How Much Rent Do You Need to Charge to Make a “Good” Investment?
Rental real estate can be one of the most rewarding and potentially lucrative income sources out there. But how much rent do you need to charge to make a specific property a good investment? The simple answer: You don't get to decide.
Supply and Demand Determine Rent Amount
The market — specifically, the forces of supply and demand — determines the rent your property will deliver. It's like any other service or commodity for sale in a free-market economy. There's a price people are willing and able to pay, and that's the rent you'll be able to charge.
Determining the rent you can charge begins with looking at your market competition. Similar properties will command similar rent prices. Compare the features and amenities of your property with the competition, and you'll be able to estimate what rent you can reasonably expect.
So how much rent makes a property a good investment? As with other types of investing, we become landlords with the expectation of making money. (I've never heard anyone say they rent properties because they just love dealing with tenants!) Perhaps you want to supplement your monthly income. Or your job transfers you and the thought of keeping your property, renting it monthly and having someone else pay down your mortgage appeals to you.
Positive Cash Flow Is Important With Rentals
Whatever your strategy, you're going to want to crunch your numbers before you jump in. It's as simple as pinpointing what rental income you can reasonably expect and figuring out what your costs will be to generate that income.
When your rental income exceeds your expenses, your property is “cash flow positive.” Here's an example: If your monthly rent is $1,800 and your costs total $1,500, your property is $300 cash flow positive.
When figuring out your rental property costs, you'll want to include:
- Property taxes
- HOA or condo fees
- Utilities not paid by the tenant, maintenance
- Vacancy (typically two times the amount of the monthly rent, assuming it might take you two months to replace a tenant who departs)
- Licensing and inspection fees
There may be other line item costs depending on where the property is located. In Baltimore, many properties are assessed ground rent each year, for example. The important thing is to make sure you include in your calculations all the costs you will incur.
In addition to these hard costs, you need a financial cushion. I call this line item my “It's Gonna Break” fund. The water heater might be only five years old, but it could still go out and you'd need to replace it quickly so your tenants have hot water. So out of each month's rent, you squirrel away savings that will be used when a major item needs repairing or replacing.
An Example of a Good Rental Cash Flow
Here's how the numbers work for one of my rentals in Owings Mills, Maryland. This property is a condominium, so I don't need to budget for a new roof or outside maintenance, such as landscaping and snow removal. The condo fee also covers water/sewer, and the tenant pays the only utility bill, which is electricity.
|Total Rental Income||$17,100||$1,425|
|Renter license renewal||$60||$5|
|“It's Gonna Break” fund||$500||$42|
As you can see, the property is $331 cash flow positive each month. If the tenant renews the lease (and they usually do), there's no vacancy cost and that $1,425 flows to the bottom line. If nothing breaks, that's another expense that was budgeted but not incurred, which also flows to the bottom line.
How Much Rent Is Enough?
So how much rental income makes a property a good investment? For starters, a “good” rental property is cash flow positive.
I aim for between $300 and $500 per month per property in positive cash flow. The Owings Mills property in this example is not my best cash-flowing rental asset. It was the first property I bought, and I've learned a lot since then. I moved away from buying condos after this one. Still, this property has a decent profit margin and I have a great tenant, so I'm not looking to sell.
If you rent to a Section 8 tenant, you can typically charge a higher rent. For example, I previously rented a property to a Section 8 tenant for a rent of $1,500. That's $75 more per month than the current $1,425. The government wants landlords to make properties available for Section 8 tenants, so it will pay a bit more like a subsidy for the hassle of a little more administrative work and jumping through a few hoops, such as an annual inspection whether there's tenant turnover or not. As long as you screen your tenants thoroughly, you might consider accepting Section 8 vouchers.
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One of the main reasons to own rental properties is to increase your monthly cash flow through rental income. The other main reason is the anticipated market value appreciation. Also, real estate investing has a unique tax advantage that investors love.
As with all investments, real estate investing has risks you need to consider before you jump in.