Determining rental rates can be complicated. To get the right rental rate calculation, you need to factor in different things that affect it.
Table of Contents
- Property Value
- Rental Comps
- Demand for Rental Properties
- Rental Property Expenses
- Financing Costs
- Tax Deductions
- Economy
- Access to Public Amenities
- Rental Income Boosting Features
- How to Determine These Factors and Calculate Your Rental Rate
As a rental property investor, you need to take into account the different factors that can affect rental rates in a given market. Each market’s unique features can significantly affect the rental rate calculation of an investment property. They are some of the things you need to discover.
Real estate investing requires more than just sufficient capital and funding. For an investment to become successful, you need to put in the work and do your research since not all real estate markets are created the same way.
In this article, we will go over some of the most common factors that impact rental rate calculation and how you can interpret each factor and make it work to your advantage. We will also show you how you can get accurate rental rate estimates for potential investment properties using Mashvisor as your primary tool.
That being said, let us go over nine factors that affect how you compute the rental rate for a potential investment property in any market of your choice.
Related: How to Find Profitable Rental Investment Properties for Sale
Property Value
One of the very first things that will significantly affect your rental rate calculation is the property’s current market value. When it comes to real estate investing, each market offers something different to investors.
For instance, markets in California and Hawaii are among the most expensive locations for real estate. According to real estate website Mashvisor’s October 30, 2022, data, the median property prices for the two states are $894,774 and $1,035,565, respectively.
When setting the right rental rates, you would want to price it right so you can get a good return on your investment in as little time as possible.
Rental Comps
Another factor that comes heavily into play in rental rate calculation is comparable rental properties or rental comps.
Rental comps are rental properties that bear much resemblance to a subject property in a micro-market.
For instance, the subject property you’re considering is a four-bedroom, three-bathroom house with a two-car garage. You need to look for similar rental properties in the immediate vicinity to see how much they are being rented out.
Generally, rental comps will give you a good idea of what the average rental income is in the neighborhood.
Here are a few things to look out for when checking out rental comps:
Rental Income
One of the things that heavily influence rental rates calculation and determine an investment property’s profitability is the rental income.
Rental property investors need to take into account the rental income rates in a particular location. You need to stay within the acceptable range of rental prices if you want to be competitive in the market of your choice.
Related: How to Find Rental Rates by Zip Code
Cap Rate
Another factor that determines the profitability of an investment property is the capitalization rate.
The cap rate is derived by taking the property’s net operating income, or NOI, and dividing it by the property’s fair market value or purchase price.
Cap Rate = Net Operating Income (NOI) / Fair Market Value or Property Purchase Price
It is one of the most common ways real estate investors use to see if a potential income property is worth investing in or not.
Cash on Cash Return
Another way of determining a property’s profitability is its cash on cash return. Many people interchangeably use cap rate and cash on cash return thinking they are one and the same.
While they do seem alike, they are actually not. The cap rate formula assumes that the property is bought in an all-cash transaction, while the cash on cash (CoC) return factors in financing options.
The formula for cash on cash return is:
Cash on Cash Return = Net Operating Income (NOI) / Total Amount of Cash Invested in the Property
The cash on cash return formula shows that it only takes into account the out-of-pocket money used to buy the property. While the cap rate assumes that the property is bought in cash, cash on cash return considers financing options. The CoC metric gives you a better dollar-for-dollar projection of your return on investment.
Occupancy Rate
The last thing real estate investors like you should look out for with rental comps is the occupancy rate. Whether you plan on starting a long term rental or a short term rental business, you should check other similar rental properties for occupancy rates to give you an idea of what your calendar will look like.
The rental property occupancy rate determines the number of days it is occupied compared to the total number of days it is actively listed as a rental property. As an investor, you would want to look for neighborhoods with higher occupancy rates for both long and short term rental properties. The more days it is occupied, the better your monthly rental income will be.
Demand for Rental Properties
When we talk about rental rate calculation, we also need to take into consideration the demand for rental properties in the market of your choice. Despite the numbers that rental comps give you, the demand for rental properties can significantly change your rental income. It can positively or negatively impact your rental property business.
