About the author: Jennifer Lester is a freelance writer and founder of Good News Copy. She covers topics related to real estate, home loans, and home improvement. She is a graduate of Texas A&M University and began her career working for an investment banking firm in San Francisco, CA. She now lives in Houston, TX with her three boys.
Be Prepared for Rental Property Costs
As a real estate investor, you have the potential to earn lucrative passive income from your properties. However, in addition to the cost of buying a rental property, there are rental property expenses involved. And it’s important to be prepared for them. Use this guide to help you navigate the costs involved so there are no surprises.
How to Estimate Rental Property Expenses
Before buying rental properties, it’s a good idea to tally up your potential recurring expenses so you are prepared from the start. Estimating how much you can potentially earn from an investment property is relatively simple. Accounting for all the various expenses is a little more challenging, especially if you are just getting started in rental property investing. You’ll need to budget for:
- Rental property loan and closing costs
- Marketing and tenant screening costs
- Property management fees
- Repairs and maintenance
- Periods of vacancy
- HOA dues, taxes, and insurance
- Legal fees
- Emergency costs
We’ll break these down further below, but for now, keep them in mind as you start this process. Here are three steps to help you start creating a rental property expenses list for your real estate business plan.
Step 1: Research Potential Rental Property Costs
- Ask other landlords about their typical rental property expenses
Perhaps you got into the business of investment property after seeing someone else’s success. Or, you are part of a real estate investment club. These are great resources for information. Other experienced investors can provide insight into things that you may not have thought of.
What you will find is that many people who have had success in residential real estate are more than willing to share information and help you grow in your own real estate investment business. Wondering what to do if you don’t know that many people in the business? Here are some ways to help you develop a strong network in real estate.
- Talk to local property managers
Property managers are another great resource of information about rental property expenses, including rental property maintenance expenses. They work in the industry day in and day out in this business and are sure to have a wealth of detailed information on the subject. Plus, if they know that you are considering hiring a property manager, they will probably be more than willing to share information with you. And you just might find the right fit for a property manager in the process.
- Reach out to utility companies
Find out what the monthly utilities on the property are. The utility company may be able to provide you with details, or perhaps just an estimated average. But either way, this will give you a good understanding of these expenses. Even if you plan to pass these bills on to your tenant(s), while the property is vacant and awaiting new tenants, you will be responsible for these bills. So it’s a good idea to know what they are. Plus, this may be a question that your prospective tenants ask you.
Step 2: Make a Rental Property Expenses List
Using the information collected from your research and inquiries above, put together a list of all the different operating expenses you might incur from your rental property investment. Operating expenses include both fixed and variable expenses associated with the management and maintenance of your property.
Fixed expenses to include on your list are:
- Natural Gas/Heating
- Property Taxes
- Homeowner Association Fees
Variable expenses that you may have to factor in include:
- Periods of vacancy
- Capital expenditures
Calculating fixed expenses is fairly easy, especially if you’ve done the upfront investigative work. The variable expenses listed above are not as simple because they don’t occur regularly.
For example, your rental property could be occupied for two full years, then experience a vacancy for several months.
The exact percentages for vacancy of rental property expenses aren’t the same in every market. However, during your investigation process, it’s a good idea to ask other investors and local property managers about the percentages they use in their calculations.
Let’s say that through your research and investigation, you decide to estimate that your property will be vacant one month each year. Your vacancy factor percentage would be 1/12 or 8.3 percent.
Repairs and capital expenditures happen on an as-needed basis. So the best way to factor these in is by using the percentage rate too. When you are just getting started, this is challenging because you don’t know exactly what your expenses will be. However, you can ask experienced landlords and property managers about their expenses. Add them up and divide by 12. Then divide that number by the monthly income your property brings in to reach your percentage rate.
- Overall cost of repairs for the year = $1,200
- $1,200/12 months = $100 per month
- $100/$1,000 monthly rental income = $100
- Percentage rate to include for repairs = 10% of the monthly income
Step 3: Put it All Together in Your Business Plan
Now that you’ve gathered the data you’ll need to determine your expenses, it’s time to put it all together. After you determine where to buy your rental properties, add up all of the numbers to get an accurate estimate of what your rental property expenses will be.
Do this process with each new investment so that you are prepared ahead of time for any potential expenses. And keep in mind that this average may need adjustment over time as property value, utility costs, etc. can fluctuate.
Rental Property Operating Expenses
Operating expenses include all of the costs you’ll incur to manage and maintain your property. These expenses include the fixed and variable costs we broke down earlier, plus additional soft costs associated with your property. In addition to the recurring rental property expenses, you’ll also want to account for the following:
- Home inspection
- Appraisal fees
- Closing costs
- Marketing expenses
- Property management costs
- Accounting fees
- Cost to screen tenants
- Pest control
- Business permits
- Legal advisors
- Emergency costs
Home Inspection Fees
Before purchasing a new rental property, you’ll want to have it inspected. There is a fee associated with this. However, paying for an inspection could help you avoid costly repairs in the future. This fee usually ranges from $200 to $500, depending on property type, size, and location.
An appraisal is needed so that mortgage companies know the value of the home before lending money via a hard loan or otherwise. It is up to the property investor to pay this fee, which usually costs anywhere from $300 to $600 depending on the type of property.
When you purchase a new property, there will be closing costs to incur. These generally range from 2 to 5% of the purchase price. Closing costs include the cost of the mortgage loan application, recording fees, and underwriting fees.
