Real Estate Investing Basics

Property Analysis: Three Budget Items Not to Forget

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real estate investor budgeting

Investors are presented with so many different facts, figures, and statistics when buying an investment property — it can be absolutely dizzying. Almost everybody has a different formula when it comes to rates of return and cash flow analysis. While it is imperative that investors have a good way to analyze investment properties, there is no right or wrong answer to this equation. I believe it boils down to experience, location, and personal preference when deciding what line items and assumptions to use when creating your deal analysis.

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Most models include the staple expenses like principle and interest (assuming financing is involved), taxes and insurance.  Other common expenses that may or may not be in your model include home owners association fees (if this applies) and property management (assuming you are not self-managing). Additionally, most investors build in an expense allocation for vacancy and maintenance based on their experience, the age of the home, the average for the area, etc. Again, there really isn’t a right or wrong amount for these categories, it’s really more a matter of personal preference.

Rarely do I see models that take into consideration other expense itemizations.

Here are 3 additional categories that should probably be included in any deal analysis:

1.)    Turnover Expense:  Many investors forget to factor in the expense associated with getting a property in condition to re-lease once a tenant has moved out. This can include new paint, new flooring, cleaning, minor handyman, etc.  For example, if you expect the average tenant to stay in the property for 2 years and you believe $1800 is a good budget amount to get the property  re-rentable …. You would want to budget an additional $900 each year to cover this expense.

2.)    Accounting and Legal:  While some investors do their own bookkeeping, others find that once they begin owning multiple investment properties, it makes sense to hire a bookkeeper and/or an accountant. This is especially true as investors begin to form LLC’s and trusts to hold their real estate. While this is not a major expense, the difference between doing your own taxes and hiring an accountant can be as much as $1,000 a year. In addition, the annual filing fees for a corporation vary from state to state, but can run as high as $800/yr.

3.)    Due Diligence:   Almost all investors forget to include monies spent on due diligence in their internal return numbers. Due diligence can be anything from inspection reports and appraisals to travel expenses associated with making the buying decision. An investor could easily spend $1,000 in due diligence just to determine whether or not the investment makes sense. Considering this affects your upfront cost basis, it has a direct impact on your rates of return.

Again, it’s up to every investor to formulate their own method for calculating expected levels of return on investment properties.  However, it’s important to include as many possible expenditures as possible to ensure accuracy when analyzing potential deals. The last thing any investor wants to deal with is unexpected expenses and properties that do not perform up to original expectations.

Ken Corsini G+ is the host of the Deal Farm Podcast (on iTunes) and has 10 years of full-time real estate investing experience. His company, Georgia Residential Partners buys and sells an average of 100 deals per year and has helped hundreds of investors around the country make great investments in the Atlanta market. Ken has a business degree from the University of Georgia and a Master Degree in Building Construction from Georgia Tech. He currently resides in Woodstock, Georgia with his wife and 3 children.

    Curtis Gabhart
    Replied about 7 years ago
    You may also want to calculate reserves or upcoming maintenance. I.e. A roof that is 15 years old may need replacing in 5 years for $10,000. Good post
    Jason Eggett
    Replied about 7 years ago
    Great insights Ken! My wife and I are actually going through some “turnover expenses” right now before our new tenants arrive next week. We are doing all of the work ourselves, which has saved us money, but it has taken up a lot of our time. So on the next turnover, we will definitely be budgeting for other people to do the work.
    Replied about 7 years ago
    Good points. On turnover expenses, this expresses precisely why it’s so important to increase your time of tenancy through staying a little below market on rent, and in keeping tenants satisfied. Staying 5% below market and doubling tenancy terms pays for itself easily (especially when you factor in the leasing fee of 1/2 to 1 month that will have to be paid to a prop mgr or agent if you don’t self manage, or all the time you spend locating a good tenant if you do self manage). Also, turn work is very low end work, and you should be sure not to overpay for it. In other words, don’t use the $30-50/hour staff from your prop mgmt company, or other skilled contractors. We are looking at using a turnover service that has a fixed rate based on # of bedrooms, covering 2-tone painting, carpet/HE floor cleaning, and thorough cleaning of the entire unit. A 2BR unit can be turned in this fashion for about $600. But I agree that turnover expense should be a separate line item on your proforma, and is a function of your vacancy rate. Even though investors often include “something” for maint, reserves, and occasional terrible tenant that wreaks havoc, it is typically underestimated. This is fostered by many (not all) turnkey property sellers setting unreasonably low expectations. 5% of Gross Potential Rent is commonly used, and is not nearly enough if you intend to hold the property for a mid to long-term period, even if the property is “fully rehabbed”, or has a home warranty provided. 10-15% is a more appropriate range, depending on age of house, level of rehab, rent yield, etc.