The easy answer is “whatever a tenant is willing to pay.” That answer though makes it difficult as an owner to predict the average rent that can be charged over a period of 5 or 10 years, and thereby determine if it is economically feasible to rent their unit, or if they should simply sell.
It’s an important decision – because margins on rentals can be very thin if the unit is highly mortgaged.
Certainly part of the process is to check what similar units are renting for, near where your unit exists. Maybe it also includes looking at some historical rental data. But good planning usually involves a bit of a formula.
There are two formulas – one on average income, and one on the unit price.
As an owner, look at the average income your tenant may have. When we rented our unit – a two bedroom – we assumed a young single male with either a female or male roommate. In Canada for 2009 A non-elderly male (average) and a non-elderly female (average) make 40,600 and 35,800 respectively. Combined they would have 76,400 in income (both before tax).
The maximum a person should effectively pay in rent (including utilities) is 30% pre-tax. Because our condominium includes water, waste and electricity in the condominium fee, we don’t have to factor those into the 30%. So from an average income perspective, we should be able to charge about 1910/month. This turned out to be well over what the local market turned out to be – probably because other units don’t include electric, and maybe we are thinking that one or both might be students, which might reduce the (average to non-earner) income. If we change the female to non-earner, her income goes to 18,100 – or now a total income of 58700. 30% of that number is $1467.50/month, and if you subtract utilities (to be competitive with the market) then you get about $1387.50/month expected rent.
There is a rule of thumb that indicates if the cost of the unit is 15x or less the rental cost (yearly basis), then people will migrate from renting to buying. If the unit is 16x or more the rental cost people will continue renting. The smaller the percentage of the unit they pay per year, the better the odds of renting the unit. The sweet spot seems to be 16x or higher cost:rental makes better economic sense.
Assuming that we want to charge the highest rent, but still have it make worthwhile sense to a renter, we want to charge a rent that is 1/16 the cost of the unit. If we were desperate to rent the unit, we might charge 1/17 or even 1/21 of the cost – both being much more attractive to a renter. The city of Calgary places our Fair Market Value at $248,000. So our maximized rent would be 248,000 / 12 (months) / 16 (our ratio) = $1291. If we subtract utilities, we would be renting at $1211/month.
Which Formula Works
We are successfully renting our unit at $1200/month. It’s in line with the other local rents, and is competitive for both the city and the rental market (which changes as rental occupancy goes up and down). From a personal perspective, the Unit Price approach seems to be easy and very close to the actual rental amount. We should be aware though that if the rental market softens, we could expect to see rental rates at lower then 1/16 – if it was at 1/19, then the market would likely only support $1007 rent (or 17% cheaper), something we should be aware of.
The income ratio tells us the type of people we are likely going to be interviewing – with a pre-tax income of rent X 12 / .3 or in our case (at $1200) about $48,000 before tax.