Editor’s note: In part two of a three-part series on "accidental landlords," Inman News looks at the most challenging decision involved in marketing a rental — establishing the asking rent. The "ghost market" for homes and condos complicates the process. Part 1 looked at the factors to consider before pulling a for sale property off the market to rent, and whether to hire a property management company to handle the details.

Editor’s note: In part two of a three-part series on "accidental landlords," Inman News looks at the most challenging decision involved in marketing a rental — establishing the asking rent. The "ghost market" for homes and condos complicates the process. Part 1 looked at the factors to consider before pulling a for sale property off the market to rent, and whether to hire a property management company to handle the details.

Whether it’s the property owner, a Realtor or a property management company calling the shots, the most crucial decision in marketing a rental property could be determining the rent.

No matter how many people see a rental listing — and no matter how well that listing shows off a property’s best features — all other things being equal, renters are likely to look at the property with the most attractive price first.

The biggest mistake accidental landlords often make is to base the asking rent on their mortgage payment and other expenses associated with a rental property (see Part 1).

"If they set their pricing like that, they’ll either have no interest (from renters) or they’ll end up renting the property well below market cost," said Douglas Pope, co-founder and director of operations at the map-based rental listing site HotPads.com. "If your property goes off the market in just a couple of days, you know you left money on the table."

If setting the asking rent too high decreases the odds of landing a tenant, some beginning landlords may not realize that underpricing can lead to potentially more serious problems.

Would-be condo flippers often drastically underprice when they decide to rent their properties, said Lisa Trosien, a Chicago-based property management consultant and educator.

"They panic, and say, ‘I’ve got to get someone in there to cover my monthly costs — I don’t care if I make money on the deal,’ " Trosien said. "While I understand that mindset, that’s where a lot of times they run into trouble."

Underprice the rent on a condo unit and you will attract tenants who wouldn’t qualify as buyers in the same development.

"They are going to get the bottom of the barrel — somebody who may damage the unit, or a smart renter who knows how to stretch out an eviction," Trosien said.

Determining market rent is not unlike appraising a property. "Comps" — comparable properties in the same market or even neighborhood — are used to determine the going rate.

Property management firms often rely on companies that gather market intelligence to help them determine rents. Free apartment search sites geared for consumers can also be useful in getting a feel for the market (see Part 3).

The size, location, age and condition of a rental all influence rent, as well as amenities such as parking, swimming pools and common areas, and appliances such as washer-dryers and dishwashers.

A two- or three-bedroom condo or single-family home is typically larger than a similarly configured apartment. Although that can be accounted for by determining rent on a price-per-square-foot basis, condos and single-family homes may also have other advantages over apartments — such as privacy and prestige — that are more difficult to quantify.

Because renters may prefer condominiums and detached single-family homes to apartments, mixing and matching housing types may not produce suitable comps.

The ghost market

Ultimately, supply and demand determine rents, and the housing slowdown can affect both ends of the equation.

On one hand, homeowners in markets where home prices are falling are facing foreclosure because they can’t refinance out of risky adjustable-rate mortgages with big payment resets. Many of those homeowners will become renters, increasing the demand for rental housing.

But with housing inventories rising to record levels in some markets, investors may snatch up homes and condos and lease them out, adding to the supply of rentals.

Accidental landlords — owners of homes and condos who want to sell, but are trying to outlast the market downturn by renting them out — are another source of home and condo rentals in what’s often referred to as the "gray" or "ghost market."

Rents in the San Francisco Bay area have been on the way up in the last couple of years, with double-digit annual rates of growth in San Francisco proper and Silicon Valley during the third quarter of 2007, said Caroline Latham, the founder and owner of RealFacts, which collects market data for multifamily property managers.

After several years of slow or flat growth, pent-up pressure is once again pushing Bay Area rents up, although not to the extremes seen during the late 1990s dot-com boom.

Back then, Latham said, many Bay Area landlords had long waiting lists, and tech workers were sharing housing or even moving back home with their parents. When the dot-com boom went bust, the rental market cooled down.

"You could not only get dollars off the asking rent, but maybe six months of free parking and a washer and dryer," Latham said. "But concessions have pretty much disappeared from the market at the moment."

While occupancies in the years after the dot-com bust were hovering at 90 or 91 percent, "now that’s come up nearly everywhere," Latham said. "By and large occupancy is now about 95 percent — that’s generally the precondition for being able to get rent increases."

The 95 percent occupancy rate represents "the ideal, balanced market," Latham said, allowing property owners to make a profit, while providing enough supply so that renters have some choices about how and where they live.

