Owning rental real estate can be a great way to grow your wealth. Notice I said “can be.” It can also be a great way to LOSE money—if you don’t do it right.
One of the best ways to lose money is to not properly account for all of your expenses. And while every home is different, and therefore every comprehensive list will be different, there are a lot of things that are the same for every property.
Here is a very long list of things you should be budgeting for—and including in your calculations when you’re running the numbers on a potential new property!
Capital Expenditures are frequently called CapEx for short. Think of them as expensive, infrequent repairs or replacements. Things like a roof, a furnace, appliances, a water heater. You aren’t going to be buying a new roof every year—the lifespan of a roof typically starts at 25 years and just goes up depending on the material used.
But eventually you’ll have to replace your roof, so you’ll want to have funds available when you do. Right now, a roof starts at $15,000. The way to figure out how much you’ll need to budget for your eventual roof replacement is to divide the amount of time left on your roof by the cost of the replacement.
I’ll use my own home’s age for the examples. My roof is 3 years old, and I’ll probably be looking at an $18,000 repair cost. So 25 years average roof minus 3 years old is 22 years or 264 months. $18,000 divided by 264 months is $68.18 per month that I should be saving toward my eventual roof replacement.
But CapEx isn’t just a roof replacement. A water heater starts at about $600 and the lifespan is 8-15 years on average. (When you replace yours, put a drain pan underneath it. This WILL be the best $20 you ever spend.) HVAC systems start around $5,000 and only go up.
CapEx is super important to keep in mind as you’re evaluating a deal. If rent is only a couple hundred dollars more than your mortgage payment, you’re losing money as soon as you buy the property.
Eventually, this market will shift, your tenants will move out (hopefully at the end of their lease while leaving their unit super clean!) and you won’t be able to find the next tenant, creating vacancy. While I see many people calculating 5% for vacancy, one month’s rent is actually 8.3% vacancy. I’m always very conservative in my numbers, and if you plan for 8 but only need 5 or less, you win.
You own the home, so you’ll need to keep it in good repair. Routine maintenance helps keep your home in tip-top condition, and alerts you to the start of problems so you’re making a small repair instead of fixing a huge problem.
Much of this is DIY-able, but it’s best practice to consider the cost of hiring it out when running the numbers on a potential rental in case your portfolio becomes too much to do yourself or you simply choose to be hands-off.
Some things to think about when creating your budget are:
HVAC Maintenance: Use the same company year after year, and have someone give your system a thorough once-over to make sure everything is in good working order.
Furnace Filters: provide a filter for your tenants to change and remind them to change it every month. Clogged furnace filters create undue strain on the system and lead to earlier replacement. (My HVAC guy says skip the expensive filters and use the cheap paper ones - the expensive ones can actually inhibit the airflow for your AC and cause it to freeze up.)
Gutter cleanout: gutters get clogged by leaves and debris. If there are no tall trees near your home, this is less of a concern, but clogged gutters can lead to roof damage and ice dams in the winter if you’re in a cold area.
Sprinkler blowout: if you live in an area where it freezes, you’ll need to make sure the sprinklers are blown out every fall.
Lawn mowing: this one can easily be passed off to the tenant if you make it clear in the lease that they are responsible for it.
Snow removal: this is another one that can be passed off to the tenant, so long as you make it clear in the lease.
During the course of owning the home, things will break. That’s just the way life goes. You have a CapEx fund for the infrequent replacement of big-ticket items but don’t forget those smaller things.
A good rule of thumb is to hold back between .5% and 1% of the purchase price of the home per year for repairs. On a $300,000 house that’s $1,500 - $3,000. Some years you’ll have funds left over and some years your repairs will go over, but you’re a YNAB user to be prepared, right?
Cost of Doing Business
Owning a rental property is owning a small business and there are costs involved in owning and running a business.
Insurance policy: you’ll need a Landlord Policy to cover the structure in case of damage. This is typically less expensive than a homeowner’s policy because it does not cover the interior contents of the property. If you provide appliances, make sure to ask if the policy covers them, and get a rider on the policy to cover them if you need it.
Lease: the lease is the governing body of the relationship with your tenant. It contains the rules for how your tenant should behave and treat the property, what they can and cannot do (ie, pets, long term guests, parking, etc.)
You need a GREAT lease. Downloading a free lease off the internet does not adequately protect your interests in the property. Check out this resource to purchase a state-specific lease, written with attorneys in conjunction with each individual state’s landlord tenant laws.
Utilities: in some areas, it is common for the landlord to pay the utilities, and in some areas it is common for the tenant to pay them. Find out what’s normal in your area, but if you are responsible for utilities, make sure you factor those into your budget.
Rent collection service fees: there are free rent collection services, but they come with lag times between your tenant paying the rent and you receiving the payment. If you want your rent immediately, you’ll pay for that luxury.
Professional services: once you become a landlord, you open up a whole new set of responsibilities. Some are obvious—keep the property habitable, make repairs quickly, etc. Some are not so obvious, like certain tax breaks. Even if you do plan to do everything yourself, factoring in the cost of hiring it out is a great way to run the numbers on a property before you buy it. If this landlording thing really takes off and you want to grow your portfolio, you want the option to go completely passive. If it only works when YOU do all the work, you’ll always have to do all the work. You can DIY everything if you want, but there are some professional services that are completely worth it.
A good, real estate focused CPA will frequently save you more money on your taxes than they charge you. A great Property Management company will take the day to day off your plate—for a fee of course. Typically 10% of the monthly rents and finding a new tenant costs one month rent. If you’re barely making a profit, this could be a deal killer.
Reserves: we touched on this above in the repairs section, but you NEED to have a pool of money set aside to fund those repairs when they are needed. Things break, that’s the reality of owning a property. You don’t want to go into massive debt because you were ill prepared. A good reserve fund starts at about $10,000 per unit, depending on the age and condition of the property. A newer property needs less, and an older property needs more.
The number one cost new landlords forget to factor in is their time. It takes time to set up your rental. If you are going to hire everything out, it still takes time to find the right person to run your property for you. And you SHOULD take the time to find a great Property Manager. Here is a list of 76 questions to ask your Property Manager BEFORE you hire them.
If you’re going to run the property yourself, it’s going to take a lot more time. Make sure you’re adequately compensated for your time! Advertising your property for rent, tenant screening, showing the property, maintenance calls, rent collection & deposit, and paying bills for the property all take time. Here’s more of an overview about what exactly is involved in renting your house.
For new landlords, it can be easy to overlook these very real costs associated with owning rental property—it’s more than simply the delta between the rent and your mortgage payment. Not properly accounting for these expenses can end up costing you big money and turn what looked like a great deal into an endless money pit that eats up all your profits.
You can make great money and generate long term wealth by investing in real estate, but you need to run your numbers correctly and account for everything. Just as in your daily life, your rental property also needs a budget.
Mindy Jensen is a licensed real estate agent in Colorado, author of How to Sell Your Home, and the Community Manager for BiggerPockets, where she helps new and experienced investors learn the proper ways to invest in real estate to grow their wealth. She’s also the co-host of the BiggerPockets Money Podcast.