If you are thinking about investing in a rental property in the near future, you need to think carefully about your typical rental property expenses. Even though you are focused on the mortgage payment, there are other real estate expenses you will encounter. These include homeowners’ insurance, property taxes, maintenance expenses, and possible HOA fees. Furthermore, you might face an occasional repair bill, which could be expensive.
That is why most Real Estate calculators include a maintenance reserve that you should be building every month so that when the repair bill comes, you are not caught completely by surprise and have some money saved up
The General Calculation: Operating Expenses Percentage
If you are looking for a ballpark estimate of the money you will spend on operating expenses, this could help you. In general, you should expect to spend between 35 and 80 percent of the gross income coming from that property on operating expenses. Of course, this is a wide range, and different properties are going to fall into different areas. Here is an example calculation:
If you collect $1,500 per month in rent from a potential property, gross operating expenses of 50 percent would be $750. 40 percent would be $600, while 60 percent would be $900.
In general, the nicer the building is, the higher the percentage of operating expenses you’ll be facing. For example, if you have a simple duplex, your operating expenses will probably be closer to 40 percent. On the other hand, if you have a fancy vacation home with a lot of HOA fees, higher taxes, and more expensive insurance, your operating expenses might be closer to 80 percent.
These operating expenses should include everything from your mortgage to your HOA fees, maintenance fees, and insurance costs. Your utility bills might be included with the rental price, or you may bill them separately, so you need to think about this as well.
If you are estimating operating expenses prior to purchasing a property and you get a number that is less than 35 percent, you are probably missing something major, so double-check your information and make sure you have all the information you need before you move forward.
Estimating Your Average Monthly Maintenance Expenses
After you pay your mortgage, your biggest home expense will probably be home maintenance. Even though this may seem unnecessary if everything is working, the goal of home maintenance is to prevent major repair bills in the future. For example, if you get your roof maintained every year, then you might be able to prevent dangerous leaks down the road. Furthermore, if you get your HVAC system maintained on time, then you might be able to reduce your utility expenses because your HVAC system will be operating more efficiently.
So, what is included in your home maintenance expenses?
So, how can you estimate your average maintenance costs? There are two ways to do this. They include:
The Square Foot Rule: Budget $1 per square foot every year for home maintenance. So, if your home is 2,400 square feet, you would need 2,400 x $1 = $2,400 per year in home maintenance expenses. This equates to $2,400 / 12 months, or $200 per month.
The Percentage Rule: Budget 1% of your home’s value every year for home maintenance expenses. So, for a $250,000 home, the calculation is 0.01 x $250,000, or $2,500 per year. $2,500 per year / 12 months = $209 per month.
These rules more closely approximate the maintenance expenses for newer homes. For older homes, the number is likely to be higher because older homes have more problems.
There are a number of factors that will play a role in your maintenance expenses.
All of this will impact how much you spend on monthly maintenance expenses.
Estimating Property Taxes
Another major expense you will face as a homeowner is property taxes. Nationwide, the average property tax rate is 1.1 percent ; however, this is usually something that is determined by county. The average property taxes in Hawaii are 0.3 percent, while in New Jersey, the average property tax is 2.2 percent. Therefore, before purchasing a property, you should look at the property taxes in that area.
If you take out a loan for your home, you should expect to pay property taxes monthly with your mortgage. Your lender will be responsible for escrowing your property taxes with your mortgage payment, so you don’t have to worry about paying a lump sum in property tax at the end of the year.
On the other hand, if you do not have a home loan, you are responsible for paying your property taxes. You should budget accordingly to make sure you pay your property taxes on time.
With this in mind, how might a sample calculation work?
Calculating Monthly Property Taxes: The value of your home is $360,000. Your annual property tax is 1%. Your annual property tax payment is $360,000 x 0.01 = $3,600 per year in property tax. Monthly, this is $3,600 / 12 months = $300 per month in property tax.