"I think that is threatened by the existence of this gray market — all those houses and condos that are going to come on to the market will increase the supply by some untold number," Latham said. "As properties bought as speculative investments come on the market in some way, it’s sure to affect rents."

Some large multifamily housing projects originally conceived as condominiums during the boom are coming onto markets around the U.S. as rentals instead. Further complicating the supply-and-demand picture, some investors who tried to convert apartment complexes into condos got only partway through the process, leaving some buildings with a mix of for-sale and rental units.

Latham said it’s hard to measure how many people want to rent out their homes or apartments.

"There was a lot of speculative purchasing, people who were buying those condos never intending to live in them themselves, or even bother with the cash flow of renting them out," she said. "They just intended to make profit when they sold them to the next person down the line. That strategy is not working out for a lot of people. We’ve been trying to estimate what the impacts on rents are, and so far haven’t come up with any good numbers."

According to Marcus & Millichap Research Services, the markets with the lowest apartment vacancy rates at the end of September were New York City (2.2 percent); neighboring Fairfield County, Conn. (3 percent); Long Island, N.Y. (3.1 percent); Central New Jersey (3.2 percent); Orange County (3.2 percent); Los Angeles (3.5 percent); Northern New Jersey (3.5 percent); San Jose, Calif. (3.6 percent); Miami (3.7 percent); and Norfolk, Va. (3.8 percent).

"Rental markets are getting a lot stronger in a lot of cities — it depends on where you are," Trosien said. "Florida is really struggling."

Florida‘s condo craze

Florida’s condo market, where investors and speculators were active during the boom, illustrates how condos and condo conversions may affect rental markets.

According to Marcus & Millichap, the five markets that saw the greatest percentage of apartment units converted from apartments to condos during the housing boom are all in Florida.

Nearly one in three apartments in Ft. Lauderdale — an estimated 28,800 units — were converted to condos. The pace of condo conversions was also impressive in Orlando (24.2 percent of apartments converted); Palm Beach (23.7 percent); Miami (20.7 percent); and Tampa (15.6 percent).

Other cities on Marcus & Millichap’s list of top 10 condo conversion markets include Charleston, S.C. (15.3 percent converted); Jacksonville, Fla. (11.6 percent); Las Vegas (11.6 percent); Phoenix (9.6 percent); and San Diego (7.8 percent).

While apartment vacancy rates fell precipitously in the top 10 condo conversion markets from 2003 to 2006, the trend has since reversed itself in each of those markets.

If a 5 percent vacancy rate represents a balance of the needs of property owners and renters, the apartment vacancy rate in mid-2006 favored renters in just two of the top 10 condo conversion markets — Charleston and Phoenix.

By the end of the second quarter of 2007, vacancy rates exceeded 5 percent in six out of 10 of those markets, putting renters in the driver’s seat in Orlando, Palm Beach, Tampa and Jacksonville. In just 12 months, Marcus & Millichap reports, the vacancy rate in Palm Beach shot up from 4.2 percent to 7 percent.

Ron Witten, a consultant who advises developers, investors and lenders on major U.S. apartment markets, said rents are generally tied to the housing inventories. In some markets, for-sale homes may be so abundant — and attractively priced — that they attract buyers who might otherwise have been renters.

"The number one factor (on rents) is how overbuilt the overall housing market is in each of these metro areas," Witten said.

In markets like Austin, Texas and Raleigh, N.C. — where there’s no evidence of an oversupply of single-family homes or condos — the subprime fallout will turn many families into renters, Witten said. While other apartment owners will move up to home ownership, "there’s no dilution of demand. It’s a swap — some move from A to B, while others move from B to A."

But in areas where developers built lots of new homes and condos during the boom, oversupply has the potential to depress rents, Witten said. Compounding the problem, many areas that saw a boom in construction were also popular with speculators who bought properties that are now or soon will be back on the for-sale or rental markets.

According to the Mortgage Bankers Association, 32 percent of home loans in default in the state of Nevada at the end of June were to borrowers who didn’t occupy the property in question (see Inman News story). In other words, they were second homes or properties bought to flip. The non-occupied share of loans in default was also much higher than the national average of 13 percent in Arizona (26 percent), Florida (25 percent), and California (21 percent).

Trosien said those areas — and also places like Chicago and Washington, D.C. — are examples of ghost markets, where owners of rental properties are "competing against not only professionally managed developments, but people who went in and bought to flip."

