Rental income is what generates steady cash flow and long-term profitability for investors. So, as you can imagine, it’s essential to know a property’s income potential before investing your hard-earned money into it. How exactly is this accomplished, though? Well, there are a few financial metrics that can be utilized when looking into a piece of real estate.
One key tool in evaluating an investment property’s revenue potential is the use of rent comparables (rent comp), which helps determine the market rent for a rental. Alongside this, the Gross Rent Multiplier (GRM) is often used as an important metric in estimating a properties value based on its rental income.
If this all sounds a bit confusing because you’re not familiar with the terms rent comp or GRM, rest assured, you’ll gain enough knowledge from my article to fully grasp these terms. With all that said, let’s dive in…
1. Understanding Rent Comparables (Rent Comp)
A rent comp is a popular resource for determining the fair market rent for a property by comparing it with similar properties in the same area. A comparable such as this is similar to a comparative market analysis that’s put together when someone is selling or buying a home to determine the fair market price.
Rent comps analyze properties in close proximity that have a comparable square footage, number of bedrooms, and so on, as make note of what the going rents are for those properties. This gives the investor who’s considering a rental in the neighborhood, invaluable insight into how their property, that has similar specs, will perform and if it has the potential to have positive cash flow or not.
Let’s break this down a bit by pointing out some specific reasons why rent comps are important. For starters, those who are running this metric to calculate how much they can charge per month will be able to determine if the rent will be high enough to cover their mortgage and other payables. If it’s not, this defeats the purpose of investing in a rental in the first place. You’ll want the rent to be high enough so expenses are covered with some profit as well. But at most, the mortgage would absolutely have to be covered for it to make sense.
On top of this, if you don’t run rent comparables and end up charging rent that’s too high, the property may sit vacant, which can be costly. In contrast, if the rent is too low, prospective renters may think there is an issue with the property. As you can see, it’s crucial to price your rental accordingly. Make sure to bookmark the following article for additional tips on determining the best rental rate – Three Ways to Determine How Much You Should Charge for Rent.
How to Identify and Analyze Rent Comparables to Set Competitive Rental Prices
So, how do you go about doing a rent comparison? Well, first, you’ll want to find a rent comp resource or tool that can gather up the neighboring property specs and lay out all the necessary information for you. To do this, you may want to pull from at least two different sources to ensure you’re getting reliable numbers. With that said, where do you get rent comparables from, or the information to create your own? I’ll give you a few ideas to start with.
Rent Comps Resources
- Local Realtors
- Property Managers
- Other Investors in the Area
- Dealcheck
- Rent Zestimate (Zillow)
- Rentometer
Creating a Rent Comp Report or Spreadsheet
Through the resources above, you should either be provided with information that you can place in an Excel spreadsheet that will lay out all the surrounding properties and their specs, or a report will be generated for you.
For those inputting data into a spreadsheet, you should have at least five properties listed with details that include the going rental rate for each, addresses, distance each rental is from the property of interest, the square footage, cost per square footage, number of bedrooms and baths, property type, age of the home. This will give you a good comparison of the average rental rate in similar neighborhoods.
Head over to this page on the Rentometer website that shows examples of rent comp reports that are generated, as well as Excel spreadsheets that display the essential details. You can also see a full rent comp report, which will provide you with a good understanding of how useful comparables such as these are.
Additional Tips for Putting Together Rent Comparables
There are certain things you’ll want to take into account when comparing one turnkey property to another as far as rent is concerned:
Compare Similar Properties
The rent comps should really compare apples to apples, as much as they can, not homes to apartments, for example. Or, if you’re looking into a one-story rental home, then two-story rentals shouldn’t be thrown into the equation when comparing numbers. However, sometimes this is not possible. You may be considering buying the only one-story home on the block, while all others are two stories. If this is the case, certain calculations should be made regarding the increased square footage to equalize the rent comparison.
Take into Account Amenities and Features
Of course, there are the obvious elements that are factored in, like square footage and bedroom count, which would be on your rent comp report. However, it’s important to also consider other elements that may raise or lower rent for properties you’re comparing, and these items can be added to your report. Items that may affect the rental rate might be if there is a pool, noticeable curb appeal or exceptional landscaping. Also, take note if the properties have a garage or just street parking, include a deck, or appliances such as a washer and dryer, central air, and the like.
Once you have your report completed, you should have a good blueprint of what neighboring homes are renting for to make a sound decision as to what the property your interested in will rent for, and if it is worth investing in or not.
Ok, now let’s move on to the second metric commonly used by real estate investors.
2. Utilizing Gross Rent Multiplier for Rental Income Estimation
GRM stands for Gross Rent Multiplier and It’s a key metric utilized by real estate investors to determine the potential profitability of a rental property. Here’s a breakdown of what it means and how it’s used – The GRM is a ratio that compares a property’s fair market value to its gross annual rental income. It essentially represents the number of years it would take, based on gross income only, for the property’s rental income to cover its purchase price. This calculation helps investors quickly compare different properties to identify which may offer better returns based on rent alone.
