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.
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.