What are good assumptions to determine monthly expenses?

Question

Hello fellow investors,

There are expenses that come with single-family rentals.  What are some estimates you use to determine your net rent after expenses?

I live in Sacramento.  So far, my expenses include the following:

- Property Taxes: 1.25% of purchase price

- Rental Insurance: 0.5% of purchase price

- Management Fees: 10% of gross rent

- Vacancy Rate: 10% of gross rent

- Repairs & Capex: 10% of gross rent

- Utilities: (garbage, sewer, water): 10% of gross rent

- Mortgage: 30 year with 20% down payment

With these assumption, I get negative cash flow in my area.  I applied the parameters to other areas such as Memphis, Nashville, Cleveland, etc. and the cash flow is barely positive.

I see people saying they achieve north of 15% cash on cash returns.  Is it because their assumptions are different than what I have?

Thanks.

Jon Holdman · Answer

A simple one is the 50% rule.  That says 50% of gross rents go to expenses (per IRS definition), capital (also per IRS) and vacancy.  The remaining 50% is your net operating income (NOI).  Out of the NOI you have to cover debt service, if any.  That's only the P&I part of the payment, taxes and insurance are in expenses.

If you're self managing you can earn the PM's cut, which is roughly a third of the 50% that goes to expenses, capital and vacancy.

The danger with slicing this onion too thin is that you're tempted to shave a little off here and a little off there and you end up at an unrealistically optimistic evaluation.  Reality will be whatever it will be.  All this is just to try to make a prediction before you really know what reality is going to be.

Gerald Harris · Answer

You got that right formula.

I think in other areas the cash flow is better.   For example.   Here in Charlotte NC you can get a house for 30k fixed up.

Rent it out for $750 per mo.

after your

1. debt service (piti)

2. monthly expenses of upkeep

3. Your management fee (if you choose a manager) 8 to 10%   the return is incredible.

Check this out:

I have a guy here who focuses strickly on renting rooms to professionals

So if you take the same scenerio above and assume its a 3 bedroom house

You can rent rooms for $450 each month.

That's 1350 per month in rent.    for that same house!

So you go from collecting $750 per mo in rent to $1350 per mo in rent.   Thats 600 in monthly income.

Its a game changer and room rentals are in demand

Chris K. · Answer

Another thing to consider in conjunction with the 50% rule is the 1-2% rule (it varies from area to area). This says that your monthly rent should equal 1-2% of your purchase and rehab cost (again depending on your area). In your example if you were able to collect $1500/month rent on your $150,000 purchase you would be at $105 cash flow per month which is what some people shoot for. As suggested you'll just need purchase some deals that are below market value.

Michael J. · Answer

I would never pay trash and utilities in a SFH unless it was very common in the area. Where I live tenants in SFH pay all utilities including trash unless trash is part of property taxes.

One way to help increase your margins in a tight area is to buy below value, rehab and rent for full price. I know some people that regularly buy at 50% or less of ARV and put about another 20% into the rehab. This gives them a lot more room to work with and make the numbers work.

Henry Le · Answer

@Gerald Harris

Yes, I looked at Charlotte, NC and the prices are incredible.  My friend moved there a while back and he couldn't believe how affordable the houses were.

The room rental is a good idea.  I haven't thought about that before.  Friends and coworkers rented a room in their house, but they still lived there.

@David Hutson

I'm looking forward to the Sacramento Meet Up this coming Thursday.  Look forward to seeing everyone there!  Thanks for the great info, you've been extremely helpful and kind with your knowledge! =)

@Tou V.

I would imagine it'll be harder to cash flow when interest rates go up.  Ideally, I would want my first rental to be fully rehabbed.  But who knows, expenses can come out of nowhere.  And you're absolutely right, those major capex can really eat up all that prior cash flow.

Thanks for the replies thus far everyone!  Really appreciate it.

Tou V. · Answer

I'm no expert, but your assumptions are pretty close.  The 10% for utilities depends if the renter is paying for it or not.  A lot of SFR the renter will pay for it.   It's pretty hard to cash flow  when houses costs $150-200k and you can only rent them for $1200-1500.  What I've seen is some investors buy fully rehabbed properties, thus making their repairs expense almost zero.  After a few years they sell it and it's up to the next guy to cough up $$$ for repairs.   Between the utilities and repairs, that's  about 20% you could save.   Depending on what condition you bought the house in.   If you self manage you could say you're saving a total of 30%, but then you'd be using your time.  I have a couple of SFR and they cash flowed great for years until the roof , AC, windows, insulation needed replacing.   That's 20k in expenses  at the same time.   Yes, the reasoning is not correct as you should be saving throughout the years for those repairs, but most small time investors don't.

David Hutson · Answer

Vacancy rate for Elk grove is high.  All of my properties average 4-5% so go with 6%.  It's always better to go highh.  Insurance is usually around $700 for homes around $250k, but that is a general number. Utilities are $70 every two months and water, charge it to the tenants because if it isn't metered today it will be very soon.  20% down is good for the first four mortgages you have.

This is a perfect question to bring up at the Sacramento Meet Up on Thursday.

Paul Hoeppner · Answer

Does anyone adjust their expenses for a condo rental?  The reason I ask is because you'll never be replacing roofs, siding, driveways, etc and you won't have any landscaping or snow removal.

Thanks!

Paul

Rick Baggenstoss · Answer

@Henry Le Personally, I don't dwell too much on the recent crisis.  It's not likely to be repeated any time soon.

Rents tend to lag house values (SFR not condo/apt).  Buy a decent house in a decent neighborhood, keep it nice, and you'll have little to worry about.

Rick

Henry Le · Answer

@Rick Baggenstoss

Thanks for the advice.  Yes, capex like new roof, HVAC, and water heater can really destroy all previous cash flows.  If I went through a turnkey company then maybe those things can be more predictable.  And vacancy is the hidden expenses, who knows how long it'll take to fill the unit.  In my area at least, rent rates are higher than the mortgage payment (cost of owning a house).  So I wonder to myself if that is really sustainable.  What happens if the rent rates start to decline?

Prior to the financial crisis, appreciation was all the rage and everyone assumed housing prices can never go down.  Now it's all about cash flow, but what if you have to lower the rent rates?

What are good assumptions to determine monthly expenses?

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