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What Expenses to Expect when Owning a Rental Property

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Buying and holding turnkey investment properties is a great way to build an investment portfolio. Unlike stocks and bonds, a good rental property will increase your income AND your net worth.  Once you have selected a type of property and a market with demographic trends that lead to appreciation, you need to know how to calculate cash flow to make sure the investment property will perform to your standards.  

Fixed Expenses / Hard Costs

Fixed expenses are costs that must be paid on a monthly or annual basis.  These are usually straight-forward and easy to account for.   

Debt Service: If you leverage other people’s money to buy the property, your lender will expect the mortgage to be paid on a monthly basis.  This principal and interest payment is often the largest monthly expenditure, but it is also one of the easiest to determine ahead of time.  You can use a spreadsheet or mortgage calculator to manipulate terms such as rate or years and see how your payment would change.

Insurance: Landlord policies provide liability protection as well as coverage for your investment home.  Most companies also offer a Loss of Rents rider that will ensure the property continues to produce income in case of a fire or other extreme situation.

Taxes: Property taxes vary significantly from area to area.  For instance, some areas have rates in the 4-6% range while in Louisville, the tax rate is just above 1%.  Make sure to get a good number from your turnkey provider when putting together your proforma.

Property Management: One of the best values in turn key real estate investing is a great property management company.  They will find and screen your tenants, prepare leases, collect rents, handle 2:00 am maintenance calls and so much more to make sure your property is earning you as much as possible. Typical fees are 10-12% of monthly income.   

HOA Fees: This is not typical for most turnkey investment properties, but would be a fixed cost if it applied to a house you are considering.  Monthly fees can range from as little as $20 per month to several hundred.  Make sure to ask if any HOA fees apply before signing your purchase contract.

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Variable / Soft Costs

If the property won’t cash flow at least a couple hundred dollars per month after hard costs, you may be looking at a bad deal.  There are variable costs that must be accounted for as well.  These won’t occur consistently, but sooner or later you will experience each and you should have a reserve fund to deal with it.

Turnover Costs:  High turnover rates can be devastating to your portfolio.  In fact, this is the most important variable cost you need to understand.  Some property management companies charge a full month rent for completing a turnover.  If you have a bad management company or a home with deferred maintenance, you might have a turnover every year.  On the other hand, better homes attract better tenants.  To reduce turnovers, we don’t accept anything less than a two-year lease.

Vacancy Allowance: By definition, if you have a high turnover rate, you are going to have a high vacancy rate.  This isn’t a cost as much as it is a loss of income.

Together, you should budget 4%-10% of your monthly income for turnover and vacancy reserves.  The better the property and the better the management company, the safer it is to budget less.  

Repair Man

Repairs & Maintenance: Everyone who has ever lived in a home knows things inevitably break.  In addition, it is good financial practice to conduct periodic preventative maintenance checks.  An allocation of 5-7% should cover a well-maintained home.  If your investment property has low-quality materials and deferred maintenance, you will be looking at 8-12% though.

Capital Improvements: Unlike some of the other variable expenses, these can usually be planned and in many cases will generate a positive return on investment.  For example, replacing the dated kitchen cabinets once the current tenant moves out may lead to increased rent for the new tenants.  

Utilities: Like HOA fees, these are not common in single family turnkey investment properties.  For multi-family (especially units that were converted from single-family), you should take time to find out who is responsible for all utilities.  If you are responsible for the water bill, you need to have a reserve that will cover not only the regular bills, but also the ones where the tenant left the sprinkler on all night.

As a general rule, once these fixed and variable expenses are accounted for in your Proforma, you should be break-even or better on a mortgaged property.  If not, you will want to really understand how this particular deal is meeting your goals.  

Summary
Article Name
What Expenses to Expect when Owning a Rental Property
Description
Investing in a rental property is big step. We know investment rentals can provide great cash flow, but what expenses should you be prepared for?
Publisher Name
Freedom Property Group
Erik Hitzelberger

Erik Hitzelberger

Founding member of Freedom Property Group and Part-Time REI. I started investing in 2006 as a method to produce additional income for my family so that we could have the security that we wanted. Now I enjoy teaching others how to achieve financial freedom just like I have.
Erik Hitzelberger

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