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Rental real estate can be one of the most profitable and potentially lucrative sources of income. But how much rent should you charge for a particular property to be a good investment? Simple answer: you can’t decide.
Supply and Demand Determine Rent Amount
The market, especially the forces of supply and demand, determine the rent for your property. It is like any other service or product sold in a free market economy. There is a price that people are willing and able to pay, and that is the rent they will be able to charge.
Determining rent starts with looking at your competition in the market. Similar properties will have similar rental rates. Compare your property’s features and amenities 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 investments, we become owners with the expectation of making money. (I’ve never heard anyone say they rent a property because they like dealing with tenants.) Maybe you want to supplement your monthly income. Or your job relocates you and the idea of keeping your property, renting it out monthly, and paying your mortgage to someone else appeals to you.
Positive Cash Flow Is Important With Rentals
Whatever your strategy, you’ll want to crunch your numbers before you jump in. It’s as simple as identifying what rental income you can reasonably expect and calculating what it will cost to generate that income.
When your rental income exceeds your expenses, your property is “cash flow positive.” Here is an example. If your monthly rent is $1,800 and your expenses are $1,500, your property has a positive cash flow of $300.
When calculating your rental costs, you should include:
- Mortgage
- Of course
- property taxes
- HOA or condo fees
- Utilities unpaid by tenant, maintenance
- Vacant (usually double the monthly rent, assuming two months for the tenant who has moved out)
License and inspection fees
There may be other product costs depending on where the property is located. In Baltimore, for example, a lot of real estate is valued at ground rent each year. The important thing is to make sure that you include all the expenses that you will incur in your calculations.
In addition to these direct costs, you need a financial cushion. I call this line my It’s Gonna Break Foundation. A water heater may only be five years old, but it can still go out and you need to replace it quickly so your tenants have hot water. That way, you save savings from each month’s rent to use when an important item needs to be repaired or replaced.
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 condo, so I don’t need to budget for a new roof or exterior maintenance like landscaping and snow removal. The condo fee also covers water/sewer and the only utility the tenant pays is electricity.
| ANNUALLY | MONTHLY | |
|---|---|---|
| Total Rental Income | $17,100 | $1,425 |
| Expenses: | ||
| Insurance | $268 | $22 |
| Mortgage interest | $6,424 | $535 |
| Taxes | $1,568 | $131 |
| Condo fee | $2,460 | $205 |
| Renter license renewal | $60 | $5 |
| Maintenance | $120 | $10 |
| Vacancy | $1,725 | $144 |
| “It’s Gonna Break” fund | $500 | $42 |
| Total Expenses | $13,125 | $1,094 |
| Cash Flow | $3,975 | $331 |
As you can see, the property has a positive cash flow of $331 each month. If the tenant renews the lease (and they usually do), there is no vacancy cost and the $1,425 flows through. If nothing breaks, it’s another cost that was planned but not done, 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 with positive cash flow per property. In this example, the Owings Mills property is not my best cash flow rental asset. It was the first property I ever bought and I’ve learned a lot since then. I stopped buying condos after this one. However, 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 usually charge a higher rent. For example, I previously rented a property to a Section 8 tenant for $1,500 in rent. That’s $75 a month more than the current $1,425. The government wants landlords to make the property available to Section 8 tenants, so you’ll pay a little more in return for a little more office work and a few hoops to jump through, like an annual inspection if there’s a turnover of tenants or not. . As long as you thoroughly screen your tenants, you may want to consider accepting a Section 8 voucher.
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Summary
One of the main reasons for owning a rental property is to increase your monthly cash flow through rental income. The other main reason is the expected appreciation of the market value. Plus, investing in real estate has a unique tax advantage that investors love.
As with all investments, investing in real estate has risks that you should consider before entering.