Investing in Real Estate Part 2 - Expenses Associated with owning Rental Properties
In the first
segment we went over the importance of getting clear on your investment goals
and discussed three possible scenarios for real estate investment.
The first is
the fix and flip scenario – this type of investment can yield a quick return,
but it is risky and hard to find in today’s market conditions.
The second
is an investment for cash flow. While
the property may increase in value over time, the main objective here is to
generate a passive cash flow. To achieve
this, an investor will typically put a lot down and look for a property with
low monthly expenses.
The third is
a buy and hold scenario. Here the
investor is looking for long term gain and the appreciation over time. Typically, the plans on holding the property
at least 7 – 10 years and may put as little as 20- 25% down. The rent should cover expenses initially, but
over time the investor will see some passive income (in addition to the
appreciation in value) as rents increase.
So, when we
talk about getting enough rent to cover expenses – what expenses are we talking
about? A new investor typically takes
out a loan on the home, just as you would with a primary residence. So, the first expense is, of course, the down
payment and money for capital reserves.
As stated above, the down payment could be as low as 20% of the purchase
price. I recommend holding enough cash in reserves the initial
improvements you need to make to the home and 3 – 6 months of carrying costs.
The rest of
your expenses could be figured on a monthly basis:
1. Your mortgage payment as well as
property taxes and insurance payments.
2. Property Management – If this is your
first investment property, I STRONGLY recommend that you hire a property
management company. There is a lot that you won’t anticipate, and it is will be
a life saver to have someone experienced managing your property for you. Plan on this costing about 10% of your
estimated income.
3. You also need to plan for the
property to be vacant at some point. 5%
of your projected income is a good estimate.
4. Money for repairs, maintenance and
supplies – 6% of your projected income is a good estimate here, but it really
depends on the age and condition of the home.
5. Finally, you need to consider expenses
such as HOA dues and things like utilities and lawn care if the tenant isn’t going
to be responsible for those items.
Then, it is
just a matter of doing some math – Estimate your expected income from rent (I
use Zillow and Rentometer) and subtract the anticipated monthly expenses.
This is
where an experienced real estate professional can be helpful. I use a tool to help calculate not only the net
proceeds, but also how the investment is expected to perform over time.
And that’s
the FUN part! We sit down together and
identify some properties you like and see if they work for your investment
goals. Low maintenance properties in desirable neighborhoods work well for the
buy and hold scenario.
Even if the
idea of investing is just a budding dream for you, I’d still love to sit with
you and show you some real life examples so that you have a clear vision of
your goal.
In the next
segment, I’ll share a few thoughts on financing your investment.
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