Remember that this is probably going to be included in your monthly payment to your lender. If the monthly payment appears higher than you thought, take a look at the breakdown. It probably includes your monthly mortgage payment, your home insurance payment, and your property taxes.
Finally, if the property you are purchasing is not going to be your primary residence, your real estate taxes could be significantly higher. For example, if you are purchasing a rental home or a vacation home, your property taxes could be double or triple what they usually are on a primary home. Therefore, you should read the regulations carefully in that county, or reach out to a local real estate agent who can help you. That way, you are not blindsided by higher taxes.
Estimating Home Insurance Expenses
Another major monthly expense is your home insurance. Home insurance can vary widely from state to state, similar to property taxes. Therefore, it is important to get quotes on home insurance in your area before you decide to purchase property. Nationally, the average price of home insurance is $1,600 per year; however, it depends on a number of factors.
Similar to your mortgage payment and property taxes, home insurance is something that is usually included with your monthly payment to the lender. Your lender will usually require home insurance as a condition of the loan.
On the other hand, if you purchased a house using cash, then home insurance is not required; however, given the value of your investment, it is probably still a good idea for you to have it. If you are not going through a lender, your home insurance may be billed annually or semi-annually, depending on the carrier.
Since most people will go through a lender, home insurance will probably be billed monthly. Let’s take a look at a sample calculation.
Monthly Home Insurance Premium: Your annual home insurance quote is $1,200. Monthly, you will pay $1,200 / 12 months, or $100 per month in home insurance.
Remember that this will probably be included in the monthly payment to the lender, so be sure to read the breakdown of the monthly payment to see if your home insurance is included.
There are a number of factors that will impact the price of home insurance.
There are ways to save money on home insurance as well. For example, if you have a home security system, your carrier will probably think there is a lower risk of someone breaking into your home. Therefore, they might be willing to give you a discount on your home insurance.
Finally, flood insurance is usually sold separately. If your house is located in a flood plain, your lender might require you to purchase flood insurance in addition to home insurance. It is not unusual for flood insurance to cost an extra $700 to $800 per year , so if you need flood insurance, be sure to include this in your estimated expenses.
Depending on where your home is located, you might need to pay HOA fees. Before you purchase property, you should take a look at what the HOA fees might be. They can vary widely from place to place, and some locations do not have an HOA at all. In general, HOA fees for condo buildings and townhomes will be higher than single-family homes because the HOA fees associated with condo buildings might cover more amenities such as parking, pools, gyms, and common areas that neighborhoods with single-family homes might not have.
Some HOA fees are billed monthly while others might be billed quarterly, semi-annually, or annually, so be sure to look at the breakdown on the ledger.
To calculate monthly HOA fees, the calculation is as follows:
Monthly HOA dues: Your annual HOA dues are $240 per year. Monthly, you will pay $240 / 12 months, or $20 per month in home insurance.
It is not unusual for HOA fees in condo buildings to be several hundred dollars per month, so be sure to build this into your estimated real estate expenses. Single-family home HOA fees are usually less expensive.
Property Management Fees
Finally, if you are purchasing property with the intention of renting it out, you might want to hire a property manager to help you save time. You will still be responsible for all of the operating expenses listed above, but a property manager might help you find long-term renters, locate contractors, and be the first point of contact if an emergency happens to one of the utilities.
While property management fees vary, they are usually billed based on a percentage of rental income. They typically fall between eight and twelve percent of the monthly rent, but you should get quotes from multiple management services, see what they cover, and make sure you are getting a fair rate.
Let’s take a look at how to calculate property management fees. The calculation is as follows:
- Gross monthly rent is $2,000 with a ten percent commission on rental income. The monthly fee is: $2,000 per month / 0.10 commission = $200 per month in property management fees
You should take a look at the contract to see if the rate changes with time. That way, you know what to expect.
Finally, property managers might also escrow property taxes and home insurance premiums for you as well if you do not have a lender who can do this for you. This could be another way you can save time on property management.