Real Estate Deal Analysis & Advice

How to Accurately Estimate Expenses on a Rental

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closeup of hand using calculator and taking notes with pen on a notepad

When it comes to new investors—or individuals who are interested in learning more about investing in rental real estate—it’s the financial side of things that seems to cause the most confusion and frustration.

People aren’t sure how to calculate the anticipated monthly profit margin, or cash flow, on a rental unit. And in most cases, this comes down to an inability to accurately estimate operating expenses.

How to Calculate Operating Expenses and Cash Flow

Cash flow is easy to calculate once you have an idea of what your operating expenses are. The equation looks like this:

(Monthly Rent) – (Monthly Operating Expenses) = Cash Flow

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The issue is that inexperienced investors typically use inaccurate operating expense numbers. As a result, they end up with deals that, on paper, either look worse than they are or seem too good to be true.

Underestimate your operating expenses during the due diligence phase, and you could end up with a nightmare property that loses you money on a monthly basis. Overestimate the expenses, and you might discourage yourself from making an offer—even if it’s a good investment.

Related: The Top 8 Real Estate Calculations Every Investor Should Memorize

taxes, rental property, real estate investor, rental income

Account for These Specific Expenses—and More

While you’ll never predict operating expenses down to a specific dollar amount, there are ways to estimate a fairly accurate number. As you do your research on potential investments, make sure you’re accounting for expenses such as:

  • Property taxes and insurance. While they should be accounted for in your monthly mortgage payment (if the property is financed), it’s always smart to break down property taxes and insurance so that you know how much to anticipate.
  • Utilities. While renters will likely cover most of the utilities, there could be certain expenses that fall on your plate, such as trash and recycling, water, or other similar items.
  • Maintenance and repairs. It’s easy to forget about maintenance and repairs, since they come and go without much warning. As a general rule of thumb, some investors anticipate 1 percent of the property value per year. So, if a property is valued at $150,000, that would be $1,500 per year (or $125 per month). Definitely set aside some money in your monthly budget. Otherwise, you may be forced to take out a personal loan to cover basic repairs down the road.
  • HOA fees. Is the investment property located in a neighborhood or planned community? If so, you should inquire about any possible HOA fees. Failing to account for these costs could skew your numbers big time.
  • Possible vacancies. In a perfect world, your rental property would stay leased on a year-round basis. However, renters can be fickle, and you should expect some turnover. As a general rule, account for one month of vacancies per year. To drill this down to a monthly figure, take your monthly rent and divide it by 12. This will give you your monthly vacancy allowance.
  • Property management fees. Are you planning on using a professional property management service? Again, this is an easy one to forget about. Get quotes from different companies in the area to figure out how much you'd be paying per month. You might also find that you don't need a property manager for one property. Weigh the pros and cons, and come up with a game plan. Regardless of what you decide, it's nice to have enough cushion in your cash flow to pursue this option at a later date.

Related: 3 Quick Ways to Increase the Net Operating Income on Your Multifamily Property

What to Expect When Projecting Costs

When projecting operating expenses, expect the numbers to be somewhere in the 35 to 80 percent range of gross operating income. Nicer properties will have higher percentages, while less expensive investments tend to have lower figures.

"Beware: If your calculation is below 35 percent, there is a high probability something is wrong in your estimation," real estate agent Leonard Baron wrote in an article for Zillow. "Make sure to independently verify your projected costs with a few other experienced property owners."

What Are You Forgetting?

By no means does this article provide a comprehensive list of all the expenses you’ll ever encounter. Depending on your situation, you may find that some of these expenses don’t apply, while other significant costs do.

Carefully evaluate your numbers, rerun them multiple times, and ask for a more experienced investor to look over your spreadsheet for a second opinion.

Do you have a good handle on your operating expenses? Were you miscalculating? How so?

Let’s talk about it in the comments. 

