Monday, October 30, 2006

Determining Rent Determines Your Wealth

One of the most important aspects of the investment game is creating a positive cash flow from your rental properties. The basic principles apply: buy low/sell high; cover your monthly expenses with your monthly rental payments; go to the bank a happier, richer person.

Setting up just how much you want to walk away with each month, however, isn't as simple as adding up all your expenses, tacking on an additional 25 percent and sitting back waiting for the tenants to move in.

There are two basic systems for determining the rent to charge.

The first is "return on investment," directed by how much money you want to make on your investment plus the amount of annual expenses for the investment.

For example: if you put $20,000 down on a property and you want to receive a 10 percent return on that down payment (total of $2,000 per year); First add up all your expenses (say, $12,000 per year for mortgage and $2,000 for maintenance and upkeep). Then add in the desired annual return, thus you would need to bring in $14,000 per year in rental income to meet your goal -- ergo, the rent charged would be $1,200 per month.

Unfortunately, for most investors, the above formula is not how they determine the monthly rental. Instead, you may be at the mercy or blessing of the market analysis method.

This method is not unlike conducting a comparative market analysis (CMA) for a property for sale. Find out what the price of the latest sales for properties like yours in your neighborhood or city and list the house at, below or a little above that average (depending on the state of the market).

In rentals, you do the same. What are the rentals going for in your area for your type of property? What's the condition of your investment property compared to those that just rented. Make an adjustment for condition and location, set the rent level and get the house listed.

The blessing of this method is that if you're in a market with job growth and there's a shortage of affordable housing to purchase, you could possibly charge hundreds of dollars more per month than the same period a year ago, if the market demands it.

In Montgomery County, Maryland, a suburb of Washington, D.C., that type scenario exists currently. According to the local MLS, last year at this time the average single-family home rented for about $2,500 per month. This year, the rent average has shot up to more than $2,800 per month -- that's $3,600 more per year. That type of cash flow growth makes any investor very happy.

There are various mistakes to avoid in the setting of your rental level. The first is getting greedy and trying to grab too much rent than the market will allow. Fortunately, most times, the market will tell you pretty quickly if you're listed too high. It just won't rent.

In your research, determine what's the average days on market for a rental. If it's 45 and you've been on the market for 60, then you may have a pricing issue. But also check on the condition or amenities offered in your property. You may have a really nice condo, but the ones across the street have a pool and playground and yours is priced the same as those units; obviously, the consumer is going to choose more for their money.

Leaving the unit vacant too long could eat up all your profit for the year. If your expenses are $2,000 per month, for instance, and you let the unit sit vacant with a price of $2,400 for a month, you're behind now by $2,000. If it rents the next month for $2,200 -- you've not only cut back your cash flow, you've decreased the balance sheet. Now you're income is short $2,200 for the next year (the amount of rental income you could have gotten if it had been priced right to begin with). Put it into a second month without adjusting and you could quickly go into the hole in your investment business.

As you move forward year after year, keep up with the rents in the area long before the term of your tenant's lease comes to an end. Knowing what you're unit will rent for ahead of time, keeps you on track with keeping good tenants in your unit on a consistent level to maximize your rental cash flow.

Published: September 8, 2006

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