Consider investing in rental properties? You’re probably curious about how -risky a possible purchase is. You may also be wondering what you can expect to earn. Calculating regular operating costs is an important part of analyzing a property investment. We’ll show you how.
First – a definition. What is an operational expense?
Operating expenses are regular or semi-regular costs incurred in maintaining rental properties and dealing with tenants. These are the funds required to keep your rental property – guessed correctly – operating.
Most investors are surprised when they learn that mortgage payments do not fall under this category. This category does not include any renovations or replacements of appliances. Operating expenses are those costs that do not add value to the property. Investors should keep in mind that expenses that add value to the property are classified differently.
What is a healthy budget for expenses?
In the end, you want to generate a positive cash flow from your real estate investment. How much can you spend on operating costs? Investors agree that between 35-80% can be spent on operating costs and still make a profit. You’ll make a profit if you spend only $600 per month on operating costs and charge rent of $2000. Let’s look more closely at these expenses.
- Maintenance:
Estimating the cost of home maintenance and repairs is difficult. You can’t predict how often you will need a plumber to fix a roof leak or call for repairs. The cost of these services can also vary greatly depending on the age and condition of the home. Investors typically set aside 1 percent per year of the property value. For example, if you purchase a $500,000 property, you would need to budget $5,000 for maintenance each year. It is best to overestimate the cost of maintenance, as this is an area where many owners overspend. - Management:
You can save yourself a lot of time and hassle by hiring an outside property manager. Call around to local property managers to find out what they charge. You can expect to pay the manager between 5 and 10 percent of your rental income. - Taxes & Fees:
In addition to the mortgage, property taxes can be a significant expense. Contact your local county assessor for the property tax cost on your new home. In California, you should consider how Proposition 13 will affect your property tax.
Did you know, while we’re talking about taxes, that some of the costs of renting a property can be deducted? The IRS outlines which expenses can be deducted, and how to maintain a good record. You can deduct “ordinary, current, and necessary” expenses. This means that you can include maintenance and routine repairs in this category, but not capital improvements like bathroom upgrades or appliances replacements which affect the value of your property.
- Contingency Funds and Other Expenditures:
Do not forget small or irregular costs, such as garbage collection, pest control and vacancy fees. If you underestimate or reduce your budget too much, these items can have a negative impact on your gross income.
Add up all your expenses, subtract your mortgage and then subtract your rental income. After all expenses are accounted for, do you still have enough profit? You can rest assured that you are making the best investment if you have done research and know what you will be spending.
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