Hi All,
A common issue with Real Estate is the determination of profitability. Common complaints are that tenants will destroy the property, the mortgage cost is too, and the profits after all expenses are low. This can be offset by learning a bit about rental property math.
Rental properties tend to have six major expenses: the mortgage, maintenance, property management, taxes, insurance and vacancy. These six expenses must be accounted for to ensure a property produces profit. A common mistake, especially among members of the military, is assuming that the rent just needs to cover the mortgage. This leads to overestimating the profitability of a house. A second issue is making the assumption that a place you or your family want to live for a few years will be suitable for a rental property. Although this can be true, it’s common to choose to live in a property that just does not rent well. For these reasons, when choosing a property, you need to evaluate all possible factors prior to purchasing the property.
Mortgage: This one’s easy. Plug the numbers with a downpayment, escrow, term, and interest rate. This will tell you how much you need to pay a month.
Maintenance: My average is 10% of rent per month for repairs. This is the average. Some months you’ll spend more and others less. For those that you spend less on, you’ll need to save up for the months with higher expenses.
Property Management: This is usually 10% a month. Sometimes you can find lower, but you will likely pay 50% of the first months rent to the Property Manager. So, overall estimate 10%.
Taxes: These you can find estimates on redfin, zillow, trulia, etc… For the exact values you will need to either dig into county records or ask the seller.
Insurance: USAA is likely the place you’re going to go for insurance. There are some warnings to USAA which I’ll cover in a different post. Whatever redfin or zillow tell you, add $30 per month.
Vacancy: Estimate 10% for vacancy per year. Remember we have 12 months a year, so instead of 10% per month you could use 8.33%.
Final formula: Profit = Rent * 71.77% – Mortgage
This will give you a close estimate on the profitability of a property. You will then want to put in more specifics such as lower vacancy, higher maintenance costs, lower downpayment, etc… All of these are options when you look for a new property to add to your portfolio.
It’s important to evaluate these factors closely before making an offer. If you overestimate the profitability, you can lose a significant amount of money quickly. A great example of that is my 1st house I bought. I underestimated the taxes on the property and USAA did as well. This resulted in an increased escrow account that pushed my monthly costs from $1,180 to $1,580 in five years. My rental income remained nearly the same. I actually was earning -$50 a month right before I sold it. However, thanks to appreciation I was able to get some profit.
I’ll try to update more frequently!
-Will