Rental Property Conversion Series: Setting the Appropriate Rent, Part 2

Last week, in part 1 of Setting the Appropriate Rent, I encouraged you to look at your mortgage obligation as part of your analysis.  I suggested that you start with a 1% rule for rental income to total mortgage obligation.  This week, we pick up with a discussion of the expenses you expect to incur as owner and landlord, as well as considering the comparable rates in your area. 

What expenses do you expect to incur as owner and landlord?

There are at least a few common expenses for a property-owner/landlord to consider, including property taxes, management & maintenance fees and insurance.

Although 35% of the rental income at first glance may be a safe set-aside to pay expenses, it will be beneficial to have as accurate a picture as possible of the types of expenses you expect to incur and an estimate based on your expectations. 

For primary to rental property conversions, the benefit of having lived in the property that you own is that you should have a feel for what a lot of your expenses will look like. 

Property Taxes

As a homeowner, you should be aware of the tax bill on your property without having to do much research.  Depending on your jurisdiction, your state or local tax authority should send you the proposed tax assessment for your property and the resulting tax bill. 

Some may even have the property taxes rolled into the mortgage payment each month.  If so, the lender essentially collects your estimated tax amount on a monthly basis as part of your mortgage payment and holds that portion in escrow.  At the end of the tax term, the lender makes the property tax payment to the taxing authority out of your escrow account.  For purposes of your rent analysis, remember that if your mortgage payment is $1500 and includes your tax payment, any rental amounts in excess of $1500 will cover your mortgage and property taxes. 

Property Management & Maintenance Fees

Will you hire property management? If you are planning to have a property manager, plan to pay at least 10% to 15% of gross monthly rental income for property management fees, although I have seen as high as 30%.  I’ve also seen a very high charge in the first month such as 60% of the first month’s rent and then lower rates, such as 10%, in the following months. 

It is wise to do a search online of the property management companies in your area to get a feel of the average charges for management services in the same locale.  The decision of whether to hire a property manager will depend on your circumstances.  For my husband and I, it is necessary because we will not be living in the same state after our property is rented.  Thus, we will need someone to look after the property, be available for tenant maintenance and repair issues and we would like the property manager to handle rent enforcement. 

Your situation may be different.  You may be living in the same general area as your rental property.  You may feel comfortable handling your tenant’s maintenance and repair concerns and you may also be comfortable with collecting rents.  But think long and hard about what goes into managing your own property.  Really think about whether you are up for the task.  It may be worth the cost to pay someone else to handle tenant issues.

Maintenance and repair fees should also be anticipated.  If you are using a management company, that company may use an in-house technician and charge on the basis of hourly labor rates for routine maintenance and repairs.  Alternatively the management company could outsource maintenance and repair work to third party contractors.  At any rate, expect maintenance & repairs typically to occur during normal business hours with higher rates for dispatch outside of normal business hours during the week, and on weekends and holidays.  

If you are planning to manage the property yourself, you can either do the work or hire a contractor.  Since you have been living in the property prior to conversion, you should be aware of maintenance schedules on most items and the typical costs associated with such maintenance.  If you will do repair work yourself, acquaint yourself with area contractors and familiarize yourself with average rates for services in your area.

Landlord and Rental Home Insurance

You should plan to have insurance on the property and factor in insurance premiums as part of your fee calculus.  Be sure to thoroughly research the type of insurance that is appropriate for your situation and your property once it is rented.  Policies range from minimal to broad, comprehensive coverage and premium amounts will be dependent on the scope of coverage. 

Think long about the kind of coverage you will want.  Do you want only to cover the property building?  Do you want to cover yourself against landlord liabilities?  Some policies even cover lost rents.  In this economy, it may be good strategy to be covered against lost rents.  Premiums on insurance vary, so do your homework. 

Utilities

As the landlord, you must decide whether to maintain the utilities, which are already in your name or turn responsibility over to your tenants.  If you maintain the utilities, you will have to recover your payments in the rents you charge.  The rent is usually higher on a unit that has the utilities included (maintained by the property owner) and this should be a consideration for you when you are approaching the competitiveness of your rents. 

