Today let’s tackle the most fundamental question a new landlord might ask. Ideally, it would be one of the first questions to ask: How much rent should I charge?
The math is surprisingly easy. So I’ll tell you the math first, then I’ll tell you the reason.
How much rent should I charge: What the math says
When I see a new real estate listing, I often know in 30 seconds or less if I’m not interested, without even looking at any pictures. It only takes a few seconds to do the math to figure out if I can turn a profit on the property or not.
I just follow the 1% rule. I need to charge one percent of the purchase price in rent. That means if I pay $95,000 for a property, I need to charge $950 a month in rent. It really is just a matter of moving the decimal point.
I’ve seen more complex formulas for figuring out how much to charge, but they all come within a few dollars of 1% of the purchase price, so I no longer bother with those. It’s nice to be able to make a quick decision without needing a spreadsheet and a bunch of numbers.
For a multi-family unit, prorate it. If the units aren’t equal in terms of square footage, prorate it based on square footage. Charge more for the larger unit and less for the smaller one.
Why 1 percent?
The one percent rule makes it difficult to not at least break even. It ensures that when you have the property rented out, you’re making enough to make your mortgage payment and still have some profit. If all goes perfectly, you’ll pay for the property in 8.3 years.
Nothing ever goes perfectly, of course. You make the purchase, then find a problem you didn’t expect. Or maybe there’s just some delay in the repairs to get it ready for market. Of course your tenant doesn’t move in on day one. If the tenant wants to move in immediately, he or she is desperate. I have experience with that, unfortunately. And of course the best tenants move out, because they’re the ones who can get loans to buy a place of their own. So occasionally you have to deal with a vacancy of a month or two.
But here’s the thing. When it takes 8.3 years for the property to pay for itself, 17 things have to go wrong to extend the timeframe out to 10 years.
I won’t say that won’t happen, but 17 things is a lot.
What about charging more than 1 percent?
I bought some property in the 2010-2011 timeframe, near the bottom of the market. Obviously I didn’t do that to lose money. You bet I rent those properties out at the current going rate, which is higher than it was in 2010.
I don’t do it to be mean. I ate Ramen noodles, drove a 10-year-old car, and put off other purchases to afford to do that, so it’s a reward for being willing to make that sacrifice. The improved profit margin is helpful. One of those properties sprung an expensive surprise on us a few years in, so it was good that we had some profit margin to work with.
The thing to remember is that the one percent rule relies to an extent on averages. So it works best if you have multiple properties, so your good-performing properties can carry your underperforming properties. Not every property makes money every year.
In some markets, you’re doing well just to find a property that meets the 1 percent rule. During real estate booms, such properties are rare.