One of the greatest advantages to rental properties is that the returns are predictable.
Investors can forecast the cash flow and returns they’ll earn from a property before buying. How many other investments can say the same?
Where new investors run into trouble is underestimating expenses. They often ignore expenses simply because they don’t occur every month and just assume a property’s cash flow is “rent minus the mortgage.”
It’s why so many new investors lose their shirts.
Here’s what you need to know about estimating each rental expense, so you can accurately predict the cash flow and returns on any property from now on.
Repairs & Maintenance
Like vacancy rate, maintenance and repair costs don’t hit you every month. But when they do, they can get expensive.
I typically budget between 12 to 15 percent of the rent for repairs and maintenance. Brand new properties probably won’t require major repairs as soon as older properties, but over the long term, you’ll have to replace every single component in the property. Budget for it starting from the first month.
The higher the neighborhood turnover rate, the higher your maintenance costs will be. The long-term tenant who stays 10 years probably won’t ask for fresh paint and new carpets every other year. But when you market vacant properties for rent, often you need to repaint, redo the flooring, and conduct other maintenance to attract the best possible tenants. High turnover is one reason why I no longer invest in lower-end neighborhoods.
Similarly, if you accept Section 8 tenants, you’ll have an annual inspection, and you better believe the inspector will find at least a few repairs they’ll require of you. It’s how they prove to their boss that they’re visiting every property on their rounds. Be sure to budget extra money for maintenance and repairs if you accept Section 8—I don’t anymore, for that and other reasons.
Too many new real estate investors ignore vacancy rate, because it’s a negative expense—a lack of income, rather than a monthly bill. But at the end of the year, it has just as much impact on your bottom line. (See this visualization of how cash flow works.)
Vacancy rates vary by neighborhood. Hot, high-demand neighborhoods might see vacancy rates as low as 2 percent, while cooler, lower-demand neighborhoods could see vacancy rates at 20 percent or even higher. It’s up to you as an investor to do your homework on any given neighborhood’s vacancy rate before buying there and to include it in your cash flow calculations.
Ask around among property managers and landlords who operate in the neighborhood. Real estate investing clubs work well for this, and you can also find them in local real estate investing groups on Facebook or local threads on BiggerPockets.
Make sure you know this figure before investing!
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