fredherrman@mac.com
Fred Herrman
"Helping You Reach Your Financial and Real Estate Investment Goals"

For Investors - Lease Pricing Tips

January 11,2021 | Posted By Fred Herrman in Investor Information
Share On:
 
This is not a how-to for the steps of putting a property onto the market for lease.  This is more of a thought process one should go through as one is pricing a property for sale.

When a person finishes comping a property, meaning that they have come up with a price for their property to be leased at by looking at surrounding, equal type homes that have leased in the past few months, there is an initial reaction to want to price one’s home just above that price.

So, let’s say you have a single family home or a condo that you want to lease out, and you have found that equal sized and equal amenity homes in the area have leased out for $1,750 per month.  Each owner wants to squeeze as much income out of the property that they can.  

And so, for the $1,750/mo lease above, they might want to list it at $2,050/mo.  Their thinking is that if they can just get someone in there for a higher than market amount, their return on their investment will be GREAT!  And it would be great, indeed!  If the home cost you $350,000 to buy, then you’re getting a gross annual return of 7% rather than 6%.  That’s before maintenance costs and insurance and all of that.  

But the point is, hey, let’s crank up the price a bit above market and see if we can get someone in there.  I’ll describe why you can do this with homes that you’re trying to sell.  But let’s talk a little about why this doesn’t work so well for leasing.

There are a few problems with this strategy.  Sometimes an owner gets lucky, get’s a good renter in, and manages to keep them until the rents actually meet his property’s rents.  But most of the time, by putting a lease above market, you get a few issues.

Firstly, the really good renters, the one’s that you want, will probably be smart enough to walk away and go to the next lease available.  This is because the sought after lessee is the one with the high credit score (say, 770 or above, average), the one who has great income, and also the one who has some nice reserves in the bank.  This is the trifecta of characteristics that a lessor looks for in a lessee.

And so, this desirable lessee, let’s say she has an 800 credit score, has what everyone wants and can pick and choose the best options out there, will likely get whatever property that she is interested in.  And she will be interested in those leases that are priced at or below market, and that are in good shape as compared to all of the other homes that she is seeing.

Think of it like this.  The people then, with the poorer rated credit scores, say, someone with a 630 credit score, are going to be passed over for the first guy (the gal with the 800 credit score).  So the 630 guy has to keep looking and looking, coming closer to his move out date of his old place.  What happens?  He start to throw Hail Mary passes.  He starts applying for the pricier places that are above market; the one’s that those lessors who want the extra few bucks are sitting there still waiting to lease out.  

This cycle feeds on itself.  The revved up landlord who wants more money, and the low score, lower income, no cash in the bank lessee; they always find each other.  

Another reason that you want to price your leases at market is that even if you get a better score person in there for a year-term, they’re quickly going to realize that they made an error and that they can get better value out of another property for the rent that they are paying.  So they will end their lease at the end of the year contract, and now you, the landlord, have a month or two of vacant property bringing in no cash, and on top of that, you have to clean, repair, and repaint most likely.  Possibly new carpet as well if you didn’t change it before the good guy came in who just left.  

Conversely, if you have a property at or just below market, and you get the quiet librarian with the 800 credit scores (that’s every owner’s wish), she will enjoy being in a place that is valued at market and not be a lessee who feels jilted or conned by the owner.  This creates a situation where you could have her living there for four or five years.  That is well-worth the difference in price in not having a vacant property after a year or two, cleaning, preparing, painting…everything I mentioned above, which causes you to lose money.  

With all of that said, it is also important to keep your investment property at market level on a regular basis.  An owner may feel that it’s nice to have a tenant in place and that he or she just wants to keep them happy by not ever raising the rent on them.  But as we all know, especially here in California, new bills and propositions are occasionally introduced trying to make specific areas and home types come under various types of rent control laws.  Often, these rent control laws restrict owners from raising a property’s lease price by more than a certain percentage on an annual basis.  

If you were to have your property under market lease price, as I stated, maybe because you were keeping a tenant cozy in your rental, you could get caught in a situation where you could not raise the price back up to market had you been well under the market, simply because increasing your property up to market would exceed the cap on annual rental percentage increases.  The lesson here is to keep your property at, or maybe just slightly under market to keep good tenants in for the long term, but not to let the price go too low under market, and not to raise it much above market either as stated earlier. 

