It’s probably safe to say that every rental property investor wants to collect the highest rent possible. However, wanting something and getting something are two very different things, especially when real estate is concerned.
In this article, we’ll discuss how to put fin rental comps to ensure your investment property is as profitable as it can possibly be by keeping your rents at top dollar and your tenant turnover low.
What are rental comps?
Rental comps are used to compare similar rental properties to one another.
The process for putting together rental comps is similar to creating a comparative market analysis (CMA) for the sale or purchase of a property. However, unlike a CMA, the purpose of compiling rental property comps is to make sure you’re charging a fair market rent.
There are several big benefits of keeping your property rent similar to what other investors are charging for comparable housing. You’ll be able to maximize the value of your rental property by renting to the most qualified tenants, keep vacancy low, and keep your gross rental income and cash flows as high as the market will allow.
Items to include in rental comps
The best rental property comps come from properties that are closest and most similar to your property, which is also known as the “subject” property. That’s because fair market rents vary from one neighborhood to the next, and sometimes even from street to street within the same area.
Important items to include in rental comps:
- Property rent
- Property market value (to calculate performance such as gross rental yield and cap rate)
- Rent per square foot
- Size of property
- Single vs. multi-story
- Number of bedrooms
- Number of bathrooms
- Parking (such as off-street in a garage or carport vs. on-street)
- Appliances included (such as washer, dryer, and refrigerator)
- Pet friendly
- Lot size
- Landscaping front and back
- Construction date of property
- Condition of property
- Recent upgrades or improvements (such as flooring, roof, or HVAC)
- On-site amenities such as front porch, rear deck, children’s play area, swimming pool or spa
- Community amenities such as greenbelts, parks, access to public transit, shopping and restaurants
Where to find rent comps
There are a number of resources you can use to find comparable rents to put together rental comps:
Offline sources for rental comps
- Leasing agent has real-time price information about what other investors are really charging and what incentives they may be offering tenants to sign a lease
- Property management companies handle other rental properties just like yours, and can give you a good idea of the best rent to attract qualified tenants who pay the rent on time and renew their lease one year after another
- Fellow investors that are members of your local club are usually more than willing to help out, because even though you’re their competition, you may also make a good JV partner when a big deal comes along
Online sources for rental comps
- Stessa Rent Estimates are a quick and easy way to compare your proposed rent with other local properties similar to yours. This is a paid service that generates a comprehensive report including detailed comps and market analysis.
- Rent Zestimate from Zillow uses millions of data points and local market trends to obtain a starting price point for your rent. By entering the property address, Zillow will take into account key factors that influence a property’s fair market rent including physical attributes, amenities, and recent upgrades.
- Live rental listings on Craigslist can help you see what other similar properties in your area are asking for rent.
Figuring our rent comps for single-family vs. multifamily
When you put together rental comps, it’s important to remember that there’s a difference between how rent comps on single-family and multifamily are viewed. For example, let’s compare a single-family house to a triplex (3-unit) multifamily property:
- Square footage = 1,200
- Beds/baths = 3/2
- Rent = $1,000 per month
- Rent per square foot (annual) = $10 per year ($1,000 monthly rent / 1,200 SF x 12 months)
- Rent per property (annual) = $12,000
- Square footage = 2,400
- Square feet per unit = 800
- Beds/baths = 2/1 per unit
- Rent per unit = $600 per unit per month
- Rent per property = $1,800 total per month (3 units x $600)
- Rent per unit (annual) = $7,200 per year
- Rent per square foot per unit (annual) = $9.00 per year
- Rent for property (annual) = $21,600
- Rent per square foot for property (annual) = $9.00 per year
At first glance, it might seem like the multifamily property is the better investment because there is more total monthly rent. That may be true if you’re focused on rapidly building up the cash flow in your rental property portfolio.
However, per unit rents from multifamily income property are usually lower on a per square foot basis when compared to single-family homes. In the example above, even though the multifamily property is twice as large as the single-family rental, the per square foot rent from the multifamily is less than the single-family house.
That’s why it’s common to find multifamily rental comps frequently expressed on a per-unit basis (or per door basis), while rent comps for single-family houses are most often expressed on a per-square-foot basis since the entire house is a single unit rented to one tenant. Using a different rental comp measurement for houses and multifamily income property makes it easier to make an apples-to-apples comparison.
