A Pricing Strategy To Maximize Rental Income And Minimize Turnover
My latest search for a tenant was not easy. After hosting six open houses over a one month period I’ve finally found the one who will hopefully stay for longer than one year, pay on time and take good care of the place. It’s a darn small world because her boss is a fellow tennis club member I see literally every week. He enthusiastically gave her a thumbs up so here’s hoping for the best!
The average search duration during my previous three changeovers took half as long. I attribute two reasons for the duration difference: 1) Pricing and 2) Pickiness. Over the past 10 years I’ve seen my net worth grow just like most of you. As a result, I’ve become more picky in choosing “the ideal tenant” because my rental property is decreasing as a percentage of my overall net worth. With such a decline comes a reduction in time I want to spend tending to this asset. Meanwhile, I raised my asking price by $400, equivalent to a 12.5% increase.
My first tenants were French citizens with no credit or rental history. I was a first time landlord back in 2005 who based my decision on gut and paystubs. They fortunately turned out to be terrific tenants who stayed for four years until they got married and decided to buy a place of their own. Perhaps I was lucky, or perhaps most tenants are simply honest to goodness people and being so thorough isn’t necessary.
With each subsequent tenant I’ve scrutinized just a little more. A minimum of 40X monthly rent for annual income and credit scores of over 720 are non-negotiable criteria now. The average credit score for a rejected mortgage applicant is 729 so I’m not far off. The one thing landlords need to realize, however, is that you can’t always get what you want. After the fifth showing I almost gave in by lowering my price, but figured out a win-win pricing strategy just in time.
MAXIMIZE YOUR RENTAL INCOME WHILE LOWERING TURNOVER
I could ask for the moon and probably get some meteors if I priced my rental property low enough. The key is to figure out the current market for your rental property as well as understand your own tolerance for turnover. It’s safe to say that every single landlord wants high price, low turnover. My issue was that I priced at the absolute top of the range and couldn’t get the pick of the litter.
Basic Marketing Steps Landlords Should Consider:
* Search online to understand the market. Craigslist is the easiest and most efficient place to search for comparable properties. I have a two bedroom, two bathroom condo overlooking a park in a nice area in San Francisco. I first search for ALL two bedroom, two bathroom condos in my area. Then I narrow the list down to five listings that are as close to my unit as possible. Seldom will I find a perfect match, but I come close. Then I refine my search further by inputting an upper maximum price in the search 20% higher than the average of the five listings to make sure there isn’t anything I’m missing. The markets are relatively efficient within a +/- 10% pricing range, but you never know.
* Make your listing beautiful. Now it’s time to list your property online. Of course you are going to write the most wonderful, detailed description about your place as possible. It’s important to include keywords to major parks, hospitals, grocery stores, restaurants, bars, main streets, and nice attractions as possible for search purposes. I’ve had numerous students from one graduate school contact me due to putting their school in my listing. The second crucial step is to upload as many pictures of as many rooms as possible. Craigslist allows for up to 8 pictures, so make them count with your best picture first.
* Avoid pricing ending in $X.000. In other words, $3,499, $3,497, or $3,495 looks more attractive than $3,500. Pricing just below the hundreds figure also helps when prospects are searching online. The search engine might miss the whole figure, but the simple truth is that $3,495 sounds better than multiple listings at $3,500. There are countless studies which have proven this fact and there are whole courses on pricing in business school.
* Better to price high than too low. Unlike selling a property, where pricing low helps draw people in to create a bidding war, pricing a rental property low will unlikely get you a better price. There is no bidding war culture for rental properties yet. In all my years of landlording experience in San Francisco, I’ve yet to have someone offer me a higher monthly rent. Instead, tenants will sweeten their offer by paying for 3, 6, 12 months up front and hand over a higher security deposit. At the end of the day, none of that increases my rental return because I’m expecting my tenants to pay me in full anyway. The only two things that increases my rental return are higher rent and lower costs (mortgage and maintenance).
Two out of four times I felt I priced my unit too low by $100-$300 because I had a mad house of people come visit during the open houses with 8-10 offers each time. I could not in good conscience go back and raise my asking price online out of fear of all interested tenants being turned off by my greed. Instead, I sifted through all the applications to make sure I picked the best.
* “Or Best Offer” is going to hurt more than it helps. As a safety net, I decided to use “Or Best Offer” after my asking price to encourage prospects to offer me a higher rental price if they are really interested. Nobody did. Instead, prospects began offering me lower rental prices instead! The large majority of people who see OBO think a chance to get a better deal. It’s just the way we are wired as consumers. Nobody likes to pay full asking at the department store. And certainly nobody offers more than asking either. Another feedback I received from a relocation agent was that OBO might turn away prospective tenants in a hot market who view the term as fishing for more. People who don’t want to get in a bidding war are therefore going to be put off. OBO hurts both ways so take it out and be firm on your pricing.
* Calculate the cost of having no tenants. Take one month of rent and divide by 12 to figure out how much you can lower your rent and break even by having one month of no rent. For example, take $2,395 / 12 = $199.58. In other words, you can charge $2,195 a month instead of $2,395 a month for twelve months to come out even. The question is how long you are willing to wait for the right tenant.