So I mentioned that this doesn’t necessarily apply so much for homes being sold.  I truly believe as an agent it is always better to price a home at market and get as much activity quickly as possible while the listing is fresh.  However, in selling a home, there are an assortment of different strategies based on what the seller needs at any point in time.  

One is the lady who just got a great job in Arizona and needs to get the money out of her house as fast as possible to start her move.  That person might consider pricing the home just below market to get a lot of activity.  If there is a frenzy and multiple offers come in, then the owner and agent can set a date and tell all offer-makers to submit a best and final offer by, say, Tuesday at 5:00pm.  That solves that because in doing so, the price may be pushed up a little by the knowledge of each potential buyer that there are competing offers.  

Then, there is the person who just wants to sell it...whenever.  They’ve moved out, and they say, “Just list it and sell it.”  I’d go with as close to market price as possible.  That’s simple.

But another strategy is for the seller who is afraid of leaving something on the table.  Let’s say that her home is comping at $350,000, and she thinks in her mind that she should get $365,000 for it.  She did some customization inside and believes that it should go for more.  

Well, what I do as a Realtor© is first to show her the comps of her area indicating the $350,000 market price.  But, if she is insistent, then I also offer to list it at her price of $365,000 with the proviso that we float the property price down regularly, like every two weeks, by a couple of thousand dollars or so.  

What this does is that it lets her start at her price, and if there is little to no activity beyond visits, she is able to see that the market is not paying what she thought for her house.  And by floating it down, it also keeps her property active on the MLS (on various client searches and such that are refreshing with new prices).  

As long as the seller understands that what we are looking for is activity, as in offers being made, then she can witness for herself where that threshold becomes apparent for her specific property.  

Now, to get to my final point that I mentioned at the beginning of this article.  Why could you implement this strategy with a sale property, while listing a home above market for a lease has been shown to not work well for the owner?  

Two reasons.  One is that buyers are pre-approved by a lender.  They already know what they are cleared to by in terms of listing price, and when an offer is made, the pre-approval letter from the lender is included with the offer.  So you generally know, with a few rare hiccups from the lender’s side, that a prospective purchaser can hit the target of whatever price is being offered.  

But secondly, you must realize that any property that is being purchased with a loan is also going to be appraised.  This is something that is important for each seller to realize when pricing their property.  When they price the property above market, they are also risking that when the appraisal is completed by a third party sent via the buyer’s lender during the escrow period, that a buyer has two options, as does the seller.  

If the property appraises for $350,000, but the buyer’s offer was for $365,000 (remember that we listed above market for $365,000 in this scenario), then the buyer can either request from the seller that the price be brought down to $350,000.  That’s once choice for the buyer.  The other choice is that the buyer can put up the rest of the $15,000 from their personal savings or wherever is allowed and fill in that gap money.  Because the lender will generally not lend on more than the appraised value of the home.  

The seller has two choices.  The seller can either at that point reduce the price to $350,000, or they can ask the buyer to fill in the gap money.  If the buyer doesn’t agree to filling in the gap money, and the seller is still stuck with the $365,000 price in her head, then the buyer can walk away and terminate the transaction (as long as they never waived the appraisal contingency on their offer).

But this is the conversation I would have with the seller before any of this started. I would let them know that if they do decide to price their property higher than market, and if the scenario above occurs, that if they then stick to their guns and won’t reduce the price as a result of the lower appraisal outcome, then that appraisal, as well as all other reports and inspections, needs to be made available to the next person who makes an offer.  Meaning, that when the next offer comes in from someone, they too will know about the lower appraisal having been assessed.  That may turn away people down the line if they know that the seller won’t negotiate down from an appraisal that does not match the offer price.  

There are no hard and fast rules for pricing property.  Each property has to be looked at, compared with other like properties, and then priced in a way that works for the seller and for the property’s time and place.

Anyways, to get out of the thick of it, that’s why when selling a home, you can start a bit higher in price if that’s a strategy that meets your needs and you have the time.  It’s because the buyers in that range will already have been pre-approved by a lender.  With leases, there is no pre-approval process.  It’s all in the lessee’s credit scores, income, and reserves; that magical, golden trifecta of investment property tenants' characteristics.  

Testimonials

Fred offered wonderful service when I needed to sell a house. I literally turned the keys over to him one day and then never had t...
- Robert P. - Calabasas, CA

Location

First Class Real Estate
2926 W. Magnolia Blvd. Burbank, CA 91505

DRE# 01789650

Copyright © 2002-2021 RealtyTech Inc.
Real Estate Websites by RealtyTech Inc.