The process of setting rent for a property is not as simple as you might think. There are many variables to consider that will affect the final amount. Whether you are a tenant seeking a new lease, an investor looking for a new opportunity, or a developer looking to maximize revenue, understanding what determines rent is important. Let's take a closer look at the myriad factors that play a key role in setting rent.
Physical factors
Construction Cost
When a developer or initial landowner constructs a property, they incur significant costs including materials, labor, and sometimes interest on loans taken out to finance the project. The developer or landowner must set a price that not only recovers these costs but also allows for a reasonable profit margin. This initial cost burden inevitably has a significant impact on the subsequent rental value of the property. The main drivers of construction costs include:
Materials: The cost of construction materials is an important consideration. Higher quality materials will generally increase construction costs, but they may also increase the lifespan and appeal of a property, potentially increasing rental prices.
Labor Costs: Labor costs vary depending on local economic conditions, the level of craftsmanship required, and the scale of the project. The more specialized the labor, the higher the cost, which will be reflected in the sale price and rent.
Financing: Developers and landowners often consider financing options such as loans to cover construction costs, and interest on these loans adds to the total cost of the project. Higher interest rates or longer repayment periods can increase the total construction cost, which can affect the final price and rental value of the property.
Profit margin: Finally, a reasonable profit margin must be built into the selling price for the project to be economically viable. This profit margin will vary depending on market trends, risk assessment, and return on investment goals.
Condition of the building
A property in like-new condition will command a higher rent than one that is in need of major repairs and updates. The cost of any necessary renovations, renovations and improvements will directly affect the rent you can command when the property is ready to rent. The better the condition of the property, the higher the rental price you are likely to command. Key aspects of a property's condition include:
Maintenance and repairs: If a property needs major repairs or maintenance, the costs are often passed on to tenants in the form of increased rent. This can include everything from repairing structural damage to upgrading outdated fixtures.
Renovations and improvements: The need for major renovations and improvements, such as adding energy-efficient systems or modernizing interior spaces, can increase rent. However, these upgrades can also make your property more attractive to potential tenants.
Age of the property: The age of the property will affect its condition and therefore the rent it can command. Older properties may require more maintenance, but they may also have architectural features that are desirable to certain tenants.
position
“Location, location, location” isn't just a cliché in the real estate industry. Location greatly influences property values. Access to major transport routes, proximity to amenities, and the desirability of the neighborhood all affect property values and therefore rents. Factors such as one-way or two-way traffic, signalized intersections, and the presence or absence of parking all affect rents. Additionally, especially for retail businesses, the amount of frontage and visibility can also make a big difference. Key aspects of location include:
Transport Access: Properties located near major highways, public transport links or bustling commercial centres are generally more popular and can command higher rents because they offer convenience to tenants.
Proximity to amenities: If a property is close to amenities such as shopping centers, parks, good schools, medical facilities, etc., it will be more desirable and, as a result, higher rents.
Neighborhood desirability: The reputation and desirability of a neighborhood will affect rent prices. Factors such as safety, noise levels, and overall atmosphere all influence what tenants are willing to pay.
Accessibility and visibility: For commercial real estate, ease of accessibility and visibility are important. Properties along one-way streets or with little parking are likely to be less popular and command lower rents. In contrast, high visibility, traffic lights at intersections, and ample parking can make a property more attractive, especially for retail businesses.
Taking these physical factors into consideration provides a more comprehensive understanding of the many factors that determine a property's rental value. Being aware of these factors can help landlords and tenants make informed decisions in real estate investments.
Real Estate Market Factors
Market Overview and Trends
The overall health of the real estate market and its general trends also affect a property's rent. Rents are often compared to similar properties within the same market or submarket and can vary widely even within a small geographic area. City, state and national level trends, such as economic conditions and urban development plans, can also affect rents. Important aspects to consider include:
Market Comparisons: Rents are often compared to rents for similar properties in the same market and submarket. These comparative metrics are helpful in determining the rent for a particular property. Therefore, understanding the rents for similar properties in your geographic location is very important.
Health of the Economy: The overall health of the economy at the city, state and national level has a direct impact on rents. Typically, a strong economy will increase demand and drive up rents, while a recession will cause lower demand and drive down rents.
Planned urban development: Future urban plans can also impact rents. For example, if there are plans to improve infrastructure, build new amenities, and revitalize the area, property values and rents may increase in anticipation of these improvements.
Currently available competitive buildings
The availability of similar properties in the market plays a key role in determining the rent. An oversupply of similar properties can lower the rent, while limited inventory can increase the rent. Comparisons are also made with recently sold properties and properties currently on the market to give an idea of what the going rate for similar properties is. This includes factors such as:
Local supply and demand: An oversupply of similar properties may drive down rents as landlords compete for tenants. Conversely, limited availability may increase competition among tenants and drive up rents. Recent sales and current listings: Rents can also be determined based on the sales prices of recently sold properties and the rents of currently available properties. This gives landlords an idea of the “going rate” for similar properties, which helps them set rents competitively.
Traffic Count
For commercial real estate, traffic volume (the number of vehicles and pedestrians passing by a property) can directly affect rent prices. Higher traffic volume increases visibility, which brings more customers to businesses operating in the property, increasing the value of the property. Traffic volume is typically considered in two main categories:
Visibility: Properties with high traffic volumes can command higher rents due to their high visibility. More vehicles and pedestrians passing by a property increases the chances of attracting customers, making such locations more attractive for retail businesses.
Accessibility: Properties with high traffic and easy access are more popular and command higher rents, but heavy traffic congestion may scare off potential tenants, so a balance needs to be struck.
Interest level
Finally, interest rates play a key role in determining rents. Many commercial real estate investors are leveraged and are sensitive to changes in interest rates. Low interest rates make borrowing costs cheaper, which can encourage investment in real estate, increasing property values and rents. Conversely, rising interest rates can increase financing costs, decreasing demand for real estate and decreasing rents. Key factors to consider include:
Borrowing costs: When interest rates are low, investors have a lower borrowing cost. This encourages investment in real estate, which increases property values and rents. Conversely, when interest rates rise, borrowing costs increase. This reduces the demand for real estate, which can lead to lower rents.
Investor behavior: Investor behavior in response to changes in interest rates can also affect rents. For example, when interest rates fall, investors may be more willing to pay higher prices for properties, which can lead to higher rents.
The factors that determine property rental rates range from the physical characteristics of the property to market trends to current interest rates. A thorough understanding of these factors provides valuable insights to all stakeholders in the real estate market, leading to more informed decisions and optimal outcomes.
Marc Altieri > Vice President, Leasing and Investments
Marc Altieri joined SimonCRE in 2021 as Vice President of Leasing and Investments, where he is responsible for communicating with tenants throughout the development process, coordinating with brokers and buyers, and ensuring timely and accurate transactions through comprehensive due diligence.
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