Rental properties are considered a stable and rewarding way to make money, both in the short-term and in the long-term. The general idea goes something like this: You buy a rental property, rent it out to one or more tenants, and collect rental income in excess of your monthly expenses—resulting in a steady profit every month. Over time, the property appreciates in value, so when you sell it, you’ll turn a profit, resulting in a secondary way to make money.
Of course, in reality, things are more complicated. Not every rental property has the potential to offer a substantial return, and if you budget poorly, you may end up with a net loss every month, rather than a net gain.
How to Budget a Rental Property Properly
If you’re new to the world of investment properties, there are a few tips that can help you budget your rental income and expenses more accurately, allowing you to form a better long-term plan for yourself:
- Shop around for a loan. First, take your time when shopping around for a loan, and look at the different rates offered by different institutions. Owner-occupied and investment property loans are generally treated as distinct, and are given separate rates and fee schedules. In other words, you won’t be able to use a default mortgage payment calculator and be able to come up with the total monthly costs for your investment property. Do your due diligence and figure out exactly how much it’s going to cost you.
- Incorporate maintenance costs. As a landlord, you’re going to be responsible for fixing the majority of things that go wrong at this property; that could mean something simple, like fixing a leaky sink, or something more complex and expensive, like replacing the roof. These costs vary wildly, and are somewhat unpredictable, but as a general rule, you can count on spending about one percent of the home’s purchase price on maintenance each year. This may be more or less, depending on the nature of the property; older properties, especially those that haven’t been well cared-for, are going to be more expensive than newer properties.
- Incorporate repair and upgrade costs. You may also be interested in making major repairs or upgrades to improve tenant perceptions. These are usually applied during vacancies, when you’re between tenants. Depending on which upgrades are necessary, these could cost you thousands of dollars.
- Look at rental prices for similar units. Don’t assume that tenants will be willing to pay whatever price you happen to set. Look at rental prices for similar units in the same area. What are people willing to pay, historically? In some areas, you may not be able to charge enough to make it “worth it” for your investment.
- Account for vacancies. Vacancies represent a loss of income, and no matter how careful you are with tenant screening or how good of a landlord you are, you’re going to experience them—so it’s important that you account for them. There are ways to minimize tenant turnover, but you’ll still need to work at least some vacancies (i.e., income-less months) into your budget.
- Account for marketing expenses. To fill a vacancy, you’ll need to advertise the property to new prospective tenants. There are many ways to approach this, including relying on referrals, listing your property in advertising, and posting on social media. However, no matter what, it’s going to cost you both time and money. You’ll need to account for these when budgeting for your rental property.
- Plan conservatively. Finally, you’ll want to plan as conservatively as possible. Most of the expenses and sources of income in this list are variable and will change depending on unknown factors and volatile changes. You can protect yourself from the unexpected by giving yourself more of a buffer between your expectations and reality.
The Importance of Patience
If you’re interested in buying rental properties with the highest lifetime rate of return, or the best profitability, you’re going to need patience. Chances are, the first properties you view aren’t going to have all the features you need to turn a profit. This is partially due to the elusive nature of valuable rental properties, and partially due to the sheer number of competing property investors you’ll be dealing with. In any case, you’ll need to take your time, budget conservatively, and only pull the trigger on a property if you’re reasonably certain it’s going to pay off.
Rental property investment isn’t for everyone, but it does have the potential to pay off in both the short-term and long-term. Do your research, try to get whatever experience you can, and set an appropriate budget to maximize your chances of success.