Rental property owners must expect and account for all costs associated with their property, including upfront costs, monthly payments, and periodic expenses.
Estimate Expenses for Your Area
There are so many variables from state to state and property to property that it can be difficult to get exact numbers. However, it’s worth doing as much upfront work as possible to accurately assess the viability of your property as a source of cash flow.
Property taxes vary widely from state-to-state. How much money you put down upfront, as well as your financing source, affects your monthly income tremendously.
Most expenses can be figured out beforehand for your area.
You can call your utility company and ask them what the utility bill has been for the past few months. You can also get quotes beforehand on things like landscaping and hiring a property manager. HOA and property taxes are also prices on which you can get concrete information.
Some costs, such as vacancies and maintenance can be harder to figure. However, by setting aside a conservative amount each month to handle these expenses, you can avoid financial devastation on your rental property business.
Keep a Profit and Loss Statement
This may sound simple, but many business owners (especially new ones) neglect to keep basic accounting records from the start.
First, open a Google Sheet or an Excel spreadsheet. At the top of one column, type in “Income.” At the top of the next column, type in “Expenses.” Every time money goes in or out of your account that has to do with your business, put it in the spreadsheet.
In addition, opening up a business checking account can handle most of the work for you. This keeps your personal income and expenses from mingling with business funds. By having a dedicated business checking account, you can log in and get a clean, itemized list of all money coming and going.
16 Common Rental Property Expenses
Here are some expenses that most landlords are going to incur:
- Purchase Price
- Closing Costs
- Renovations
- Mortgage Payment
- Property Taxes
- Homeowners Insurance
- Landlord Insurance
- Marketing Costs
- Screening Costs
- Property Management
- Upkeep and Maintenance
- Utilities
- Landscaping
- HOA
- Vacancies
- Business Start-up and Management Costs
1. Purchase Price
Perhaps the most important factor is what the property actually costs to acquire. A property that’s too expensive is going to provide a poor cash-on-cash return, while a property that’s too inexpensive may be in a poor neighborhood and require too much maintenance.
Most investment properties require a minimum of 20% down, but there are ways to acquire properties cheaper. This could include finding a private financing partner or refinancing your current home to rent out and then purchasing a new primary residence with an FHA loan.
2. Closing Costs
Part of acquiring your investment property is what you’ll have to pay in closing costs. Depending on your particular deal, there could be dozens.
Here are a few of the more common ones:
- Appraisal
- Origination
- Underwriting
- Transfer tax
- Recording
- Prepaid mortgage insurance, homeowner’s insurance, property taxes, and possibly HOA fees
- Discount points
Understand that all of these (and more!) will count towards the total cost of the property.
3. Renovations
Are you purchasing a run-down property that requires a new roof and water heater before you can rent it out? Be sure to include these in your upfront costs when weighing the investment.
It’s almost a guarantee there will be some costs to get the property rental-ready, such as cleaning carpets and painting.
4. Mortgage Payment
Perhaps even more important than the purchase price of the property is what your monthly mortgage will be. This is because when it comes to calculating your monthly cash flow, the overall cost of the property matters less. What you have to pay each month matters more.
5. Property Taxes
In general, your mortgage payment will include property taxes. Each state sets its own property tax, ranging from Hawaii at 0.32% to New Jersey at 2.23%. Your property taxes may increase (or decrease) if the state changes the amount.
In addition, your property taxes are paid on the assessed value of the home. So while the mortgage stays the same during the life of the loan, the amount you pay per month can fluctuate as your property tax changes.
6. Homeowners Insurance
Mortgage lenders require homeowners insurance in order to protect their investment. If you don’t pay off the loan, the house belongs to them, so they want to protect themselves from financial loss.
Similar to property taxes, as homeowners insurance increases, your monthly payment can increase even if your mortgage remains the same.
7. Landlord Insurance
While not required, landlord insurance is recommended to help protect landlords from loss from unexpected damage (such as a fire or hurricane). Landlords with insurance are also protected from physical damage to the home and any detached buildings on the property (like a shed).
However, landlord insurance will not cover:
- Intentional damage from the tenant
- Expenses due to expected wear and tear (such as a fridge breaking down after 10 years).
8. Marketing Costs
Finding tenants often costs money, such as ordering signs to put up on the property, or paying to advertise your unit on the internet.
You may also consider rent concessions, such as throwing in a security system or requiring a smaller deposit. These costs can be attributed to marketing as well.
9. Screening Costs
Good landlords will pay for a full tenant screening report for every viable applicant. Luckily, most states allow you to charge application fees to cover the tenant screening costs.
However, some states limit what you can charge. For example, in Massachusetts, landlords may not collect application fees at all. In New York, the maximum is $20. Landlords in those states can incur hefty costs if they have many properties and plan to screen many applicants.
10. Property Management
Choosing to hire a property management company is completely up to you, but it’s an extra cost you’ll have to account for. Typically property management costs around 8% – 12% of your property’s monthly rental price.
While that can seem expensive, it frees up your time to focus on other activities (such as finding other suitable rental properties). It also removes many of the headaches associated with rental property ownership.
11. Upkeep and Maintenance
Whether you have a property manager or not, you’ll still need to budget for the cost to keep the property in liveable condition. This includes painting walls and replacing appliances, but can also include larger costs, like replacing a roof.
Generally, experts suggest setting aside about 1% – 2% of your property’s monthly rental income. Setting aside more money better protects you from emergencies but also reduces your accessible cash.
12. Utilities
This cost can either be passed on to the tenants or you’ll have to pay it yourself. However, if you pass the cost to your tenants, you’ll likely have to lower the rent slightly. In other words, the cost of utilities will usually come back to you anyway.
13. Landscaping
Many landlords choose to have the tenants mow the lawn but will hire a gardening service if there’s extensive landscaping on the property.
14. HOA
Depending on the property’s location, you may have to pay a monthly HOA fee or pass it on to your tenants. Much like utilities, if you pass the cost to your tenants, you might have to charge less in monthly rent.
15. Vacancies
One of the larger costs you’ll have to endure is vacancies. If your property brings in $2,000 per month in rent, a vacancy of 6 weeks will cost you $3,000!
Many rental property owners assume a 5% vacancy in any of their properties. If your property rents for $2k per month, this means your vacancy cost will generally be around $1,200 per year.
If you get unlucky and have multiple tenants move out within a year, your entire business could go under.
This is why it’s worth having an effective tenant screening process to ensure you get the best tenants for your property. It’s tempting to bring in the first tenants who apply to avoid a long vacancy, but that leads to more expensive issues down the road.
16. Business Startup and Management
Many owners of a few rental properties often don’t worry about a formal business structure. However, as you acquire more and more properties, it makes sense to consider an LLC for your rental property business.
Some costs associated with this could be:
- Forming your LLC
- Hiring an accountant
- Real estate attorneys (for consulting on contracts, legality of evictions, and more)
- Hiring a property manager. With a single property, many owners hire a 3rd party company who assigns a property manager. However, with enough properties, it often makes sense to hire someone yourself and cut out the middleman.
