Many people make big mistakes when they try to determine the cash flow potential of a rental property. Basically, they think that if the market rent for the house is higher than the mortgage, they’re in the money.
It’s not that easy. If it were, anybody could do it. Lots of houses can be purchased with a mortgage payment lower than the market rent.
But as any homeowner can tell you, the expenses don’t stop at the mortgage. If you want positive cash flow for your rental property, your rental collection needs to cover all expenses.
Here’s a cheat sheet of expenses to make sure to account for when doing your cash flow analysis for a prospective rental property:
First and foremost, you need to know your monthly mortgage payment. This is usually where people start, but the expense rabbit hole goes much deeper.
Property taxes to the county are mandatory; otherwise, the county can foreclose on your property, just like your lender. Property taxes are usually due once or twice a year, but your lender may require you to pay monthly into an “escrow” account to make sure there are funds available to pay those property taxes.
Property insurance is usually required by a lender so a fire doesn’t destroy the collateral — at least not without an insurance policy to claim against it.
If the property is in a FEMA-designated flood-risk zone, the lender may require flood insurance, as certain flood damage is not covered by homeowner’s insurance.
Landlords may also want to consider liability insurance, which will protect them in the event of a lawsuit filed by a tenant. The lender may require payments into the escrow fund to cover insurance as well.
Fees and Assessments
Property taxes may not be the only assessment against your property. Condo association or homeowner’s association fees are common offenders. Yes, your HOA can foreclose on you if you don’t pay your HOA fees! The lender may require you to fund HOA fees in your escrow account too — they really don’t want someone else foreclosing your property before they can.
As the landlord, you are sometimes responsible for some utilities, like water, electricity, or gas. You may be able to bill these back to the tenant for extra income.
Repairs and Maintenance
Maintenance of the property falls to the owner, not the tenant. Maintenance emergencies can arise out of nowhere and be very costly in terms of contractor costs, handyman costs, and replacement of major appliances like a refrigerator or HVAC. Smart landlords don’t pocket every dollar of excess rent — they usually pay some or even most of it into a “maintenance fund” to cover any big expenses that may arise.
Contract services are recurring maintenance services that might include gardening and landscaping, trash collection, pest control, and routine maintenance (changing air filters, flushing water heaters, etc.)
Professional services might include tax preparation and legal fees. Legal fees could include contract review, litigation costs, and eviction fees.
If you decide to hire a property manager to free yourself from operational responsibility for the property, you will usually need to pay that manager a percentage of the gross rents collected. Current rates are typically 8% -10% of the gross rents.
Few rental properties can maintain 100% occupancy at all times. With proper management you can get close, but it’s usually wise to factor in at least some vacancy expense — time when your property is vacant and not collecting any rent. Cities usually have a prevailing market vacancy rate which you can use to be conservative, but somewhere between 5% and 10% of the gross rent potential is standard.
If you calculate all relevant expenses and come out with a number that is less than the gross rent potential, congratulations! You have identified a property with strong potential for positive cash flow, all the while appreciating in value.
Having trouble estimating expenses? Martel Turnkey can help! We have extensive experience making accurate calculations of real estate expenses. Every property in our inventory includes detailed expense projections, which we can back up with evidence. Want to do cash flow analysis the easy way? Reach out to us — we’re glad to help!