When I was learning the appraisal ropes, I figured out that many of my peers didn't want to analyze market rent. I had experience figuring out market rents for my own investment properties, and thought it couldn't be much different. The research involved in finding out who is paying what rent for different kinds of properties isn't really that much different than how I used to compute how much rent I would charge. What is different today is the way I report my findings. In 1987 I reported my findings by advertising my rentals in the newspaper. Today I report my findings to my clients who are interested in a thorough analysis of what the current market rent is for their investment property or loan collateral.
After the US economy tumbled, property owners who found themselves managing long-term rentals often offered rentals at whatever rent amount the market would bear. Believe me when I tell you that almost any rent is better than paying the whole mortgage on an investment property. I say that cautiously because I have discovered a direct link between the anxiety of paying the whole mortgage on an investment property and the selection of a renter who for one reason or another does not turn out to be "long-term". That is a topic for another blog, suffice it to say that if you don't know where your bottom line is, you may very well be paying people to live in your investment properties.
That's where I come in as an appraiser. I do the research to figure out what people are paying for renting properties similar to yours. The emphasis here is "what people ARE PAYING". When you look in the newspaper, or on Craig's List, you are looking at "what people ARE ASKING". Depending on the rental market forces, this might be very different. Here is an example. In early 2009 I advertised a property expecting to rent it for $1,900/mo or the equivalent of $0.80/sf. After 2 months of marketing it I took $0.67/sf.
So an appraiser figures out what renters are paying for rent at the time that the property sells. This is important because if the property is producing rental income at the time it sells, there is a good chance that the buyer as well as the lender is basing their purchase decision on the income from that rent. In the case of a purchase the lender has probably compared the home's Gross Rent Multiplier with recent sales of other income properties to see if the rent amount is supported in the market area.
After I've figured out what the market will bear for rent, my client usually asks me to draw up an Operating Income Statement. This report allows the landlord, or investor to easily see how much money they will make in a given year after typical expenses. I research vacancy rates, utilities, taxes. The cost of typical annual repairs, management fees (even if the landowner manages the rental themselves), and replacement reserves (to cover things like leaky roofs, broken dishwashers and microwaves, and carpet replacement) is calculated, and finally a Net Cash Flow is concluded.
You might wonder why a landlord would go to all this trouble. This is the good part. If you, as a prospective income property buyer/landlord, go through ALL these steps before you sign on the dotted line, you will know how low you can really afford to go when it comes to renting your income property.
It's exciting to say "My mortgage is going to be $1,400 per month and my Real Estate agent said I could probably rent my property for $1,600 per month...YIPPEE!! I'm going to be making $200 per month!!!
There is no one - except maybe your BFF - who will ask you how much per month you will be setting aside for property taxes, and insurance. Probably not even your BFF will ask you how much you need to set aside for vacancy and replacement reserves.
If you want to make money on income property don't underestimate your expenses, because they like so many other onerous things in life, come in groups of three.