Owning rental property can be a rewarding experience, both personally and financially. Unfortunately, many landlords actually lose money on their investments because they fail to account for or severely underestimate the expenses they will incur. Having an accurate idea of the expenses you will face as a landlord will help set you up for financial success.
How to Estimate Expenses on Your Rental Property
If you do not already own other properties in the area, you need to do some investigating in order to determine what costs to estimate. The following are some ways to get an overview of what costs are associated with the area in which your property sits.
Talk to a San Diego Property Manager: A San Diego property manager will gladly answer questions for you because they are interested in earning your business. Property management companies are invaluable resources, since managing monthly expenses is one of the many jobs they perform for their clients.
Call the Source: You already know some of the entities that charge a monthly fee, such as the utility companies so pick up the phone and ask them to provide you an average for the property from the past few months.
Talk to Other Investors: Ask other landlords in your area what expenses they incur that might be unique to the area. You can connect with other investors through a real estate club or your real estate agent. You can also look in the public record to find the names and contact information of neighboring property owners.
Once you have an idea what expenses you are looking at you need to identify which ones are “fixed”. Fixed costs are regularly occurring, repetitive expenses you face in owning a rental property. Fixed costs are not necessarily the same amount month to month but can still be closely estimated. The following are common fixed costs you are likely to incur:
Although it is usually the tenant who pays for the utilities you will be responsible for these costs when your unit sits empty. Basic utilities you should budget for are water/sewer, electricity, garbage and natural gas.
In San Diego County you will be responsible for paying property taxes to the county twice per year. San Diego property taxes are calculated on the assessed value of your property which can not be increased more than 2 percent a year. (They also include bonds approved by the voters, which can raise them as well.) When budgeting for tax expenditures it is important to look to next year’s projection instead of the prior year’s figures, as taxes do go up every year.
Insurance is often included in your mortgage payment but you should double-check to be sure. It is common for insurance to be paid once or twice per year but some companies will allow you to pay monthly for an additional fee, you just have to ask.
If your rental is located in a building or subdivision you will likely have to pay Homeowners Association Fees. A Homeowners Association is a group of neighbors legally bound to uphold certain rules with regard to the building or subdivision. HOAs are most common with condos or upscale areas.
These are fees enacted by the HOA or a government agency that you will be responsible to pay each month. One common assessment to be aware of in parts of San Diego County are Mello-Roos, which are used for community facilities. There is no way to predict future assessments, but you can find out if there are any current assessments by asking neighboring property owners.
Property Management Fees
This is the cost associated with managing your property. This might be a fee you pay to a San Diego property management company to manage your property for you or if you manage it yourself, the costs associated with self-management, such as gas, paper, and your time.
When starting out in the rental property business it might be feasible to manage a single property yourself but if you are successful there will likely come a day when you have too many properties to self-manage. Whether you are just starting out or have grown too big to self-manage, it is worth checking into a San Diego property management company, as they are experts in helping landlords get the most out of their investments. The easiest way to find out how much a property management company will cost you per month is to call and ask. Different property management companies charge different fees – some flat percentages and some percentages plus add-on fees – so it is good to call around.
Variable costs are usually percentage-based costs as opposed to the single cost expenses discussed above. These costs are predicted based on percentages of rent you receive.
Unfortunately, there will be times your property sits vacant. Because tenant turnover is a fact every landlord must deal with it is vital that you budget for the times your rental sits empty to come up with a “vacancy rate.” This is typically determined by the percentage of the year your unit sits empty multiplied by the yearly rental income. For example, if your property is typically vacant one month every year you would budget 1/12 = 8.3% of the year’s rent to cover your vacancy rate. At Patrize Properties, our average vacancy is 7 days.
Repairs are difficult to predict because you never know what might come up. Luckily over time maintenance expenses tend to level out on stable properties, allowing you to budget more accurately. A good way to determine the percentage you should budget for repairs is to average the monthly cost you spend on repairs over the course of a year. You then compare that number to the monthly rent to get your repair percentage rate.
For example, say the average cost of repairs for your property is $50 per month over the course of one year. If the rent is $1,000 per month you should allow for a 5% repair budget because $50/$1,000 = 5%.
Here is a list of typical repairs:
Capital Expenses (abbreviated CapEx) are the most often forgotten about expense when it comes to budgeting. Capital Expenses, or what the IRS calls Capital Improvements, are big-ticket improvements that only occur occasionally. Some examples would be replacing the roof, updating the electrical system or repaving the driveway. These are not merely repairs but actual improvements to your property. Clearly the age and condition of your property affects the amount of CapEx you will need to budget for but a good rule of thumb is to set aside between 5-7% of the gross rent on a property for CapEx. So, if your property brings in $3,000 per month in rent, you should set aside between $150 to $210 per month to budget for CapEx.
Add it All Up
Once you have made your lists, add up your fixed and variable costs to determine approximately how much your property will cost you each month. Remember, the numbers you are using are averages, but over time they should provide a fairly accurate estimation of what you should expect to spend per month.
The 50% Rule
If you only want a rough estimate of monthly expenses so you can quickly estimate cash flow, you can also use the “50% rule.” The 50% rule assumes you will spend half of what you make in rental income on expenses NOT including the mortgage payment. So, if your rental brings in $1,000 a month you should plan on spending $500 per month in expenses. If the mortgage on that property is $400 per month, you can assume you will have $100 cash flow.
The 50% rule is not as accurate as sitting down and actually figuring out your expenses but it comes in handy if you want to quickly evaluate a property that you might be interested in purchasing.
It is important that you understand the costs of being a landlord at the beginning of your journey as many landlords end up losing money on their properties because they fail to plan. While it is impossible to predict the future, doing some research and simple calculations can certainly help prepare you for expenses you might not have anticipated when you decided to get into the rental property business.