For instance, a bad economy typically results in greater demand for rental properties as fewer people can afford to buy a home. In the same economy, smaller and cheaper apartments are usually the first to go.
Another example to consider is before the start of a school year. Generally, before school starts, larger and more spacious properties increase in demand as families are more likely to move before the school year.
According to the law of supply and demand, the greater the demand, the higher the price. Inversely, markets with lower demand for rentals mean that you cannot charge above-market prices, especially if you want to boost your occupancy rate.
Related: 20 Best Places to Invest in Real Estate in 2023
Rental Property Expenses
When coming up with an accurate rental rate calculation, you will also need to include rental property expenses in the equation.
Rental property expenses are incurred in operating a rental property business. Such expenses will greatly affect your bottom line so you need to include them in your calculation. Some of the most common expenses are:
- Mortgage payments (where applicable)
- Repairs and maintenance
- Property taxes
- Insurance
- HOA fees
- Vacancy period costs
- Property management fees
In addition, you would also need to ensure that you are making a decent enough profit and not just breaking even with your monthly rental income. Experts agree that a profit of between 1% and 6% each month is already acceptable.
If you calculate everything we’ve discussed so far and are left with a negative cash flow, you need to either look for another investment property or make adjustments to your rates. Ideally, you should be left with a positive cash flow after expenses and taxes.
As a rental property owner, you need to include different expenses in your rental rate calculation and ensure that you make a profit.
Financing Costs
A rental rate calculation should also reflect any financing options taken by an investor. While there are tons of real estate investors for the best deals on investment properties, not all of them are capable of paying in full cash.
In most cases, investors need to take out a loan or some form of financing option to buy a potential rental property. Investors who utilize financing to purchase a property need to repay the loan amount on a regular basis. This applies to conventional mortgage loans, hard money loans, private loans, FHA loans, or VA loans.
The loan payment should be deducted from the gross rental income and is, in most cases, the largest monthly expense in a rental calculation formula.
Tax Deductions
When coming up with a rental rate calculation, you should always factor in property taxes and other taxes associated with operating a rental property business. You can take advantage of tax deductions when dealing with rental property expenses. You can deduct the following when you file for your taxes:
- Property tax
- Mortgage interest
- Depreciation
- Repairs
- Operating expenses
Tax deductions can significantly influence how much money you make on your rental property and can spell the difference between profit and loss.
Economy
Generally, the local economy also plays a substantial role in determining your potential monthly rental income, so you also need to consider it when working on your rental rate calculation.
Typically, locations with thriving economies attract more people. By people, we mean both migrants and tourists. A strong and growing economy attracts workers and laborers looking for places to establish their families and careers. Similarly, an economy with a thriving tourism industry offers great potential for a strong monthly short term rental income.
So, in choosing a location for your rental property, be on the lookout for major businesses or industries setting up or leaving an area as they can drive property prices up or down. They also dictate how strong the job market will be, which also helps attract tenants. In the end, the local economy can either add or take away from both property value and rental income potential.
Access to Public Amenities
Accessibility is one of the things that can boost (or reduce) the income of a long term or short term rental property. If public amenities are easily accessible to the subject property, the potential rental income can go a bit higher compared to properties with limited access to them.
The public amenities include shopping and dining options, public parks, libraries, public transportation, hospitals, and other similar features. It is best to also take them into consideration as you make your rental rate calculation.
Rental Income Boosting Features
Lastly, each property has certain features that set them apart from other comparable properties. If your subject property has a pool, a hot tub, or a big backyard, it can add greater value to your property thus increasing your potential rental rate.
The important thing to remember is you should know which rental price boosters will get you those higher rates. Such amenities add greater value to your rental property and cost a lot to acquire on a monthly basis. Some of them are:
- Swimming pools
- Parking spaces
- Washer and dryer
- Dishwasher
As an investor, you need to pay attention to which amenities you should add as some of them may end up costing you more on maintenance and repairs. Do your research first before you add them to your rental rate calculation.
