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How to Accurately Estimate Expenses on a Rental Property in 3 Easy Steps

How to Accurately Estimate Expenses on a Rental Property in 3 Easy Steps

8 min read
Brandon Turner

Brandon Turner is an active real estate investor, entrepreneur, writer, and podcaster. He is a nationally recognized ...

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I have a proposition for you. You give me $20,000 and I’ll give you… nothing. In fact, you’ll give me another $50 to $200 per month until you go crazy or broke.

Sound like a good trade? No? Unfortunately, many rental property investors make this same trade with every purchase—because they didn’t properly calculate rental property expenses. The end result? Negative cash flow. Losing money. And unfortunately, it happens all the time in real estate investing, and it leads to financial ruin.

I should know—90 percent of the deals I have purchased have been from “failed landlords.”

But why do so many landlords fail? Simple. They don’t do do the math. They buy properties based on emotion, gut feelings, or bad calculations and then wonder why they lose money. And there’s one calculation that trips most people up: estimating the costs required to own rental properties.

How to Accurately Estimate Expenses on a Rental Property

Let’s say you’re looking at a potential property in Neighborhood A. If you already own a property in Neighborhood A, it’s easy to calculate costs—just look at your other property. It’s an easy repository for actual expenses.

However, most of the time, you’ll have no idea because you don’t own a property in the area. Or you own a home in Neighborhood B, which entails different costs. Here are a few simple tips for uncovering future potential expenses associated with your rental property:

  • Ask local property managers: Most property managers would gladly give you this kind of information, knowing that the more helpful they are, the greater chance you may use them as a management company someday. Simply call them up and say, “Hi, I’m looking to buy a rental property in the area and am just beginning my research. Do you mind if I ask you a couple quick questions?”
  • Make some phone calls: Secondly, feel free to simply call the company who issues the expense and ask them! Not sure what water will cost on your next rental house? Call the company or government institution in charge of the water billing and ask them! Most of the time, they will give you an average on the property for the previous few months—or at least provide a good ballpark.
  • Ask other investors: Finally, ask others who own nearly rental properties in the area. You can find them through local real estate clubs, by looking up public records, by asking your real estate agent for referrals, or by simply connecting with them on BiggerPockets.

When budgeting for your month-to-month expenses, don’t forget to consider the initial costs for any property—things like closing costs, appraisal fees, and broker fees. Smart rental property owners will look at the big picture, not just the minutiae.

Now that you know how to find out about the expenses, let’s talk about what expenses you need to account for.

Related: How Much to Charge for Rent in 2020: A Landlord’s Guide

Fixed Expenses

The first thing we want to look at are the fixed expenses. These can be a little confusing because they are not always “fixed” per se—despite the name!—but they do occur often and with repetition. These typically include utilities and mortgage costs.

Below is an example of the most common fixed costs you are likely to experience with your rental property. Not every one will apply to your property, but this should give you a pretty good idea.

Water and sewer

This is the charge for the use of city water and sewer. (Often, these are connected on one single bill.) On homes, this is often paid by the tenant rather than the landlord, but this is not true in all cases. Check out the nearby competition in your area and find out if you can get away with offsetting this charge to the tenant.

Property taxes

As they say, the only sure things in life are death and taxes—so of course you’ll need to account for this expense. Property taxes are sometimes included with the mortgage (along with insurance) but not always. In the U.S., taxes are typically paid in two halves, usually in the spring and again in the autumn. When estimating your property taxes, be sure to always look at next year’s property tax bill—not last year’s. Taxes almost always go up each year!

Electricity

Although usually paid by the tenant, many property owners (especially in multifamily) still pay electricity for the property or part of the property, such as parking lot lights or storage areas.

Garbage

Garbage can also be paid by either the tenant or the landlord, depending on the arrangement.

Natural gas or other heat

This expense is also often paid by the tenant—but be sure to investigate.

Insurance

Just like property taxes, insurance premiums are often included with the mortgage payment. But if not, be sure to set aside money for insurance expenses each month. Insurance is typically paid in one lump sum once a year, but many insurance companies do allow monthly payments, oftentimes for an additional fee.

Homeowners association fees

If your property is located within a homeowner association (HOA), which is a collection of neighbors who are legally bound to uphold certain rules, you will have to pay HOA fees. This is most common with condos or upscale neighborhoods.

Special assessments

Many times, an HOA or local government municipality will enact special assessments that will cost you each month. There is no great way to predict future special assessments, but talk with the neighbors to see if there are any current assessments in the neighborhood.

Property management fees

Property management is, of course, when you hire someone else to manage your property for you. However, it goes deeper than that. If you decide to manage yourself, there are still associated costs—like paper, gas, advertising vacant units, wages for any employees you hire, and your time. Calculate property management expenses whether or not you plan to hire someone else—because it’s still an expense.

Besides, someday you will be successful and have numerous properties… and will be unable to manage them all yourself. Start budgeting for that day now!

