If you want to be a landlord, then you need to get positive cash flow on your investment properties. The days of counting on the appreciation are over (at least for the foreseeable future).
I know that getting positive cash flow is easier in some housing markets, but I am a firm believer that if your rental property does not net you money each month – You have made a financial mistake. The only way to have a good chance of making money each month is to run the numbers and then run the numbers again.
I myself have been using a very basic spreadsheet I call the “Property Analyzer.” The spreadsheet shows your Purchase Price, Down Payment, Closing Costs, interest rates, number of units, occupancy rate, appreciation rates, rents collected, etc. The idea here is to make good faith estimates on what’s going in and what’s going out.
But figuring out what is going in and out can actually be a very hard task. Let’s take a big picture look at what you end up making with rentals.
Rent is straight forward, they pay and you collect (hopefully). But what about occupancy rate? Is this property going to be occupied 100% of the time? Assuming you think you can rent it 11 out of 12 months, it would be occupied approximately 91.6% of the time and you would discount your estimated cash inflow’s accordingly.
Security Deposits are hopefully returned in full, meaning that your property was returned to you in pristine condition. Keeping the deposit will most likely not be worth the hard ache that your tenant left you.
Tax Benefits are your property’s basis / 27.5 * marginal tax bracket (for example $100k property @ 25% rate is: 100,000 / 27.5 * .25 = $909.09 a year or $75.75 a month.
Appreciation on your property is something that is virtually out of your control. The neighborhood might become better or the housing market might go gang busters, don’t count on it.
Now let’s move onto the cash outflows.
Mortgage – just be careful to not assume you are getting a 30 year loan @ 3.9% — interest rates can vary on investment properties. Note: Owner occupied property usually receive lower interest rates than strictly investment properties. Also don’t forget CLOSING COSTS.
Insurance varies on numerous factors. Note: Some insurance companies do not insure LLC owned properties.
Taxes and death the only two things that are certain. You might be paying $3000 in taxes for your duplex this year, but don’t be surprised if you are suddenly paying an extra $150 or more next year, especially if a major levy passes.
Potentially an accountant or lawyer might need to become involved in your rental properties for legal or financial counsel. You also run the risk of lawsuit for various reasons if you are a landlord. You may also want to establish an LLC, which might also take some minor consulting fees.
Maintenance is general work on the property to keep it up to the working condition it was in when you rented the property. For example you have to call a plumber, HVAC guy, or have a neighbor kid cut the lawn. Just be careful that the neighbor kid doesn’t get hurt while doing it – or you are going to need to read the cash outflow above again.
Repair or Replacement can be incredibly costly and you hope that it is not frequent, but you never know. The roof, siding, appliances, water heater, toilets and plumbing, windows, and driveways all have to be replaced someday. You better assess any property you are considering buying for these major factors, because one major mistake can erase an entire year of profit. Did I mention that you might have to paint the place between tenants? Have you seen paint prices these days?
Depreciation on your property is something that is virtually out of your control. The neighborhood might become worse or the housing market might tank for one of various reasons.
Your time, I know I am going to get grief for this cash outflow because no cash actually leaves your hands. You absolutely MUST value your time. If you are spending 100 hours to find, bid, purchase/close, repair, show, screen, rent, and maintain and you value your time at $10 an hour – you just burned $1000 in your first year. You really should figure out what your time is worth and treat it as if it is a cash outflow in my opinion.
Could you have a disaster with your rental property that costs you thousands or even tens of thousands of dollars? Yes – but developing statistical models for this would vary far too much based on countless variables (location, crime levels, rent rates, etc.).
Making good faith estimates on all of the factors mentioned in this article can be tough, but it gets easier with experience. Just remember to run those numbers multiple times and be confident of any deal you are considering.