Related: How to Estimate Rental Value: The Investor’s Complete Guide
How to Determine These Factors and Calculate Your Rental Rate
Now that we’ve discussed the different factors that affect your rental rate calculation, let’s talk about how to compute the right rental rate for your business.
Rental property investors use different methods to calculate rental rates and their potential rental income. Let’s quickly go over some of them and see which one works best for you.
The 1% Rule
Most real estate investors are familiar with the 1% rule in real estate investing. It is a simple rule of thumb that most investors use to quickly determine whether a property is worth investing in or not.
The rule basically states that a property’s gross rental income should be at least 1% of the total amount invested in the property to end up with a positive cash flow. It can be applied to both long and short term rentals.
While the 1% rule seems like a good way of determining a property’s income-generating potential, it does not give you enough information to know if the property can be competitive in a neighborhood.
Rental Comps
As we already mentioned earlier, rental comps are a great way to check if a subject property can generate enough income to give you enough money to take to the bank regularly. All you need to do is find a handful of comparable properties and see how the subject property holds up against them.
Rental comps will give you a good idea of the appropriate range of rental rates in a specific location. Based on the unique features of your subject property, you can adjust your rates accordingly.
You can use rental comps to get an idea of the appropriate range of rental rates in a specific location.
Reverse Engineering
Another method that a lot of investors use to see how much rental rates they can charge is called reverse engineering. This allows you to come up with an optimal rental rate for your investment property.
Let’s take for example the following details for a long term rental:
- Target Rental Income (Net): $500
- Financing Costs: $500
- Maintenance Costs: $50
- Property Tax: $100
- Insurance: $75
- Vacancy Rate (based on Rental Comps): 5%
When you take all of the recurring expenses and add them up, you will get a monthly expense of $725. It will cover all of your operating costs so you need to generate the same amount at least to keep from going negative.
But it doesn’t end there. Since you want to make at least $500 a month, you will need to charge your tenants a minimum of $1,225 monthly. However, you also need to factor in the 5% vacancy rate. It means that 5% of the time, you will not be earning monthly income mainly due to the transition between one tenant and another (if the current lease is not renewed).
So, you will have to take your $1,225 rental rate and multiply it by 1.05 (100% + 5%). It will give you a product of $1,286. This is how much you should be charging for your rental property if you wish to net at least $500 per month.
Investment Property Calculator
Lastly, investors use technology to their advantage and go to real estate websites for their rental rate calculation needs. One such website is Mashvisor. Mashvisor specializes in helping rental property investors find the best possible deals on rental properties all over the country.
To date, it has helped thousands of investors achieve their investment goals by giving them access to relevant market information and real estate investing tools. One of its most popular and helpful tools is the investment property calculator.
Mashvisor’s rental income calculator allows investors to easily do the math in a fraction of the time. It is quite simple and straightforward to use. All you need to do is pick a potential property in any location of your choice. You can then analyze the property’s profitability using the investment property calculator.
The calculator is highly interactive and intuitive as it uses up-to-date market data gathered from highly reliable sources like Zillow, Realtor.com, and Airbnb. You may even customize the numbers according to your own research. The system will then make the computations based on your input and give you the most accurate and realistic results.
On top of that, the calculator will also give you a side-by-side comparison of which rental strategy works best for the given location.
To learn more about how we will help you make faster and smarter real estate investment decisions, click here.
Wrapping It Up
To end, every rental property investor should know how to perform a proper investment property analysis to determine how much they can charge on rent. The rental rate calculation process may seem complicated and hard but it’s not. All you need to know are the different factors that affect it and which tool to use.
As far as calculation methods are concerned, the best and easiest way is to use Mashvisor’s rental calculator. It will save you time, money, and effort and allow you to obtain the most realistic projections on rental income and ROI.
This is why a lot of real estate investors have learned to trust Mashvisor over the years. It has provided them with actual market data that makes investment property analysis highly accurate. This leaves very little room for error, which leads to increased investor confidence. When it comes to rental rate calculation, give Mashvisor a go.
To get access to Mashvisor’s investment tools, sign up for a 7-day free trial, followed by 15% off for life by clicking here.
