When considering a rental property, you'll first analyze the features of the property to determine the expenses of owning it. Knowing your expenses will aid in setting a rent cost and indicate ahead of time if the property will turn a profit. To calculate your expenses, consider your maintenance costs, home owners' association (HOA) fees, property tax, property management fees, and insurance; these are all costs beyond the mortgage.
Once you determine your costs, use the number to calculate your operating expense percentage to perform your analysis of the property. For a piece of property like a typical house, duplex, or triplex, your expenses are going to be equivalent to about 35 to 45 percent of your gross operating income (GOI), or how much money the property brings in. For fancier rentals, especially vacation rental properties, the percentage will be closer to 70 or 80 percent. This is called the operating expense percentage. For example, if your expenses run about $450 a month and you charge rent of $1200 per month (your GOI), you would determine your operating expense percentage by dividing your expenses by your GOI: 450/1200 = 37.5.
If your calculations are lower than 35%, you may have missed something. Review carefully the following categories and double-check your costs. You may also consult with other, more experienced property owners to ensure you have an accurate price estimation.
Maintenance includes repairs, cleaning, and lawn care. Due to the unpredictability of the necessity for replacing appliances or repairs, maintenance is typically underestimated. The rule of thumb for predicting yearly repair costs is 1% of the property's value; a property valued at $120,000 would have a repair cost of $1,200 per year, or $100 a month.
Consider the property's age; renovations and replacements are more likely for older rentals. The type of tenant (and pets) you have will also make an impact. If your HOA requires regular exterior painting or upkeep, include these costs as well.
Insurance, HOA, and Property Tax
These should be accurately determined by simply contacting the right source. Your insurance agent can tell you the cost for your policy, the property manager or for-sale listing of HOA fees, and the county assessor can tell you the exact amount of the property tax.
Take your time with each to ensure you have a full understanding of the amounts involved. You may need extra insurance, depending on location-specific risk – earthquake or flooding coverage for example. You should find out if the HOA fees are likely to rise by tracking the pattern of the frequency of previous increases. You should also determine what you will pay in property taxes, not the current owner pays, as it may differ.
If you hire a manager, the average rate is 6 to 8 percent of the rent, but investigate the cost for your area. Pest control and additional gardening are also potential costs. If you are paying utilities yourself, remember to include it in your costs as well. However, the cost for utilities when paid by a landlord are often a few times more than what they would be if the tenant paid; the tenant is more likely to conserve if they are footing the bill.
Above all else, remember that it's a common and easy pitfall to underestimate your costs. While you can't truly predict maintenance, estimate a little higher and ensure you know your numbers for insurance, HOA, property tax, and what you'll pay your manager if you plan on one and you should have a fairly accurate operating expense percentage.
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