Once you’ve purchased your property, you’ll need to market it to attract potential tenants. There are numerous ways you can do this, from digital ads, to social media, to flyers, to online marketplaces, and much more. So, determine what type of marketing you will do and factor it into your budget.
Property Management Costs
If you are new to real estate investing, you may manage your property on your own initially. However, as your portfolio grows, that may become difficult and you’ll want to hire a property manager. Or, if you live in a different city and/or have a full-time job that keeps you busy, you may choose right from the start to hire a management service. Either way, it’s always a good idea to factor this cost into your budget. Property management fees are around 8 to 12% of your monthly rental income.
It may be necessary to hire an accountant to help you with the bookkeeping aspect of your real estate investment business. If you plan to use an accountant to crunch numbers or handle your tax return, be sure to factor this into your rental property expenses.
Cost to Screen Tenants
You will want to screen for good tenants that have the means to pay each month and on time. But you’ll also have to comply with the Fair Credit Reporting Act. You can ask applicants to pay the fee for their application, but you are responsible for the cost of the credit check, which runs between $30 and $50.
Pests such as termites could do serious damage to your property. So it is a good idea to factor in the cost of a routine pest inspection. This price varies depending on your pest control plan and location.
You may have to pay business permit fees depending on where you live. Some cities require rental property businesses to apply for a special permit. Find out from your city or county if there are any special licenses you must carry in order to own rental property.
Because there are laws protecting both tenants and property owners, it is a good idea to seek legal advice if you are in a sticky situation with your tenants. Be sure to put aside money to cover legal fees if necessary.
Finally, be sure to keep money aside for any emergency costs. A pipe could burst, an air conditioner goes out, or some other situation that needs immediate attention. These are rental property expenses that you need to put money aside to cover.
Rental Property Management Expenses
Hiring a property management company can be beneficial, especially as you grow and scale your real estate investment business. The rental costs for landlords may vary by company, property type, and services. Factors that influence the cost of your property management service include:
- Type of property
- Size of the rental property
- Location of the property
- Condition (New, Renovated, or Older Property)
- Services provided
While each company may price their services differently, they all generally take these factors into account when determining their fees. The breakdown of these fees that you can expect to pay include:
Initial Setup Fee
Some property management companies charge a setup fee, and some do not. For those that do, the fee is usually under $500 and covers things like setting up the initial account, property inspection, and cost of notifying current tenants that they are managing the property.
Monthly Management Fee
Monthly management fees are a standard fee that property management companies charge. This fee is either a flat rate fee or a percentage of the rent. Be sure to review your contract for details of how this fee is calculated and what it includes.
It is more common for property management companies to charge a percentage rate based on the monthly rental income. This fee usually ranges from 4% to 12% of the gross monthly rent. The percentage is on the lower end for commercial properties and those containing 10 or more units. And it is on the higher end for smaller and residential single-home properties.
There are two ways that property management companies can write this into your contract. The fee can either be listed as rent due or rent collected. It’s best that the contract is for rent collected because rent due allows the property manager to collect the fee from you even if the tenant has not paid.
Some additional fees that you may incur from your property manager include tenant placement fees, vacancy fees, and maintenance fees. You may also want your property management company to handle evictions. If so, there is a fee for this service too. And if you decide to terminate your contract with the property management company before it expires, there is also a fee for that.
Rental Property Maintenance Expenses
Some rental property maintenance expenses may be included in the fees that your property management company charges you if you are using one. And other maintenance expenses are variable and occur on an as-needed basis.
For example, the cost of repairs for one month may be $0, and the next month an appliance may break and require $500 for replacement and installation. You may also incur annual or routine maintenance costs.
While it is difficult to determine exactly how much money you’ll need for property maintenance, it’s still smart to create an estimated budget and put money in reserves for maintenance expenses. Factor into your budget the following:
Routine rental property expenses include costs associated with maintaining curb appeal such as landscaping, interior and exterior cleaning, and trash pickup.
Less frequent than routine maintenance, your seasonal maintenance budget may include tree pruning, gutter cleanings, pressure washing, and snow removal if needed.
Appliances will break or need service for a number of reasons. They could be old and in need of replacement, or your tenants could misuse them. Even if you request that they clean out the lint filter and be mindful of what they put in the garbage disposal, there is no guarantee that they will. So be sure to put aside money to cover these items if and when they break.
Some of the bigger ticket appliances include HVAC systems, refrigerators, stoves, ovens, sump pumps, washers, and dryers.
If an air conditioning unit breaks in the heat of the summer or the heater fails in the midst of a snowstorm, these are things that you’ll need to take care of quickly to protect your tenants’ rights and to prevent further damage to your property. Make sure to include emergency maintenance repairs into your budget.
The Bottom Line
While there are numerous fees and expenses involved in owning rental property, the advantages are numerous. You can create passive income, generate income for retirement, or build your net worth.
Calculating and planning your costs before buying a property will improve your opportunity to create positive cash flow from it. While you do have a number of rental property expenses to cover for your rental property investment, there are also great tax deductions and benefits to take advantage of.The best way to move forward is by doing your due diligence and going into any investment prepared. And remember, LendingHome offers low rates and flexible borrower terms on rental loans to help you get started. Start today with them to get expert advice on how to become a real estate investor.
Disclaimer: The above is provided for informational purposes only and should not be considered tax, savings, financial, or legal advice. All information shown here is for illustrative purpose only. All views and opinions expressed in this post belong to the author. NMLS ID: 1125207 Terms, Privacy, and Disclosures. Copyright LendingHome Corporation 2020.