Key Takeaways
- There are approximately five steps to accurately estimate rental property expenses.
- Calculating property cash flow can be tricky, but using online calculators and spreadsheets can make the job easier.
- Make use of a rental property maintenance checklist to avoid any costly oversights.
Before deciding whether or not to become a landlord, learning how to estimate rental property expenses and cash flow is an essential skill for investors to develop. When evaluating a potential income property, investors should analyze the local market and estimate the rental income potential to deem whether or not the investment is a good deal. However, stopping the analysis there could be a fatal mistake. In order to get a more accurate picture of profit potential, landlords should also take a close look at the potential cash flow of a property, after netting out all rental property expenses. This is no easy task.
Keep reading to get a better idea of how to estimate rental property expenses, and learn how to identify great rental property deals.
5 Steps To Accurately Estimate Rental Property Expenses
To evaluate the cash flow potential of a property, a crucial step is learning how to accurately estimate rental property expenses. Unfortunately, there are failed landlords out there because they were not able to anticipate the wide range of expenses associated with running a rental property. Some experience the throes of bringing in a negative cash flow after they have paid all their expenses.
To avoid such a scenario, we urge that investors mind their due diligence and thoroughly assess potential expenses. For a methodical evaluation, try following the five recommended steps below:
- Identify initial repairs and improvements to be made: Although there may be some ongoing or unforeseen repairs to be made down the line, a great place to start is an initial appraisal of what needs to be done around the property. Make use of the rental property maintenance checklist guide in the section below so you know what to look for.
- Talk to local property managers: Property management companies in the area should be happy to provide tips and advice, hoping that you will hire them in the future. Let them know you are interested in purchasing a rental property in the local area, and that you would like their insights about common, location-specific expenses.
- Call the utility companies: Simply contact the local utility companies and ask about typical charges for services such as water, electricity and gas, and garbage collection.
- Identify Fixed Expenses: Identify expenses that you can expect to occur regularly. These expenses are not ‘fixed’ in the traditional sense as the monthly bill can fluctuate, but are cash outflows you can depend on to be paid out repeatedly and at regular intervals. Examples of fixed expenses include water and sewer, electricity and gas, garbage, insurance, property taxes, and property management fees.
- Identify Variable Expenses: There are some expenses that landlords can anticipate to occur at some point in the future, but cannot necessarily name a price tag or a frequency. Variable expenses are probably the trickiest type of expense to estimate, but should never be ignored. Examples of these can include the cost of any vacancies, unexpected repairs, or big-ticket improvements such as having to repave a driveway or replace a roof. Seasoned landlords put aside a percentage of the monthly income generated by the property to save up for future capital expenditures.
What Expenses Can I Claim For A Rental Property?
To identify what expenses you can claim for a rental property, a good rule of thumb is to see if they fit into any of the three categories below:
- Replacements
- Repairs
- Refinishing
It is only natural for investors to feel overwhelmed upon discovering the various types of expenses associated with managing a rental property, especially after understanding that a bad deal can lead to negative cash flow. For these reasons, estimating rental property expenses should be taken seriously. The good news is that a good portion of the expenses can be claimed. A good rule of thumb for deducting rental property expenses is to determine if an expense is repair-related, or improvement-related. Generally, any repairs made at a rental property can be deducted from the property’s taxable income during the filing year. On the other hand, anything that can be considered as an improvement by the IRS cannot be deducted right away, so property owners should be careful not to mix up the difference between repairs and improvements.
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How To Calculate Rental Property Cash Flow
Cash flow is defined as any amount of money flowing in and out of a business, in this case your property management business. In general, property owners will see an uptick in cash flow after they have collected rent. However, they will then be required to make payments on operating expenses, capital expenses, the mortgage, and income taxes. If rent checks could simply equate to a property manager’s cash flow, life would be so much easier. However, by the time all necessary expenses are paid, the original income from rent can be whittled down to a small amount. Some landlords might even be startled to discover that their cash flow for the month is negative. Thus, the potential rental income to be generated by a property means nothing without an accurate picture of all expenses.
In order to calculate rental property cash flow, tracking the following facets of income and expenses is required: net operating income, cash flow from operations, cash flow after financing, cash flow after taxes. Net operating income is the income that is left over after paying every-day rental expenses, including fixed and variable expenses. Next, deduct any capital expenditures to find out your cash flow from operations. Discussed earlier, capital expenditures can include setting aside a percentage of the monthly rental income to help avoid future catastrophes or emergencies, and writing it off as an expense. After operational expenses are accounted for, any financing costs should be deducted. Although free and clear ownership is ideal, most investors have to borrow money in order to finance a deal. In this step, deduct any amount needed to pay your lender, or to pay yourself.
