your units should be $575? Raising rents to the average would increase the Scheduled Gross Income (SGI) to $345,000, but would result in some vacancies. What if because of higher rents the vacancy rate went up to 8 percent, conversely occupancy went down to 92 percent? Subtracting 8 percent would put your EGI at $317,400. That means having vacancies makes you money.
Run another calculation. What if the average rents were only $525? Suppose raising your rents to that resulted in a vacancy rate of 5 percent? Your Schedules Gross Income (SGI) would be $26,250 a month or $315,000 a year. Subtract five percent from that and you get an EGI of $299,250, lower than what you have now. In that case, you’re better off leaving the rents where they are.
Oh, if it were only that simple. Of course, you can’t do it on the basis of an average of all your properties. On some the rents may be just fine, on others it may be too low or too high. What you need to discover is the market rents for each property. Once you have that, you can calculate where your rents are and the possible likelihood of vacancies.
And, of course you have no idea what your vacancy rate will be until you actually do raise rents. We’ll look at how to calculate from another direction later. But that leads us to another consideration.
Different rents for different units
Second, are you getting all the rent you can from all the units in each of your properties? Rents can often vary within a complex even with similar units. Take your properties one by one. What units can you raise the rent on in the same complex? Some are more desirable than others. Some might have a view, be close to the pool, open onto the first tee of a golf course, or have extra amenities in them. Those can draw more rent than those with a view of the unit next door, that are several blocks from the swimming pool and not even in the same zip code as the golf course. Too often we fail to take advantage of the higher values of certain units thus giving tenants a free ride.
More rent is possible
Third, are you optimizing your properties to optimize rent? What can you do to make each of your properties a more desirable place to live? A little tidying up, fresh paint here and there, and neat landscaping are all inexpensive things that create more rental value. Are you working with the police, the apartment or rental owners association, and other landlords to combat criminal activity in the area around your rental properties? Cutting down on area crime will also increase rental amounts. Think of what you can do to make your property more desirable and thus able to fetch higher rents.
Fourth, take a look from another direction. Look at how much your operating expenses and debt service are going to be in the next year, then see how much your rent income will be at current and different levels. With that figure you can calculate your profit.
That requires some budgeting, the bane of most property managers and landlords. We all hate it; hmmm, maybe a root canals instead. Why can’t we just manage our properties and let the money fall where it may? We’ll just raise the rent and hope for the best. You can always lower it later, can’t you?
Calculate the operating expenses and the debt service. Now figure out how much your EGI would be at each of several rent levels. Let’s use a four-plex that rents for $500 a unit with operating expenses of $5,500 and debt service of $18,000. The Scheduled Gross Income is $24,000 and the total of operating expenses and debt service is $23,500. That means at current rents you net $500 for the year if you have no vacancies. If two months of vacancies occur, you lose $1,000 in operating income, or about four percent, thus $500 for the year. A prudent landlord would do something to create a buffer so as to guarantee not losing money. Suppose the rent survey says that the units should rent for $525? That would result in a SGI of $25,200. If vacancies remained the same, the fourplex makes money.
The whole idea behind planning rent increases is that you can plan for covering your costs. At the same time, by using a rent survey, you can determine average rents and from those optimum rents for the property. Always ask “what will the market bear and still make me money?”
How much are you going to make next year on your rental properties? If you know, or can come close, you are most likely miles ahead of the landlords down the street and across town. You see, most landlords don’t plan much, especially for rents. They look at how much rent is coming in now and hope it lasts. They raise the rent using the I-think-it’s-abouttime method. When they figure how much they made during the year, it’s a surprise.
There are no good surprises in real estate.