If your rents are higher because of utilities, be mindful of how your rent will fare in the marketplace.  For example, when a real estate agent is searching properties to present to his client, whose price range is $1500, and you are charging $1700 with utilities included in an area where the average rents are at $1500 or below, you stand to lose. Even if yours is a better deal with the utilities included, the real estate agent that is looking for properties at or below $1500 will never see your property in their search.  So, they will never have the opportunity to sell your ‘better deal’ with utilities included. 

Also, if your tenants maintain the utilities, they are more likely to conserve the use of water, gas, and electricity and you will avoid unexpected increases in utility expenses based on your tenant’s usage. 

Mortgage Refinance

Last week, I encouraged you to consider your current mortgage obligation in your rent analysis.  Maybe you have refinanced your mortgage to obtain a more favorable interest rate and reduce your monthly mortgage payment.  But, you must be sure to factor your refinance closing costs into your rent analysis.  You must figure out how much rent you can charge and over what period of time it will take to recover your refinance closing costs. 

You must consider the cost of your refinance in conjunction with the interest rate you are moving to, whether your closing costs are rolled into your loan, and, if so, the long-term interest you will pay on those closing costs and whether and how long it will take for your monthly mortgage savings and rent profits to be enough for you to break even and begin to profit. 

I wanted to speak more openly here about the consideration for the costs of refinancing and how this piece should fit into your own analysis. But, I soon realized that this involves much more complex cost factoring than I am able to include in this discussion.  Thus, if you are planning to refinance your mortgage before converting your primary residence to a rental property, you should consult a professional accountant to help you ascertain benefits, as well as likely gains or losses.

My personal analysis considered the fact that I was in a 7 yr. ARM that was to reset in year 2010.  Thus, it was advisable for me to refinance now, while rates were at record lows.  But, I will need to take into account my closing costs and new interest rate when setting my rental rates to determine our break-even and positive cash-flow points once our property is rented. 

What are the comparable rental rates in your area?

Your analysis for where to set the rent must consider the comparable rents in your area.  You are most likely to attract renters if your rent is competitive with other rents on similar properties.

If you are working with an agent, that agent should have access to a comprehensive real estate property location system such as the MRIS (Metropolitan Regional Information Systems, Inc.) that will allow them to look up properties listed for rent.  Such a system will be able to bring up properties according to search criteria such as location, specifics of the property and the rent amount. 

My real estate agent tells me that competition is key.  You have to imagine that you are in competition with other comparable property owners in your area who also have their rental properties on the market.  Whoever sets the most competitive rent wins!! 

Well, it is slightly more complex than that when you consider the specs of the property and individual circumstances, but setting a competitive rent is definitely important.

Even if you are not using a real estate agent and do not have access to such realtors tools as MRIS, you can use such online resources as Zillow.com or Craigslist to peep rental rates on comparable properties in your area. 

Also keep an eye on the general rental market conditions.  The rental market ebbs and flows, especially in this economy.

If you are preparing to convert your primary residential property to a rental property, one of your task items will be to set an appropriate rent for your property.  When doing your analysis, it is important to start with three considerations:  your current mortgage obligation, your expected monthly expenses, and the comparable rental rates in your area.   

Indeed, there may be other cash flow items for your consideration.  Any analysis will depend largely on your individual circumstances.  For more information on what you should be thinking about when setting the rate on your property, you should consult with a certified accountant or an attorney specializing in real estate finance. 

Writings on Aspire to Grace are strictly the opinion of the author based on her experiences and are not offered as authority on the topics of discussion.

MAKE MONEY MONDAYS is a forum to discuss ways in which you can create additional sources of income.  I try to focus on particular ideas and steps you can take to create alternative income and passive income sources.  I have also begun a series of posts called “Rental Property Conversion.”  This series follows my husband and I as we turn our property into a rental property.  If you like what you see here, please use the orange icon at the top right to receive my content updates by email or RSS reader.  

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2 Comments

Filed under Make Money Mondays, Real Estate

2 responses to “Rental Property Conversion Series: Setting the Appropriate Rent, Part 2

  1. Teresa

    Your post was very informative. You made several excellent points.

  2. Pingback: Rental Property Conversion Series: Staging Your Property for Show « Aspire to Grace

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