How to value income property
Real estate investors buy income-producing property for the cash flow the investment generates. However, some income property is more valuable than others.
After you’ve put together your rental property comps, your next task is to determine the true value of the property you’re thinking about investing in by following these steps:
Step 1: Calculate the fair market value (FMV) of the property
There are two good ways to determine fair market value.
First, you can ask your real estate agent to prepare a comparative market analysis (CMA) from the MLS. You can also use a site like Redfin or Zillow to get an estimate of the property value - just know these valuations can be off by a wide margin, as they typically only consider square footage and bed/bath count in their valuation models.
Step 2: Determine the fair market rent (FMR) of the property
You’ve already put together rental property comps, so you have a good idea of how much rent the property should be generating. If the property is already rented, check to see if the current rent is too low, too high, or just about at market.
A below-market rent may be a red flag that the property is being rented for less due to needed repairs. On the other hand, a tenant paying a rent that is above-market will likely vacate for a cheaper place when their lease expires, leaving you with reduced cash flow if you have to lower the rent to find a new tenant.
You can also use the 1% Rule as a way to ballpark what the rent should be, then compare the result to your rental comps. The 1% Rule simply states that a rental property should generate a minimum gross monthly rent of at least 1% of the market value.
So, if the property has a FMV of $100,000 the FMR should be at least $1,000 per month:
- Fair Market Value (FMV) x 1% = Fair Market Rent (FMR)
- $100,000 FMV x 1% = $1,000 per month FMR
If your rental comps indicate the subject property should have an FMR of $1,200 per month it exceeds the minimum requirement of the 1% Rule:
- $1,200 FMR / $100,000 FMV = 0.012 or 1.2%
On the other hand, if the rental comps come in at less than $1,000 per month for the subject property, there may not be enough cash flow to cover routine repairs, the mortgage payment, and contributions to a CapEx (capital reserve) account. Unless you’re buying the property as a value add, it might be better to take a pass and wait until a better deal comes across your desk.
Step 3: Determine net operating income (NOI)
Rental comps and the 1% Rule tell you how much money is coming in by measuring the gross income. The next step is to determine your expected costs of owning and operating the property, then subtract those from your gross income to arrive at your net income:
- Determine the gross cash flow by adding up all of the rents and other income received.
- Subtract all operating expenses, contributions to a CapEx (capital expense) account.
- The balance remaining is your net operating income (NOI)
If your total annual gross income is $12,000 and your operating expenses (excluding the mortgage payment) are $5,500, your NOI is $6,500 per year.
To determine your net cash flow, you subtract your annual mortgage payment (P&I) from your NOI:
- $6,500 NOI - $4,000 annual mortgage payment = $2,500 net cash flow
Step 4: Calculate property value
Now – with your rental comps, property value, NOI, and net cash flow in hand – it’s time to value the income property you’re considering investing in. To recap:
- Rental comps = $1,000 per month or $12,000 per year
- Property value = $100,000
- Mortgage amount = $80,000
- Down payment = $20,000
- NOI = $6,500 per year
- Net cash flow = $2,500
Using these numbers, there are four easy calculation you can perform to compare the value of your subject property to other comparable properties in the same area:
- Cap rate = NOI / Property value
- $6,500 NOI / $100,000 property value = 0.65 or 6.5% cap rate
- Cash-on-cash = Net cash flow / Cash invested
- $2,500 net cash flow / $20,000 down payment = 0.125 or 12.5%
Gross rent multiplier (GRM) is a ratio that compares the gross rental income to the property value. Generally speaking, the lower the GRM the more profitable the property is:
- GRM = Property value / Gross annual rent
- $100,000 property value / $12,000 gross annual rent = 8.33
Remember that taken by themselves, these calculations don’t tell you how “good” or “bad” a rental property is. But by comparing the numbers to other similar properties, you can rank the value of your subject property to other rentals on the market. It all begins by putting together good rental comps.
Putting together solid rental property comps is essential if you want to maximize the value of your investment. Rent comps help you determine the fair market rent for other rental properties that are most similar to yours.
Once you know what the rental comparables are, you’ll be in an excellent position to rent your property for the best possible price to qualified tenants who will likely end up staying year after year after year.