If you want to estimate expenses and you make an offer. I’ll give you nothing if you give me $20,000. Until you go insane or broke, you’ll send me another $50 to $200 monthly.
Does this seem like a decent deal? No? Because they didn’t correctly assess rental property expenses, many rental property investors repeat the same mistake with every transaction. What’s the result? Cash flow is negative. Money is being lost. And regrettably, it occurs frequently in real estate investing, sometimes resulting in financial devastation.
I should know because “failed landlords” account for 90% of my deals.
But why do so many landlords go out of business? Simple. They don’t do the calculations. They purchase houses based on emotion, gut sensations, or inaccurate estimates, only to lose money afterward. And there’s one calculation that most people get wrong: the costs of owning rental homes.
How to Calculate Rental Property Expenses Accurately
Let’s pretend you’re looking at a house in Neighborhood A. It’s simple to determine costs if you already own a property in Neighborhood A—look at your other property. It’s a convenient place to keep track of actual spending.
However, you won’t know most of the time because you don’t own a property in the region. Alternatively, you may own a home in Neighborhood B, which comes with its own set of prices. Here are a few easy ways to figure out what your rental property’s future expenses might be:
Inquire with local property managers: Most would be happy to provide you with this information, knowing that the more helpful they are, the more likely you are to use them as a management firm in the future. Call and say, “Hello, I’m seeking to acquire a rental property in the region and am just getting started.” Would it be okay if I asked you a few simple questions?”
Make the following phone calls
Second, feel free to contact the firm who issued the expense and inquire! Are you unsure how much water will cost at your prospective rental property? Inquire with the company or government organization in charge of water billing! Most of the time, they’ll give you an average on the property for the past several months—or at the very least an approximate figure.
Inquire with other investors: Finally, inquire about individuals who own nearby rental units. Local real estate clubs, public records, asking your real estate agent for referrals, or simply interacting with them on Bigger Pockets are all excellent ways to locate them.
When planning your monthly budget, don’t forget to factor in the upfront costs of any property, such as closing charges, appraisal fees, and broker fees. Smart rental property owners consider the overall picture rather than the details.
Let’s talk about the expenses you need to account for now that you know how to find out about them.
Expenses that are not variable
The fixed expenses are the first thing we’ll look at. These can be perplexing since, despite the term, they aren’t usually “fixed,” but they happen frequently and repeatedly. Utilities and mortgage payments are common examples.
Here’s an example of some of the most recurring fixed charges you’ll encounter with your rental property. Although not all of them apply to your home, this should give you a good notion.
Sewerage and water
This is the fee for using the city’s water and sewer system. (These are frequently combined into a single bill.) In most residences, the tenant pays this rather than the landlord; however, this is not always the case. Examine the competition in your area to see if you can get away with charging the tenant for this service.
Taxes on real estate
As the saying goes, the only certainties in life are death and taxes. Therefore you’ll need to budget for this. Property taxes are sometimes (but not usually) included in the mortgage (together with insurance). In the United States, taxes are generally paid in two installments, one in the spring and the other in the autumn. Always look at future year’s property tax bill when predicting your property taxes, not previous year’s. Every year, taxes almost always increase!
Although most tenants pay for electricity, many property owners (particularly in multifamily) still pay for the property or a portion of the property, such as parking lot lighting or storage rooms.
- Depending on the contract, garbage can be paid for by either the tenant or the landlord.
- Natural gas or another source of heat
- This cost is frequently covered by the tenant, but double-check
Insurance costs, like property taxes, are frequently included in the mortgage payment. If not, set aside money each month for insurance costs. Insurance usually is paid in one big sum once a year, but many insurance firms provide monthly payments for a price.
Fees charged by the homeowners’ association
You’ll have to pay HOA fees if your home is part of a homeowner association (HOA), a group of neighbors legally obligated to follow specific rules. Condos and wealthy communities are the most common examples.
A homeowner’s association or a local government municipality will frequently enact special assessments that will cost you money each month. Although there is no way to forecast future special estimates, chat to your neighbors to discover if there are any existing assessments in the area.
Fees for property management
On the other hand, property management is when you employ someone to look after your property. But there’s more to it than that. Even if you manage your property, there are still expenses, such as paper, gas, advertising unoccupied units, paying any person you hire, and your time. Calculate property management costs whether you plan to hire someone else or not because it’s still a cost.
Besides, you’ll be prosperous and have a lot of properties one day and won’t be able to handle them all on your own. Start putting money down for that day right now!
Call your local management companies and inquire about their fees to estimate how much to budget for property management. When leasing a unit, remember that most management organizations charge both a monthly percentage and a fixed price. The most common cost I’ve seen is half the first month’s rent, though certain management businesses may charge more—even an entire month’s rent. I usually add one to two percent to their monthly payment to be sure.
Aside from the set costs indicated above, additional charges may be specific to your area. Again, find out from local landlords, property managers, and others in the real estate industry, and be sure to include them.
Expenses that change over time
Because they are often “percentage-based expenses,” I like to break them down differently. To put it another way, these costs are computed as a percentage of the rent received.
Your property will not be fully occupied all of the time. (Sorry.) Rather than whining, plan for tenant turnover! The vacancy rate is usually expressed as a proportion of the total income. As a result, a property vacant for one month every year is vacant 8.3% of the time.
Vacancy rates vary significantly between areas and property types, so be sure to ask local landlords what to expect. I usually budget for roughly a 5% vacancy rate in my location.
Repairs are another burdensome expense because you never know what you will get. You could spend $100 on repairs one month and $500 the next, or nothing. On the other hand, maintenance costs tend to level over time. When evaluating rental property expenses, I average them out over a month.
For instance, I could spend $500 this month, $100 the following month, and nothing for the next ten months. That’s a relatively common occurrence. This indicates that I spent $600 throughout the year. You’ll get $50 every month if you divide that by 12. If the rental property brings in $1,000 per month, the repair budget is 5%. Don’t put your faith in the warranty. Instead, spend your money wisely.
This may be the most overlooked expense. Capital expenditures, or “capital improvements” in IRS jargon, are the big-ticket expenses that only happen once in a while. These aren’t “repairs” but rather significant enhancements to the property. Installing a new roof, renovating the driveway, and replacing the electricity or plumbing are examples.
The amount of Capex you need to set aside highly depends on the property’s age and condition. A home built this year will require significantly fewer major renovations than one built in the 1920s.
So, how much should you budget for capital expenditures?
While there is no exact figure, I usually estimate it to be between 5% and 7% of gross rent. To put it another way, if I were looking at a six-unit property leased for a total of $2,400 per month, I would budget between $120 and $168 each month for capital expenditures. This equates to about $240 to $336 per unit per year.
Once again, there may be other monthly costs that are neither monthly nor annual in your location. Make sure to inquire about what you may expect in this area from local real estate investors.
3 Methods for Determining an Area’s Average Vacancy Rate
- Assemble everything
- Finally, add up all your numbers and see what you come up. At this stage, it’s just a matter of adding, subtracting, and a little multiplication.
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