How to charge your friends rent
Renting to friends: Fun but sometimes awkward
In some situations, it makes more sense to rent to a friend rather than share ownership. Maybe you’ve found a property with very unequally sized units. Or maybe your friend just doesn’t want to own.
The idea of becoming your friend’s landlord might feel a little awkward. But that shouldn’t stop you from pursuing what can be a clean and easy option for sharing property. It's actually a fairly common arrangement that we see.
That’s why we put together this guide: to walk you through a few different options for setting rent in a way that doesn’t seek to maximize profit, and is fair to both parties.
Method #1: Market rent method
In this method, your goal is to charge whatever the market rate for rent is. The work comes in figuring out what “market rent” is, and this can be as much art as science.
Here’s one way to go about it: you and your friend each find three spaces currently for rent that you think are comparable to the unit your friend will be renting. Review the six properties together and make sure you both agree that they are reasonable comparisons.
Next, drop the two most expensive and two least expensive. Then average the price of the middle two.
This method prevents outliers from driving the conversation.
The art, of course, is figuring out which rentals are truly “comparable." This is usually a combination of similar location, size, and level of finish.
The comparable units should be current active rentals on the market, not someone’s rent-controlled lease from five years ago.
It’s also an option to use market rate as an anchor, and then deliberately charge less. That’s the approach that Joel and Sophia took when they purchased a duplex in Fort Collins, CO. As the most financially stable of their friend group, they saw themselves as instigators—the ones with both the means and the desire to pursue the vision of sharing property.
“We looked at what market rate was, and decided to offer our friends $100 - $200 below it,” Sophia said. “Our goal was to make it as easy as possible for them to join in our vision.”
Method #2: The Return on investment method
In this method, you are going to calculate a target return on the money you invested in the property. The goal is to make a reasonable, fair return on your cash investment.
Let’s say you bought a $1m property with two equally-sized units (say or a duplex or a home with an ADU) and you put down $200k of cash for the down payment.
In this method, you will allocate $100k of that cash downpayment to your friend’s unit and try to earn a “reasonable” return on it (vs what you could get investing that money elsewhere).
There’s no clear guidance on what makes for a “reasonable” return. The number should be higher than inflation (2.6% average over the last two decades) and lower than something riskier like the stock market (~8%). One approach is to look at the typical return on real estate investment where you live. This is sometimes called the “cap rate." It’s about 5% in the Bay Area right now.
You might justify something on the lower end if your friend is going to make your life easy—staying a long time, helping with repairs, etc. And something on the higher end if they won’t.
Let’s say you choose 5% as your target return. In that case, you want to make 5% x $100k = $5,000 in return on your investment on your friend's unit every year.
So that means the rent minus your expenses on your friends unit (remember: half of the property) for the year should be $5000.
Here’s what property expenses might look like for a $1M property. The template has suggestions on how and where to find this information for your property. Note: We use only the interest part of the mortgage, not the principal, because your friend won't be getting any of that in this case.
This means you will need to cover $41k of expenses plus $5k of investment return with the rent, for a total of $46k. This equates to $3,833 per month rent.
It’s also worth considering communal resources such as a shared backyard. For instance, your friend may live in a unit that is one quarter the value of the private living space, but if you split access to a nice backyard evenly, that also has value.
Something you should also consider doing is adding an adjustment factor for vacancy. If your friend moves out, it might take you some time to find someone else to replace them. So you could add another ~5% to their rent to account for expected vacancy in the future. 5% vacancy means the unit would be empty for an average of 2.5 weeks per year (2.5 / 52 weeks ≈ 5%).
Return on investment method: Examples
Here’s how we’d think through setting rent for two properties we recently featured on Hot Friend Compounds. We’ll use the Return on Investment method.
This property has a large upper unit with 3 BR / 4 BA across two floors. The garage floor has 2 BR / 1 BA with a small wet bar / kitchenette. In terms of space, the lower unit looks to be roughly one-third of the total square footage. But since it lacks a full kitchen, let’s consider it one-quarter of the total property value.
Say you buy this house intending to rent out the lower unit to your friend. Using the Return on Investment method, you’d charge your friend $3,076 per month (see our calculations here).
2720 Martin Luther King Jr. Way, Berkeley
This stately duplex has a larger upper unit with 4 BR / 2 BA spread across two levels, and a smaller lower unit with 2 BR / 1 BA. Each unit has its own laundry and private decks that lead to a shared patio at the garden level. The lower unit is about one-third of the total square footage, and looks to be a similar level of niceness, so let’s consider it one-third of the total property value.
You buy this house intending to rent out the lower unit to a friend. Using the return on investment method, you’d charge your friend $4,546 per month (see our calculations here).
What about rent increases?
A good thing to do when renting to friends is agree on a principle for how and when rent will increase. Here are a few ways to think about it:
- Agree that you’ll increase rent X% every year to keep up with expenses
- Agree that you’ll increase rent by inflation every year
- Agree that you’ll just pass on the direct cost increases .. e.g. increases in insurance, property tax, etc.
What about capital improvements? Say you decide to invest in a solar power setup that costs you $50k (but reduces energy bills, which your tenant might be responsible for, to zero). Hopefully your friend is reasonable and you can deal with these case-by-case scenarios under the framework above. You can use the template to adjust the rate to reflect additional capital invested (and potential cost reductions).
Case study - Vandy and Lauren: When mortgages go up
Vandy and her husband hasn’t specifically thought about how they would handle rent increases. They owned their own house and the house next door, and had been renting it to their friend Lauren for about half of market rate. Their mortgage at the time wasn’t very expensive, and Vandy said “it was worth it to be able to live in community with someone we love so much.”
But then their mortgage rate was reset and her payment doubled. It no longer felt tenable to rent the house to Lauren at such a steep discount. Vandy and her husband sat down with Lauren and walked her through all their thinking around increasing her rent, showing her the changes to their mortgage and rents for similar properties in the area. Lauren ended up bringing on occasional subletters to help cover the rent increase—a solution that felt comfortable for everyone.
“It was very collaborative. We really want to share this place with each other. And we each have our own limitations and constraints of what we can do. We were all driving towards making it work.”
- Vandy
When it gets hard
Sometimes really bad stuff happens. Maybe a tenant or their family member gets sick and has big medical bills. There may be a perception (true or not!) that you as their landlord are more financially stable and could afford to help them out.
Or on the other side of things, maybe a wildfire hits and your property needs to be evacuated. You and your friend don’t have a place to live, and no one’s happy.
These can be opportunities for friends living together to really shine. We’ve seen friend groups put together solidarity funds for members going through tough situations and offer their spare bedrooms when natural disasters hit.
But it’s not always that easy. In either case, stress can do weird things to friendships. Your perceptions of what’s fair may differ, and there’s often no right answer.
This is why we always recommend having well-defined contracts in place, or even just a set of agree principles. This article explains leases, subleases, and master tenancy in more detail and includes a suggested template.
No document is going to be able to anticipate everything that could happen. But it helps to have a baseline for tough conversations that you both agreed to when there weren’t stressful events afoot.
Renting to friends: Fun but sometimes awkward
These tools should clear the way to renting to a friend using a framework that can help everyone agree on what’s fair. It can also help handle future situations where rents need to change … e.g. if more money is invested in the property or if another person joins the mix. Being honest about this and being transparent about why costs are what they are can help you both get to a point where you feel comfortable about the arrangement.
