I have a proposition for you…
You give me $20,000 and I’ll give you… nothing. In fact, you’ll give me another $50-$200 per month until you go crazy or broke.
Sound like a good trade?
Then why are so many landlords making this trade with every investment property purchase?
Yes, I’m talking about negative cash flow. I’m talking about losing money on a rental property. It happens all the time, and it leads to financial ruin. I should know — 90% of the deals I have purchased have been from “failed landlords.” So why do so many landlords fail?
Simple. As I talked about in my recent article, “Why Are So Many Landlords Going Bankrupt?,” landlords simply don’t know how to do the math correctly. They buy properties based on emotion, gut, or bad math and then wonder why they keep losing money.
And where are they losing the most money?
The fact is: most landlords severely underestimate the costs it takes to own rental properties.
This post is designed to help you make smarter decisions by enabling you to accurately estimate expenses on your next investment property purchase. Let’s get started.
How to Accurately Estimate Expenses on a Rental Property
Sure, if you already own a property in the area, it’s simple to find out what costs are: just look at your other properties.
However, most of the time, you’ll have no idea because you don’t own a property in the area. Instead, here are a few simple tips for uncovering the future potential expense on your rental property:
Ask local property managers: Most property managers would gladly give you this kind of information, knowing that the more helpful they are, the greater chance you may use them as a management company someday. Simply call them up and say, “Hi, I’m looking to buy a rental property in the ____ area and am just beginning my research. Do you mind if I ask you a couple quick questions about expenses?”
Make some phone calls: Secondly, feel free to simply call the company who issues the expense and ask them! For example, not sure what water will cost on your next rental house? Call the company or government institution in charge of the water billing and ask them! Most of the time, they will give you an average on the property for the previous few months or at least give you a good ballpark.
Ask other investors: Finally, ask others who own rental properties in the area. You can find them through local real estate clubs, by looking up public records, by asking your real estate agent for referrals, or by simply connecting with them on BiggerPockets. If you are a BiggerPockets Pro member, you can use “BiggerPockets.com/meet” to find investors in any zip code in America. Simply reach out to them and ask for help!
Now that you know how to find out about the expenses, let’s talk about what expenses you need to account for.
Step One: Identify Fixed Expenses
The first thing we want to look at are the fixed expenses. Fixed expenses can be a little confusing because they are not always “fixed” per se, but they are regular in running your rental business in that they occur often and with repetition.
Related: Don’t Forget To Budget For These 3 Overlooked Expenses
Below is an example of the most common fixed expenses you are likely to experience with your rental property. Not every one will apply to your property, but this should give you a pretty good idea.
Water/Sewer: Oftentimes connected on one single bill, this is the charge you’ll pay each month for the use of city water and sewer. On homes, this is often paid by the tenant rather than the landlord, but this is not true in all cases, so be sure to check with the competition in your area and find out if you can get away with offsetting this charge to the tenant.
Property Taxes: As they say, the only things sure in life are death and taxes, so of course you’ll need to account for this expense. Property taxes are sometimes included with the mortgage (along with insurance), but not always, so be sure to check on your property. Taxes are typically in America paid in two halves, usually in the spring and again in the autumn. When estimating your property taxes, be sure to always look at next year’s property tax bill — not last year’s. Taxes almost always go up each year!
Electricity: Although usually paid by the tenant, many multifamily properties still pay the electricity for the property or part of the property (such as parking lot lights or storage areas).
Garbage: Garbage can also be paid by either the tenant or the landlord, depending on the arrangement.
Natural Gas/Wood/Other Heat: Another expense that is often paid by the tenant, but be sure to investigate.
Insurance: Insurance (along with property taxes) is often included with the mortgage payment, but if not, be sure to set aside money for insurance expenses each month. Insurance is typically paid in one lump sum once a year, but many insurance companies do allow monthly payments, oftentimes for an additional fee.
Homeowners Association Fees: If your rental property is located within a Homeowners Association (which is a collection of neighbors who are legally bound to uphold certain rules to live within the area), you will have to pay a “Homeowners Association Fee.” This is most common with condos or upscale neighborhoods.
Special Assessments: Many times, a homeowner’s association or local government municipality will enact special assessments that will cost you each month. There is no great way to predict future special assessments, but talk with the neighbors to see if there are any current assessments in the neighborhood.
Other: Besides those fixed expenses listed above, there may be other expenses that are unique to your area. Again, talk with local landlords, property managers, and others in your local real estate market to find out, and be …read more