Since this might sound a little confusing to some, I’ll go over a few GRM formulas as an example:
The Gross Rent Multiplier Formula
The classic GRM formula actually calculates the GRM itself by dividing the property’s fair market value (or asking price) by its gross annual rental income. Here’s the formula:
Gross Rent Multiplier (GRM) = Property Value / Gross Rental Income
This formula is typically used to understand the market value comparison. For example, by comparing the GRM of a property to the average GRM of other properties in the neighborhood that are similar, you can figure out if the asking price is in line with the expected rental income. A higher GRM might suggest a potential overpricing, while a lower GRM could indicate a better deal.
Once you have the GRM, other formulas can be used to calculate property value as well as rental income potential – let’s take a look at a few examples:
1. Evaluating Property Value (Investment Potential):
Formula: Property Value = Gross Rental Income x Gross Rent Multiplier (GRM)
This approach helps you estimate the fair market value of a property based on its potential rental income and the typical GRM for similar properties in the area.
Example:
- You’re considering a property with a projected gross annual rental income of $24,000.
- The average GRM for similar rentals in the area is 6.
- Using the formula: Property Value = $24,000 x 6 = $144,000
This suggests the property’s value might be around $144,000, based on the projected income and typical GRM.
2. Estimating Potential Rental Income:
Formula: Gross Rental Income = Property Value / Gross Rent Multiplier (GRM)
This helps determine the potential rental income an investor can expect from a rental property based on its purchase price and the area’s typical GRM.
Example:
- You’re interested in buying a property valued at $300,000.
- The average GRM for similar rentals in the area is 8.
- Using the formula: Gross Rental Income = $300,000 / 8 = $37,500
This suggests you could potentially earn around $37,500 annually in rent from this property.
It’s really worth becoming familiar with GRM metrics. I can say this with confidence because I use this metric on every property I consider. The bottom line is that it’s a reliable and helpful tool that’s well-known in the real estate sector.
3. Tips for Optimizing Rental Income Strategies
Rent comps and GRM metrics are just one part of the equation, there are other elements to consider as well when it comes to growing your wealth through increased rental rates. Optimizing rental income involves a combination of strategic property management, proactive marketing, and staying informed about market dynamics, and I’ll discuss these strategies below. Before we dive into them though, you’ll want to make note of the following articles to make sure you cover all your bases, not just your rental income:
- Protecting Your Real Estate Investment for Long-Term Profitability.
- Risk Mitigation Strategies for Real Estate Investors
- Economic Indicators that Affect Real Estate Investments
Property Upgrades Call for Increased Rental Rates
Investing in property upgrades can enhance the value of rental homes, which can justify an increase in rental rates. Modernizing interiors, updating appliances, and improving common areas can create a more appealing environment for tenants and increase demand. These upgrades not only attract higher-quality tenants but also encourage longer-term leases, and this can reduce vacancy rates. As the improvements increase the demand for the property, landlords feel more confident about adjusting rental rates.
Tenant Amenities Make a Higher Rent Justifiable
When viewing a rental property, tenants often consider the value of the amenities provided. Modern amenities can make higher rent justifiable because they enhance the living experience. For instance, properties offering a garage, in-unit laundry, and security systems contribute to a comfortable and secure living environment, ultimately making higher rent a worthwhile investment for prospective tenants.
Effective Marketing Reels in Reliable Tenants
Well-thought-out marketing strategies play an important role when it comes to reeling in reliable tenants, which can, in turn, help maintain higher rental rates. By pointing out the unique or best features and benefits of a property through advertisements, targeted social media campaigns, and virtual tours, landlords and property managers can draw in ideal tenants. Exceptional marketing materials can create a positive first impression and attract tenants who value quality and are willing to pay for it. This approach not only reduces vacancy rates but also ensures a steady stream of income.
Staying Informed About Market Trends Can Help Increase Rental Rates
Staying informed about market trends can help keep rental rates on the rise. By keeping an eye on the latest trends in the real estate market, property owners can pinpoint opportunities to adjust their rental pricing. Market trends also provide insights into supply ups and downs, economic conditions, and competitive elements, all of which can push rental rates up or down.
Tenants Screening & Landlord Insurance are Imperative
Getting reliable tenants from the beginning can greatly improve your chances of maintaining a steady income stream. This includes renter background and criminal checks, as well as checking on references from their previous residence. One bad tenant can cause the rent checks to stop flowing in for months, especially if an eviction occurs. I recommend reading over my latest article for some pointers on this – Understanding Tenant Background Checks and Security Deposits. In addition to this, having landlord insurance in place can help protect yourself against financial losses in rental income interruption under certain circumstances stances.
Power Resources for Real Estate Investors
- The Financial Freedom Academy
- Freedom Number Cheat Sheet
- 90-Day Financial Empowerment Bootcamp
- Morris Invest & SDIRA Program Overview
Utilize Rent Comps & GRM Metrics to Enhance Your Real Estate Investing Strategy
I encourage investors to implement these metric tools if their goal is to optimize rental income. Why? Because regularly reviewing rent comparables keeps your rental rates in line with market trends, and GRM calculations helps in identifying the most lucrative investment opportunities. Adopting the use of these industry tools can lead to significant financial returns and bring about long-term success in your real estate journey.
Feel free to schedule a complimentary call with our team if you have any questions about rent comps, GRMs, or simply want to inquire about our available new construction rental properties that we have available. We’d love to speak with you to discuss your real estate investing goals and answer any questions you may have.