In the world of real estate, rental properties are some of the best investment options you can try. In addition to providing you with passive income and tax benefits, rental properties are known to produce strong returns throughout the year no matter how the market moves.
That said, owners always fail. This is due to the lack of proper research and calculations on the initial cost and ongoing expenses associated with rental properties. A good real estate investor knows how to “do the math” to make sure they don’t lose money when buying a rental property.
Whether you’re a beginner or a seasoned landlord, this article can help you master the art of accurately forecasting rental property expenses.
One of the best ways to get a rough estimate of potential expenses for a rental property is to ask around. By asking the right people and the right experts, you can get near-accurate numbers to help reduce the risk of making the wrong investment decision.
Some of the best sources to ask around include:
Realtors know what real estate investors are looking for, especially those who focus on rental properties. They have experience and knowledge of financial performance metrics, such as ROI and ROI. They can even provide details of recent transactions they’ve worked on, including operating expenses for rental properties in the local market.
2. Local property management companies
One of the best sources for accurate information is a local property manager or management company that has a working knowledge of rental spending in specific neighborhoods. While you can just consult with them for an expense estimate, you can also hire them to find the right property based on your needs and goals and help manage the rental property for you.
Like real estate agents, property managers are paid based on commission rates. They may also charge different types of fees, depending on the service you need. You can click here to read if you want to know more about property manager commission rates and fees.
3. Experienced rental property investors
Existing landlords and other experienced rental property investors are other great sources you should consider. Networking and asking other property owners and investors how they estimate expenses can give you insight that you may not have considered before.
In general, real estate agents and property managers can tell you what you want to hear to convert you into a customer. On the other hand, other investors are often willing to help newcomers by sharing real experiences.
4. Utility companies and suppliers
Utility bills are a big part of a property’s monthly expenses. Thus, you should consider consulting your local utility providers and getting an idea of historical billings. Although they can’t provide specifics, utility companies should at least give a rough estimate that can help calculate your rental expenses.
In addition to utility companies, you should also ask suppliers and contractors, such as plumbers or pest control companies. Maintenance is another big expense item when managing a rental property, so it makes sense to take the time to request service estimates to calculate expenses.
Determine the fixed Vs. Variable expenses
Now that you know how and where to find out about expenses, it’s time to make a list of potential expenses to consider.
In general, rental charges fall into two categories:
Fixed expenses occur often and repeatedly. Some examples of fixed expenses are electricity, water, property taxes, insurance, natural gas and other heating sources, HOA fees, and property management fees.
In general, variable expenses do not have fixed schedules. Although they repeat, you won’t need them as often as in the previous examples. Examples of variable expenses include capital improvements, repairs and maintenance services.
In addition to the types of expenses above, you also need to consider acquisition costs, which can include the mortgage down payment, as well as marketing and tenant screening.
You can spend days and weeks following the steps above to determine the most accurate estimate of potential expenses for a specific rental property. However, if you’re just looking for a rough estimate, especially when narrowing down your options, you can use the 50% rule.
This simple empirical calculation allows you to quickly estimate potential expenses and cash flow for rental properties. With this rule, you must consider that half of your overall rental income will be for expenses, not counting your mortgage payment.
For example, if a property is earning $2,000 per month, you should assume that $1,000 will go to non-mortgage expenses. If your mortgage payments are AUD 500 per month, you can assume that you will make a profit of AUD 500 each month.
Remember that the 50% rule is just a rule of thumb and should only be used to quickly filter properties and narrow down your options.
Compared to other types of investments, rental properties can help protect your money, providing you with significant income, with little or no effort for years.
That said, rental properties will require additional fees throughout their life cycle. And, you need to know the “big picture” of your rental properties, including present and future expenses. With the tips above, we hope you can now make rough or fine estimates to make informed investment decisions.