Here Are the Costs of Owning a Rental Property
Real estate is my favorite thing in the world, and it should be yours too.
But don't think, even for a second, that all the rent you collect goes straight into your pocket. Investors tend to mess up their rental property analysis all the time. And I get it, if you just assume no vacancy for the first year, maybe the numbers will look a lot better and make sense.
So let's talk about all the expenses you need to account for in your rental property.
We'll break all of the costs you can expect into a few different categories. First, the fixed ones we can plan for.
Fixed Costs of Owning Rental Property
Variable Costs of Owning Rental Property
Less-Predictable Rental Expenses
Fixed Costs of Rental Properties
Now, don't assume we can't decrease these fixed costs over time. In fact, that's hopefully a part of your strategy when you get into a new deal. Always think about how you can get rid of expenses like mortgage insurance premiums or reduce costs like property management. It would be smart to keep an eye on mortgage rates too, you might be able to refinance into a cheaper mortgage.
Every mortgage payment includes a portion that covers your interest due.
Assuming you get a conventional fixed-rate mortgage, this cost will be laid out in your loan's amortization schedule. It's a document that explicitly says how much of each mortgage payment covers interest and how much goes towards paying down the principal balance on the loan.
Technically, every payment will include a different amount of mortgage interest but I consider this a fixed cost because you get a schedule that lays out what every payment will be for the life of the loan and you don't need to worry about this changing unexpectedly.
Just like your mortgage interest, every mortgage payment includes a portion that goes toward the principal balance on your loan.
This payment also leads to what is known as debt paydown.
This cost directly decreases your debt and as a result, technically increases your net worth by the same amount. Kinda cool and often underestimated in my opinion.
Unless you manage your rental properties yourself, you will probably be relying on a property manager.
This is also a fixed cost most of the time since you will negotiate the terms ahead of time and sign a contract with them, usually for a percentage of the rents you collect. I see most property managers charging 8-10% of your rents depending on your scale and other factors. Short-term rentals will cost significantly more too.
Mortgage Insurance Premiums
This cost doesn't apply to everyone, but if you buy a property without a large enough down payment, lenders may require you to get what is known as private mortgage insurance (PMI).
It protects lenders in case you were to default or stop paying your mortgage.
PMI adds a mortgage insurance premium (MIP) to your mortgage payment, but it most likely will not change over the life of the loan. In fact, unless you get an FHA loan, you can usually cancel PMI once you build enough equity in the property.
And don't worry if those acronyms MIP vs PMI are confusing, everyone will know what you mean if you use either one.
Variable Costs of Rental Property
If you own real estate, odds are you're on the hook for some form of tax on it.
I'm not a tax professional and this is certainly not tax advice, but generally, property taxes will change based on the value of your property. Hence, this is a variable cost since nobody knows exactly what their property will be worth in the future. We can't forecast these costs as we could in the above expenses like our amortized mortgage payments.
Talk with a professional if you want to get a better idea of how much these expenses will change for you. I would add too, that it also depends on your local tax code and sometimes can only increase by a certain amount per year.
Insurance premiums will probably increase over time.
Inflation, the cost of labor, the cost of materials, and the age of systems in your property can all contribute to higher costs to the insurance provider and they will pass that cost along to you in the form of your insurance premiums increasing.
If you assume your premium today won't go up, you'll be disappointed with your future projections. The hard part is estimating how much they might go up. Talk with an insurance professional to get a better idea of how much you can expect this cost to increase over time.
Bonus point, a lot of real estate investors also get umbrella insurance to increase their liability protection. Talk with an insurance professional if that's something you might be interested in, but that too may not be a fixed cost.
Homeowners Associations... these can be a blessing or a curse and it all hinges on the quality of the HOA in question.
A poorly run HOA may not be building reserves responsibly and may swiftly increase dues to cover a large expense. Because of your lack of control in this process, the amount you pay in dues towards your HOA can change and absolutely should not forecast a fixed cost.
It would be wise to vet an HOA you might be buying property in. Make sure they manage their finances responsibly, and that other members are happy with the organization. Ask about maximum and expected increases in HOA dues if you can too.
Also, HOAs can be dangerous. It is possible for HOAs to ban rental activity altogether which could have a significant negative impact on your rental property business.
Less-Predictable Costs of Rental Property
Maintenance and Repairs
We all dread the 2AM call from our tenants complaining about a toilet that won't flush or a leak in the kitchen.
Unfortunately, maintenance and repairs are often unexpected costs that can be hard to forecast. I try to use historical data from properties and build up reserves based on average costs from prior years. Sometimes I don't use everything in that reserve budget, sometimes I might not have enough. But it helps establish a ballpark number for what kind of costs you might have to face.
Also, try to do as much proactive maintenance as possible to reduce future repairs.
If the shutoff valves under the sink are green and corroded, it might be smart to spend a few bucks replacing them now instead of dealing with a flood at an unknown future time.
Similar to maintenance and repairs, your property's systems won't last forever.
The roof needs to be replaced every so often. Appliances tend to break. Carpet and flooring has to be redone as well. All of these are larger systems in the house that might come up less frequently but can be significantly more costly.
Perform inspections of your property and review the condition of the larger systems.
If you notice a lot of wear and tear, it might be smart to start budgeting for the costly replacement of one of these major systems.
And similar to maintenance and repairs, it would be smart to try and forecast and build reserves for these expenses. If your roof will need to be replaced in 5 years, figure out how much it will cost and start building your reserves ahead of time.
Rental property is just as it sounds. It's rented property, meaning the tenants that live there will not live there forever.
As a result, you need to account for the window of time where you will not be collecting rent. If you're lucky your tenants might stay for a few years resulting in no vacancy, but eventually they will move out and you might miss a month of rent or more.
Figure out what makes sense for your property and include this missed rental income in your rental analysis.
Miscellaneous Costs of Rental Property
Every property has different amenities and maintenance requirements.
Properties with heavy snowfall might have to lean on snow removal costs. Maybe your rental has a large yard and it needs to be landscaped and maintained. Or maybe you purchased a property on septic? You have to have it emptied and pumped out over so often.
And don't get me started on pools.
These are just a few of the added costs most investors forget to factor into their investment analysis.
Take the time to carefully think through all the amenities your property has or the specific costs you might be responsible for based on the details of the property. Leaving out a significant cost can turn what looks like a killer deal into a terrible investment.
Business Costs of Rental Property
Last but not least, owning rental property is a business and with that comes various business expenses.
Vacancy is bad for business.
Not only do you miss out on rent, but you have to find a new tenant to move in ASAP. The most effective way to do this will usually include some form of advertising, an additional expense that you should account for.
Similarly, when a tenant moves out you need to make your property rent-ready again.
Most of the time, tenants won't deep clean the unit before moving out and at least some level of cleaning will be needed. This isn't usually a significant cost and you can usually deduct it from the previous tenant's security deposit.
Lastly, owning a rental property is not easy. It's a lot of work, and to do that work you often need stuff.
Whether it be specific office supplies to run your business or tools to help advertise your vacancy, there are a lot of specific costs that you will definitely forget to account for in your projections.
My advice? Be smart about what you spend your money on. You can probably bootstrap your business and get by without those premium business cards for the first few years.
Owning a rental property business comes with lots of expenses.
Some are easy to predict, while others are impossible. The best we can do is acknowledge the expenses that are likely to come up and ideally budget conservatively for them. This is not an exhaustive list of all possible expenses but should be a good baseline for getting started.
If you want more details, I'd recommend taking a look at the Schedule E form you will likely report to the IRS. It breaks down the categories of expenses you should expect running a rental property business.