The Winning Pricing Strategy
I started my search at the end of April for a June 1 move-in target date. I received a couple offers at full asking, but nobody who I thought was ideal. Some had two dogs, others wanted their parents to stay with them for multiple months a year, and so forth. Here’s a post on how to prevent tenants from abusing the lease with long term guests. I finally came up with the following strategy:
* Offer a pricing incentive based on duration. After five open houses and only 10 days away from the target June 1 move-in date, I began to worry I wouldn’t get anybody with my 12% higher rental increase amount. Instead of lowering my asking price I decided to employ an incentive base pricing system if the tenant was willing to stay for a second year. As soon as I added a $100 discount for a second year, I started to get an uptick in inquiries from people who all said they would love to stay for two years or longer. Bingo! Their desire to stay for two years or longer is congruent with my desire to have long term tenants.
I hate turnover and I don’t know many tenants who enjoy the process of moving either. The distaste for turnover is one of the most powerful tools landlords have in raising the rent. If you are happily living in your $2,500 a month apartment, are you really going to bother moving if the landlord raises the rent by 4%? The tenant will probably search online, but it’s unlikely the tenant will move, especially if the tenants have dependents.
Let’s forget about holding a tenant hostage for a moment and focus on incentives. Because you are pricing at the top end of the comparable range, you will have less interested parties submitting applications. Or you might have plenty of people submitting applications and not following through because they’ve found better options. The incentive of lower rent the second year may also produce better tenants who are more self-sufficient for the first year because they don’t want to risk losing the deal.
* Set pricing expectations early. Everybody gets annoyed with an increase in pricing with no service or feature changes. Imagine your cable company, gym membership, or yoga studio raising their prices by 5% one month. Just out of principle, you might quit. To lower the chances of your tenants leaving, set expectations at the time of the lease signing.
My lease states there will be a $100 discount in the second year if a tenant is in good standings and stays for a full one year. In addition, I add that after the second year is over the rental price will go back to the original first year price and no more than the first year price + $100 e.g. first year: $3,800, second year: $3,700, third year: $3,800 – $3,900. In effect we are both locking in a probability of three years of no rental price increases. In a hot rental market that is music to a prospective tenant’s ears.
The pricing strategy drastically increases the probability of the tenant staying for more than one year because not having to move AND getting a price decrease is too attractive a proposition to pass up. After year three, I will raise the rent back to market levels, but by no more than a 10% increase just to keep things kosher. If the rental market inexplicably falls, I’ll keep the rent the same.
LOVE YOUR TENANTS LIKE FAMILY
The ideal tenant is one who never asks for anything, always pays on time, and always pays market level rents. Unfortunately for landlords, many like me don’t have the heart to raise the rent to market levels or to anything at all due to guilt. But you have to remind yourself as a landlord that you’ve put in a lot of time, money, and risk to own your property. The market dictates price. You just have to discover what that price is.
I highly encourage all landlords to love their tenants as much as possible. Send them a bottle of wine welcoming them to the place. Be responsive whenever something is broken. Let tenants live their own lives by letting them be. Eventually they will probably move on like my current tenant who found love. In the mean time, being a nice landlord prevents all sorts of hassle down the road.
Recommendations For Protecting Your Home And Saving Money
* Make sure you refinance your mortgage. If you haven’t refinanced your mortgage in the past 6-12 months, I strongly suggest you at least check the latest rates online with Quicken Loans, the largest online mortgage retailer. Rates have been ticking up in 2013 and could surge higher with the end of Quantitative Easing. They were founded by Dan Gilbert, also owner of the Cleveland Cavaliers. Because they have the largest online network, they can provide the lowest rates. They also seem more streamlined in the refinancing process than traditional bricks and mortar banks as well. Interest rates are at all time lows and won’t stay this low forever. My latest refinance was for a 5/1 jumbo ARM at 2.625% from 3.125%. Rates are ticking up due to the ending of quantitative easing as of 4Q2013. Might as well check because it’s free and there’s no obligation.
* Check Your Credit Score: Take a moment to check your free TransUnion credit score through GoFreeCredit.com, a company I trust. 30% of credit reports have errors, which could put a serious hamper on your refinancing or new loan borrowing abilities. I had a $8 late payment I didn’t even know I owed crush my score by 100 points come up during my last refinance! If you don’t want the credit monitoring service, simply cancel before the grace period is up.
* Get the best home insurance possible. In order for your property to grow in value you must protect your property from damage. Fires, floods, leaks, theft, and other accidents happen all the time. If you have cut-rate insurance, you could very well pay way more than you should. I highly recommend checking with USInsurance.com online to find the best home insurance rates. They have a huge network of providers that will compete against each other to provide the most tailored home insurance coverage possible that is affordable. Mobile home insurance, renters insurance, condo insurance, and homeowners insurance are just a few of the options based on the type of home in which you reside. Leverage the internet to save money and protect your largest asset.