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Chapter 3

HOW TO DETERMINE RENTAL VALUE

In this chapter, you will learn to:

• Determine the market value of your rental unit by examining the rent and features of competing rental properties and comparing them to your own. Do not base rent on the size of your mortgage payment!

• Compare your property to more than five others to get a sense of the market value.

• Consider permitting pets and smokers, but screen applicants carefully. Restrictions make it harder to find a good tenant.

• Offer a rental incentive in a weak rental market such as a rent reduction, move-in allowance, or one or a half month’s rent free.

• Rent the space unfurnished: Furnished suites are much more labour intensive, and often not worth the potential additional revenue.

Inexperienced landlords often base their rent on the size of their mortgage payment or other personal circumstances. This may appear reasonable, but it isn’t. Landlords must rent at prevailing market rates, whether the rent covers their mortgage or not.

Determine the market value of your rental unit by examining the rent and features of competing properties and comparing them to your own. Appraisers call this the “direct comparison” approach.

Buy newspapers and review online classified websites to see what kind of property is currently available. Rental property typically falls into four broad classes: Secondary suites, self-contained apartments, townhomes, and detached homes. The level of desirability and value follows that order as well. A two bedroom, 1,000 square foot secondary suite won’t normally rent for as much as a two bedroom, 1,000 square foot high rise apartment in the same neighbourhood. Restrict your analysis to rental property in the same class as your own whenever possible.

After looking at the ads in a few newspapers and online classified websites, you will notice a range of rental values for similar property. At this point, you may feel comfortable selecting a value within this range and seeing how it goes.

However, if it remains unclear, examine the features of competing rentals in greater detail. Create a comparison table. In Table 1, we are comparing our recently renovated two bedroom apartment of above average size that is approximately 20-25 years old to five other two bedroom apartments in the neighbourhood.

TABLE 1: NEIGHBOURHOOD COMPARISON

In practice, you should compare your property to more than five other properties. This way, the chance of error is minimized. You might also add more features to the table to compare.

Note that the only difference between #2 and #3 is that one has a view, while the other does not. This suggests that a tenant in this area is willing to pay $50 more for a view property. Since the only difference between our property and #1 is that our property has a view while #1 does not, market value for our property may be $1000. The only way to find out for sure is to place an ad to see how prospective tenants respond.

Determining correct rental value is a serious matter. Time and money are at stake. In certain weak rental markets, you’ll find ren-ters to be amazingly sensitive about rental value. Overpricing by as little as 5 percent will result in a lack of demand.

Clearly, it is not possible to get such detailed information about comparable property from classified ads alone. Try calling other landlords with questions about their properties. Be courteous and respectful, and you will find that most landlords will be happy to help other landlords survey the market. If the landlord you call isn’t willing to help, don’t be discouraged — try someone else.

How Do Pet or Smoking Restrictions Affect Rental Value?

Reducing the pool of prospective tenants by placing restrictions on pets or smoking will make it harder to find a good tenant. These restrictions may force you to lower your rent to get a tenant quickly, even if you believe you are asking a reasonable market value rent. Consider permitting pets and smokers, but screen prospects carefully. You will find a gold mine of tenants who are responsible and who will treat your property with care.

Does your rental have a balcony or patio? Ask the applicants if they’re willing to smoke outdoors only. If they are, make it an essential term of the rental agreement. If your tenant has a good credit rating to protect, he or she will comply with this rule because he or she knows he or she will be on the hook for any smoke damage. Inspect the property at least two or three times a year to ensure compliance.

If the applicant has a pet, confirm that it’s been spayed or neutered. Small spayed or neutered pets are commonly harmless. Medium or large sized pets can be harmless too, but you should collect a pet deposit if your province permits it.

I’ve Determined Market Value for My Rental Property, but What Do I Do in a Weak Rental Market?

If your rental property is in a city where the economy is suffering and unemployment is high, then there’s probably a high vacancy rate too, meaning that it will take longer to rent your property even if it is reasonably priced. Consider offering a rental incentive. Three examples of common rental incentives and their pros and cons are as follows:

Rent reduction

If similar property in the area rents for $1,000 per month, and you offer yours for $925, the odds are higher that prospective tenants will call you first. The problem with this strategy is the adverse impact on your cash flow. Most provinces only permit a small percentage rent increase each year. While the economy may improve rapidly, it may take years of rent increases to reach true market value rent. In the meantime, you could lose several thousand dollars.

Move-in allowance

You might offer a tenant a move-in allowance of several hundred dollars. Make sure the terms and conditions of the allowance are clearly specified in your rental agreement. It should be very clear that the move-in allowance is a one-time fee paid in the first month of the tenancy.

You should require the tenant to sign a fixed-term lease that guarantees they will stay a certain length of time as well. This way you avoid the unpleasant situation where you pay an incentive, only to have the tenant move out a few months later.

Offer one or half of one month’s rent free

In this arrangement, the tenant will sign a one year lease and no rent will be collected in the 12th month. The benefit of this incentive is that it rewards a tenant for staying long term. Also, unlike simply reducing the rent, you receive full market rent from the very first month of the tenancy.

Offering one month free rent will significantly affect cash flow in your first year. For a property that rents for $1,200 per month, one month free rent means a loss equivalent to $100 per month. Offering half a month’s free rent might work just as well.

As with the move-in allowance, it is essential that the terms and conditions of this rental incentive be clearly specified in the lease. It is not unusual for tenants to mistakenly believe that they are entitled to free rent once per year as long as they live on the premises. It must be clear that the free rent is a one-time incentive paid in the 12th month.

A tip that could make your tenant stay for years: Offer tiered rental incentives in the 12th and 24th month. For instance, half a month rent free in the 12th month and one whole month rent free in the 24th month. Ensure the terms and conditions of this incentive are clearly laid out in the rental agreement.

Furnished Rentals

Renting furnished space is a tempting prospect. After all, a good furnished property rents for 25 to 75 percent more than unfurnished property. An ideal furnished rental property is an apartment condominium in or near the downtown core of a major city or an area sought-after for tourism. Smaller one- and two-bedroom apartments are good candidates for this type of rental because they can be furnished more inexpensively than larger rental property.

However, this arrangement is not desirable for most landlords, and it is certainly not recommended for inexperienced landlords. It may require significant cash up front to adequately furnish the rental. Carrying costs are higher as well, as you are expected to pay for all utilities including cable/Internet access and you will have to pay these fees even when the property is vacant. You are also commonly expected to offer some sort of housekeeping service.

The most time-intensive part of property management is time spent finding tenants. The owner of a furnished rental has to do this many times each year. It can be tempting for a landlord in such circumstances to lower tenant selection standards, making the risk of letting a bad tenant in much higher.

Strata or condominium corporations may not permit owners to run this type of rental business. The bylaws of your corporation may state that prospective tenants must sign a one year lease, or they might require a move-in fee of several hundred dollars. The move-in fee is payable even if the incoming tenant doesn’t move anything of significance into the suite other than a suitcase. Such bylaws make short-term tenancies less profitable.

It is possible to have a profitable furnished rental business, but in order to be successful it is necessary to put in much more time and effort than most landlords are prepared to do. Renting the space unfurnished is the best way to go for the vast majority of landlords. Keep it simple!