The ability to earn passive income is one of the big draws to rental property ownership. Whether you rent out a single-family home or choose to take on the much greater endeavor to own and manage an entire apartment complex, the vision of those rent checks hitting the bank account has inspired generations of real estate investors.
Any investment property owner will tell you there's more to the game than sitting back and collecting the rent! Handling the responsibilities of property management – dealing with troublesome tenant issues, risking your assets on behalf of tenants you likely don't know, and taking care of the property's maintenance requirements – can take a toll. That's why it's essential to protect both your sanity and your asset with a monthly rent payment that's fair and accurately covers your actual burden.
Before you purchase the rental property, you need a clear picture of both upfront in-vestment costs and any recurring expenses. When you buy a property to rent, you need to see cash flow from rental income to cover recurring expenses, fund a maintenance reserve, and some acceptable profit increment.
You'll also need a break-even goal for your upfront costs. For example, if you purchase a duplex for $200,000 but your lender requires 20% down, and you anticipate $10,000 in maintenance or improvements before you can rent the property – and you want to recover that maintenance investment in 5 years, a factor that additional amount into your essential monthly cash flow requirement.
Follow the numbers:
If you want your total investment (amount spent for the down payment and maintenance and improvement) recovered in five years, you'll need to earn an extra $833 per month above your expected cash flow. $10,000 in repairs plus $40,000 in downpayment =$50,000 divided by 60 months (5 years) = $833 a month.
Now that you are clear about your payback examine your monthly expenses.
Know your recurring monthly expenses before you commit to purchasing the property:
Some of these costs will be set, like principle, interest, taxes, and insurance (PITI), and won't change much. Be sure to get insurance quotes from several different companies to ensure you're getting a competitive rate.
Experienced property managers typically set a budget for repair costs at 5% of the rent, and set aside 5% for a vacancy. Professional property management fees can range from 6%-12% or more; even if you intend to manage the property yourself, you want to estimate a management fee if you choose to hire an outside company in the future.
Back to the numbers on our $200,000 rental. To estimate what you should charge for rent, you can rely on the 1% rule:
Monthly rent x 100 = maximum purchase price
Based on the 1% rule for your $200,000 purchase, you'll need to charge $2,000 per month in rent.
What does your cash flow look like assuming $2,000 in rent?
Here are your monthly costs:
|Taxes||$208.33||(estimated at $2500 per year)|
|Insurance||$66.67||(estimated at $800 per year)|
|Total operating expenses||$1374.70|
|Monthly rental income||$2000|
With a cash flow of $625.30, subtract your upfront costs of $833/ month, and you are negative $207.70. This means you need to charge more in rent to reach your payback goal of 5 years. Rent of $2207.70 will allow you to break even monthly while paying back your upfront costs within 5 years.
But there's one more essential variable: How do you ensure your rental rate does not out price the area? It’s time to evaluate comparable rental properties and find a good rent-al calculator.
Comparing the home prices in areas similar to where you are considering a property purchase can better understand the local rental market and if you are above or below what the market with bare. You'll also get a better idea of standard amenities – such as drive-way, garage, off-street parking – on offer with other rental properties. A quick search on a real estate listing site will show you the details about nearby properties.
The most popular amenities to keep in mind include driveways, garages, and a yard (or yard access.) If the rental property you have in mind doesn't offer these amenities – while other neighboring homes do – you may not be able to set your rent in the area's average range. As you search for a rental property to purchase, take these amenities into account before buying.
And while such amenities typically boost the rent, you can charge, each one comes along with its additional maintenance, which may vary by season. For example, you will want to anticipate any responsibility for snow removal. And take a good look at the drive-way in case it's been neglected and will need repairs.
A rent calculator is a handy tool to compare your monthly rental price to other available properties in the immediate area. Rentometer supplies easy-to-use, comprehensive resources for property managers, landlords, and tenants – find out at the touch of a button if you're charging (or paying) too much or too little by comparing your rent with other local properties.
A rent calculator like the Rentometer PRO Report gives you access to additional insights and data to assess current market conditions. Take a deeper dive into your rental property's performance using statistics like rent analysis, including a chart that shows the three-year trend and moving average chart. You will also find sample listing details – rental listing prices, the price per square foot, and even more information such as when the property was built, taxes assessed, and details about the last sale.
No matter how you approach your investment in a rental property, reliable knowledge to ensure that you're charging or paying an appropriate price is key to fostering good relationships between landlords and tenants. While there are inevitable horror stories shared among property managers, you set yourself up to avoid common conflicts and misunderstandings when you commit to becoming an informed, proactive manager.
This article was written by the Rentometer Content Team. The Rentometer Blog features fresh takes and insights on rental housing topics, services, and technology.