The latest Census Bureau numbers show rental vacancy rates are highest in the South (12.1 percent) and Midwest (11.6 percent), and lowest in the West (6.8 percent) and Northeast (7.1 percent).

Marcus & Millichap and Economy.com estimate that so far this year, condo sales have plummeted 55.5 percent in the Washington, D.C., area, 40.2 percent in Las Vegas and 25.6 percent in Phoenix. Condo sales have also slowed in the Florida cities that led the nation in condo conversions, including Tampa-St. Petersburg (down 34 percent); Jacksonville (down 28.6 percent); and Miami (down 28 percent).

Although most of RealFacts’ clients own, manage or develop multifamily housing projects, Latham said the firm has been retained to do studies for developers who have San Francisco Bay Area condominium projects in the works. Developers are anxious about whether there will be buyers, and if so whether the buyers will be able to get loans.

"People have been coming to us and saying, ‘What would we get if we turned this into a rental project?’ " Latham said.

Like Latham, Witten expects to see existing buildings subjected to condo conversion coming back as rentals, and new projects originally conceived as condos marketed as apartments instead.

"It’s much easier to speculate in condos than it is in the single-family market. I can put a deposit down on a new condo, and if it’s a presale I don’t have to worry for 18 months if I have to close," Witten said. "I think we ended up getting a lot of condo construction supported by those speculators that, in hindsight, was in excess of what was needed. As the market goes soft, those presale agreements are dropped, deposits are forfeited, and lawsuits are filed."

Despite that worrisome trend, Witten estimates that nationwide, there are about 10 excess single-family homes for every condo.

"I would say its on the magnitude of just under 1 million more empty single-families on the ground today than the nation would normally have, and it’s 100,000 to 150,000 units for condos," Witten said.

We need a big place

One factor that could cushion the influx of homes and condos onto rental markets is that construction of multifamily rental housing declined in many areas during the housing boom. Witten said 2007 could mark a 14-year low in new apartment starts nationwide.

Another bit of good news for some accidental landlords in markets hit hard by foreclosures is that when families lose their homes, they’re not looking for a studio apartment, Latham said. Many will want to move to a three-bedroom apartment, home or condo.

"We are just starting to see if those are the units in greatest demand, and where units are going up the most," Latham said.

According to the latest Census Bureau data on housing vacancies and home ownership, single-unit buildings such as homes and condos had a lower vacancy rate — 9.4 percent at the end of September — than buildings with multiple units. Buildings with five to nine units had the highest vacancy rate, 10.9 percent, compared with a 10.2 vacancy rate for buildings with 10 or more units.

The Census Bureau reports that the more rooms a rental had, the more likely it was to be occupied during the third quarter. Units with one or two rooms had the highest vacancy rates — 20.5 percent — and those with six or more rooms the lowest, 7.6 percent.

Rent per square foot has been "of special interest" to people thinking about renting out condos, Latham said, because condos tend to be larger than most rentals.

"Let’s say a one-bedroom unit in a rental building might be 650 square feet, but a condo might be 1,000 square feet," Latham said. Condo owners want to know, "How much more can we get because it’s a bigger unit with additional amenities?"

ApartmentRating.com founder Jeremy Bencken said a survey of the site’s users found "the vast majority of renters — people who are ostensibly apartment hunting — are interested in (renting) houses and condos."

Witten, however, questions whether condos and single-family homes are more desirable to renters than apartments.

"The reality is that professionally managed apartments have lots of amenities, and if something goes wrong, you know where to go to get it fixed," Witten said. "That’s an advantage to the rental sector."

Another difficulty of marketing a condo or home that the owner intends to put up for sale when market conditions improve is that many renters are looking for long-term accommodations.

A final consideration in setting rent is the time of year a home goes on the market. Don’t get discouraged — or assume you’ve set the rent too high — if you put a property up for rent at the end of the year and there are no takers.

October and November are "the worst time of the year" to market rental properties, said Robert Massey Jr., founder of RentalHouses.com and vice president of industry development at Primedia’s Rentals.com.

When Massey was a full-time property manager, prospective clients would approach him around that time about renting out a property they were having trouble selling.

"I’d often be contacted late in the year, because it’s a slow market for sales," Massey said. "Well, guess what? The rental market follows the same pattern. The reality is, the house will sit vacant longer than if it comes to me in April."

Up next: Part three of a three-part series on "accidental landlords" provides an overview of software and Web sites for marketing and managing rental properties.

***

Send tips or a Letter to the Editor to matt@inman.com, or call (510) 658-9252, ext. 150.

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