Calculate a Realistic Estimate of an Investment Property’s Costs
If you’ve been following the last few issues of Management One’s PM Update, you know the importance of a thorough property analysis for determining whether a potential property is a good investment. Last month, we walked you through the steps of calculating the projected net rental income of a property. Of course, that’s only part of an investment’s profitability picture. When you’re evaluating a potential residential investment property for an investor client, or for your own portfolio, you must also factor in all the expected (and unexpected!) expenses of owning the property.
What expenses should you estimate?
As part of the buy-and-hold approach for property investing, as explained in the book “HOLD: How to Find, Buy, and Rent Houses for Wealth,” before you can determine whether a property will be a sound investment, you must enter all estimated costs of owning the property into your property analysis worksheet. When listing expenses, the “HOLD” authors advise you to budget for the most costly option or scenario.
- Property management fees — If you plan to hire a property manager, you’ll need to add the associated fees to your anticipated expenses. These fees are typically a percentage of collected rents. Ask property managers in your area for their rates to better estimate the expense.
- Leasing costs — These costs will vary. The least expensive option is to list the property yourself. A real estate agent usually charges about 50% of a month’s rent to list, show, and lease a property. Or, you can use a property manager to handle everything.
- Maintenance reserve — The “HOLD” authors say you should set aside 3% to 6% of the property’s annual net rental income for maintenance and repairs. (See last month’s article to learn how to project net rental income.)
- Utilities — Your residents will normally cover this cost. Add a small (say, $15 per month) charge into the other expenses category to cover this.
- Property taxes — Check with your local country assessor or treasurer’s office to determine the property’s assessed value and recent property taxes paid.
- Insurance — Get a quote from your insurance agent and several others. “HOLD” recommends insuring the property for your home’s estimated replacement cost at minimum. The rule of thumb is to estimate insurance costs as half a percent of the property’s fair market value.
- Other expenses — These costs include unexpected or unusual expenses and homeowners association (HOA) fees.
Next, you’ll need to estimate the cost of making the house ready for residents. Go through each area of potential repair (e.g., flooring, paint, HVAC). Enter a low to mid-level and high-end figure for each repair, total these amounts, and then average the totals to obtain an amount to enter in the worksheet.
You’ll also need to factor financing costs into your property analysis; this step comes later, during the buy phase of the step-by-step “HOLD” strategy.
The “HOLD” worksheet-based approach is an accurate, organized way to estimate expenses, but it does take time and effort. An easier, more convenient way for brokers and their investor clients to calculate projected rental income is to use the Real Estate Investment Planning (REIP) program, a cloud-based application based on the “HOLD” method. Simply plug in your expense numbers, and REIP handles the rest!