To determine how much to allocate for property management, simply call up your local management companies and find out what they cost. Keep in mind that most management companies include both a monthly percentage and a fixed fee every time they lease a unit. The most common fee I see is equal to half of the first month’s rent, though some management companies may charge more—even up to a full month. To be safe, I typically add one to two percent to their monthly rate. In other words, if a manager charges 8% of what’s collected each month, I will budget 9% to 10% just to be safe.

Besides those fixed expenses listed above, there may be other expenses that are unique to your area. Again, talk with local landlords, property managers, and others in your local real estate market to find out, and be sure to include those.

Related: How Much Does Property Management Cost? Here’s What Fees to Expect

Variable Expenses

I like to break down these expenses differently because these are generally “percentage-based expenses.” In other words, these expenses are calculated by using a percentage of the rent that comes in.

Vacancy

Your property is not going to be occupied 100% of the time. (Sorry.) Rather than complain, budget for tenant turnover! Generally, the vacancy rate is given as a percentage based on the income that comes in. Therefore, a property that is empty one month every year would be vacant 8.3% of the time.

Vacancy rates differ dramatically between various markets and property types, so be sure to ask local landlords on what you can expect. In my area, I typically plan on about a 5% vacancy rate.

Repairs

Repairs are another tricky expense, because you never really know. Some months you could spend $100 on repairs, and other months you could spend $500 or $0. But on an annual basis, maintenance expenses do tend to level out. When estimating rental property expenses, I average these costs out on a per-month basis.

For example, I might spend $500 this month, $100 the next, and then nothing for the following 10 months. That’s fairly typical. This means I spent $600 for the entire year. Divide that by 12, and you get $50 per month. If the property brings in $1,000 per month, that would be a 5% repair budget.

While your tenants’ security deposits will cover some of these costs, remember most states forbid you from charging for normal wear and tear—like painting a room. Don’t rely on the deposit. Budget properly instead.

CapEx

This might be the most-ignored expense item. CapEx—short for capital expenditures, or “capital improvements” in IRS language—are the big-ticket expenses that occur only occasionally. These are not “repairs,” but actual property improvements that add significant value. This includes putting on a new roof, redoing the driveway, and updating the electrical or plumbing.

Obviously, the amount of CapEx you need to reserve greatly depends on the age and condition of the property. A property built this year will probably require far fewer major improvements than a property built in the 1920s.

So, how much should you estimate for CapEx?

While there is no rock-solid number, I tend to estimate between 5% and 7% of the gross rent. In other words, if I were looking at a six-unit property that leased for a total of $2,400 per month, I would set aside between $120 and $168 per month for CapEx. This works out to between $240 and $336 per unit per year.

Once again, in your area, there may be other miscellaneous monthly charges that are not monthly or annual. Be sure to ask local real estate investors what you might expect in this area.

Related: 3 Approaches to Finding an Area’s Average Vacancy Rate

Put It All Together

Finally, it’s time to put all your numbers together and see what you get. At this point, it’s as easy as adding, subtracting, and a little multiplication.

To make things easier, I want to offer a very helpful tool: The BiggerPockets Rental Property Calculator.

This tool allows you to fully estimate your expected return on investment, cash flow, and more for your next property. Simply walk through the simple guided steps, and you’ll discover your total expenses in no time. Our calculator is designed to make the analysis process much easier—and give you a professional document to showcase your property to lenders and partners.

If you are doing these calculations on your own, simply add up the numbers to learn how much your property will likely cost you each month. Remember, these numbers are averages over time, but should give a fairly close guess at what your financial future will be.

Another Option: The 50% Rule

Okay, great—now you know how to spend 20 minutes figuring out the expenses on a rental property. But what if you just want a rough estimate? After all, if you are screening dozens of properties every day, you can’t spend all this time analyzing every single one.

Enter the 50% rule—a simple rule-of-thumb calculation that helps quickly estimate expenses and cash flow of a rental property.

Very simply: The 50% rule states that half of what you make in rental income will leave in expenses, not counting the mortgage payment.

So, a property that rents for $1,000 per month will likely have $500 per month in non-mortgage expenses. If the mortgage was $400 per month, you could potentially assume $100 per month in cash flow.

Is the 50% rule accurate?

It depends. It is just a rule of thumb, which means you should never make a decision based on it. Sometimes expenses fall in the 40% range. Sometimes, in the 60% range. It depends on a number of factors.

However, I use the 50% rule on a daily basis to quickly screen properties.

Wrapping It Up

I don’t want you to fail. I want you to be so successful that you don’t know what to do with all your money. However, wealth creation through real estate starts with correct math.

Understanding how to calculate expenses is vital. Obviously, there is no perfect way to predict the future of your investment property, but taking a simple, mathematical approach to expenses will help you hedge your bets.

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Any questions?

I’d love if you would take 30 seconds and leave me a comment below!