Larry is an independent, full-time writer and consultant. His writing covers a broad range of topics including business, investment and technology. His contributions include
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    Rob Cook from Powell, WY
    Replied almost 2 years ago
    Capex. Often is more important and consequential than maintenance allowance/expense. The roof, appliances, flooring, paint and other items are being used up daily and will have to be replaced in time. Like depreciation, it is a real expense even though you don’t write a check for it monthly, it should be recognized and accounted for.
    Chris Schu from las vegas, NV
    Replied almost 2 years ago
    True that. Seems like even seasoned “investors” screw up CapEx. “sinking fund” is a foreign language to these people who act all surprised when the HVAC or other large ticket item acts up to the tune of thousands of dollars in repair costs. Not sequestering a portion of net income each month for inevitable future CapEx issues is asking for trouble. Too bad some “investors” want to make the numbers on the deal work so badly they short change some of the biggest “hidden” expenses and pay for it dearly later on. True due diligence is worth its weight in gold.
    Rob Cook from Powell, WY
    Replied almost 2 years ago
    Yep. I actually go the other extreme in my analysis. I use 10% each for all 4 typical allowances in my pro-formas. (Management, Vacancy, Maintenance and Capex). Add 10% for Taxes and Insurance and the old 50% rule…rules! I further UNDERESTIMATE the rental rate too. So if a deal gives a Breakeven CF based on those assumptions and typically financed (70% LTV) money, I buy it. Many overpay, and “beat my bid” but I don’t care, I wait, and will buy it from the sucker, later, after they renovate it and then have to dump it!
    Brandon Gamblin from Saint Louis, Missouri
    Replied 9 months ago
    Hey Rob.....Does that 10% come from the GOI (Gross Operating Income)?
    Miles Stanley Realtor from Schertz, TX
    Replied almost 2 years ago
    Rob, Are your percentages based on anything concrete such as experience, calculations, or portfolio typical history? I have seen that using general percentages can be misleading (again, unless in your case they’re backed up by experience, etc). As I have been analyzing properties, I have struggled with these 4 allowances and have found that, more often than not, there is negative cash flow on almost every property when using the percentages you state & underestimating the rent. The only way I have been able to reconcile the numbers and “create” the cash flow is to have my offer price be in the toilet…which the sellers will not even entertain. For cap-ex, I have looked at backing the future replacement costs of various home systems into a monthly expense for budgeting purposes. The results are even worse. I have used market data for rents and sale comps in my numbers and my analysis would suggest that rental property investing is not a logical choice in my market…but I know tons of people are doing it with success…what am I missing here? Any thoughts or advice on this?
    Rob Cook from Powell, WY
    Replied almost 2 years ago
    Miles, it is frustrating and confusing. And for many reasons. First, I do own over 50 rental units, and have for decades, to varying extents and degrees. However my use of the proforma 10% allowances for each expense, is more a discipline than based on historical experience/data. Remember, in most cases, you will NOT have reliable, actual data on a prospective property you are analyzing for purchase, so you have to swag it. Thus “pro-forma.” Then it is only a matter of which values you decide to apply for the expense allowances. I find that being conservative upfront, works best for me. The obvious downside to doing so, is, as you experienced, that I rule out most potential deals, many of which I am confident would have worked out fine. So what. Missed money is better than lost money. And I have never lost money on a real estate deal, numbering in the hundreds of transactions as an agent or party. That is primarily due to my being so selective and discriminating about which deals I take. Second, it is important to understand that this scheme of analysis is being applied in a particular niche. I generally only buy properties which nobody else wants. Usually because of condition. I do not like competition, or overpaying for properties, which compresses my wiggle room and safe margin for error. Since I am willing to buy properties in crappy condition, it gives me both an edge and negotiating power with the seller. Since they are seriously motivated sellers, and I am often the only interested buyer, they HAVE to deal with me on my terms, and capitulate or I walk. Simple really. If the seller understands that my offer may be the best, if not the ONLY offer they are going to get, then they become flexible on the price/terms. And often accept my offer, which does meet my conservative expense allowance analysis numbers. SO, you might say, my numbers and method works for me, enough so that I turn away very good deals now, passing them on to family and friends, because I am age 60 and not as interested in expanding my holdings as aggressively now. This posture and position, allows me to maintain my high, conservative standards and pass on all but the BEST deals that come along. A final thought is that all buyers/investors are not equal. While an older guy like me, with $Millions in net worth, and owning dozens of rental properties free and clear, can afford to be picky and selective and patient in my acquisitions, and also able to handle and afford the time consuming and expensive rehab investments on poor-condition distressed properties, younger investors might not. They often have careers and families that take most of their time, so cannot play in the same sandbox I can and do. And remember, a cash buyer can usually command better terms and deals, and even afford to pay a higher price since their cash flow will not have to service any debt. At my age and in my financial condition, I can afford to be picky and selective. So missing out on many good deals, but being too selective, is not as large an error for me, as it might be for a younger investor. Lots of variables as you can see. I am able to take a lot more risks than a younger/less wealthy investor, and I am not as hungry or anxious to get more deals or properties. Kind of a paradox. I remain selective, picky and careful with my investing, even though I can afford to be more sloppy or careless or pay more than I want to for properties.
    Zachary Dahlke from San Diego, CA
    Replied almost 2 years ago
    Rob, Thanks for the detailed response! I am just getting starting in my out of state REI journey and I have read other blogs that direct the safe method of setting aside what amounts to the “50% rule” for the big 6 you mentioned (Taxes, insurance, Cap-Ex, Maintenance, Vacancies, Prop management). It just makes sense to me. Cause guess what, if you are a little off and it doesn’t cost as much, it’s all money in your pocket! Even though I am getting started I will continue to be selective in my hunt, because like you said, missed money is better than lost money. early in the process as I am, I strongly believe that there are plenty of deals for those who are willing to search and crunch numbers and make numerous offers. That’s my plan, anyway!
    Rob Cook from Powell, WY
    Replied almost 2 years ago
    That is a safe approach Zachary. What I practice. Good luck!
    Cassandra Vickers from Boston, MA
    Replied 28 days ago
    Rob, I have the same question. What is your 50% rule based on? 50% of what?