The final step in the calculation is determining your cash flow after taxes. To calculate your income tax liability for the month, to be paid annually, first account for any deductible line items, such as repair expenses, interest expenses, and depreciation. Your taxable income is different from your cash flow income, and can be a good thing. For example, interest expense and depreciation are accounted for on paper, but don’t actually come out of your cash flow. Thus, the final amount of taxable income will usually be less than your actual cash flow. Finally, after calculating your taxable income and deducting your income tax, you will arrive at your final cash flow amount for the month.
Rental Property Cash Flow Calculator
If the idea of calculating the steps above were overwhelming, you are not alone. Accurately and properly accounting for financial aspects such as depreciation and amortization is a skill set mastered by accounting professionals. Although some investors may prefer make calculations on their own, there are plenty of advanced online calculators and spreadsheets available, such as this one from InvestFourMore.com.
Rental Property Maintenance Checklist
Maintaining the quality, safety, functionality and appearance of a property is a crucial but costly responsibility for income property owners. Nested under the umbrella of operating expenses, calculating maintenance fees is no walk in the park. However, creating and sticking to a rental property maintenance checklist can help streamline the evaluation process, and prevent oversight. In addition, a checklist can be referred to at regular intervals to ensure that the property continues to be well-maintained for tenants. Feel free to use the checklist below as a starting off point:
- Regulatory maintenance
- Walls and doorways
- Locks and door handles
- Carpets and flooring
- Switches and light fixtures
- Windows, blinds and curtains
- HVAC
- Appliances
- Sinks and plumbing
- Roof, gutters, drains and fencing
- Smoke and carbon monoxide alarms
- Attics and crawl spaces
When examining the items on the checklist above, the main questions to answer are whether the items are functioning properly, if they are safe, and if there are any signs of mold, mildew, infestations, or other problems that could lead to larger concerns down the line. Catching even the smallest of issues and addressing them adequately can help prevent future catastrophes. In addition, you will ensure the satisfaction of tenants and reduce the amount of vacancies, which negatively impact your bottom line.
How To Deal With Common Rental Property Repairs
After running through the rental property maintenance checklist above, landlords should also account for common rental property repairs that will be required. Tenants can be held financially responsible for any damage they have incurred themselves, but generally, the owner should take responsibility for general wear and tear issues, as well as debugging problems that will help prevent catastrophes down the line.
The following is a quick guide on how to deal with some of the most common rental property repairs.
- Malfunctioning appliances: Some minor issues can be fixed yourself, especially if all that is required is ordering a factory part. For trickier malfunctions, relatively inexpensive repair services can be outsourced, and are offered by most appliance stores. In some cases, the appliance may need to be replaced entirely, especially if there is a potential fire or health hazard.
- Water leaks and damage: Any water leaks should be addressed immediately. Not only can water cause damage to property surfaces, excessive moisture can lead to mold or mildew. In addition, even the slightest water drips can add up and cost a fortune. Find a good plumber or contractor as soon as possible to take care of the issue.
- No hot water: Chances are, you would personally hate not having running hot water, so this issue should be addressed promptly for your tenants. The issue will most likely lie with the hot water heater. Inspect the heater to see if you can quickly fix the issue yourself. Otherwise; hire a professional to check into the problem. Replacing a hot water heater can cost around $300 to $600, depending on the model.
- Bugs and pests: Dealing with an infestation can be tricky because oftentimes it can be the tenants’ own fault, such as from having pets or a lack of cleanliness. However, make sure to take care of the infestation, especially before it spreads to any other units in the property. If you are able to identify the cause of the infestation, be sure to educate your tenants in order to prevent infestations in the future.
- Garbage disposal: Garbage disposals break all the time, and usually it is because the tenants are feeding it food items that do not belong. Some landlords may opt to entirely remove garbage disposals for this reason. Otherwise, disposals can usually be fixed with an allen wrench, or if the motor is burnt out, entirely replaced.
- Running or clogged toilet: If a toilet starts to run around the clock, most likely one of the cheap plastic components housed in the tank need to be fixed. Luckily, replacing parts in the water tank are inexpensive and usually easy to fix. For toilet clogs, have the tenant call a plumber if it seems to be their fault. If the tenant reports having a sink or a bathtub that is clogged as well, it could signal a deeper plumbing issue that should be investigated.
Investing in a rental property is no easy feat and should not be taken lightly. There are a multitude of expenses associated with keeping a property properly maintained, which can lead to constraints on your cash flow. By learning how to estimate rental property expenses accurately, investors will develop the indispensable skill of being able to identify an income property that will help boost the bottom line at the end of the day.
Do you have your own tips and tricks for estimating rental property expenses and cash flow that were not touched upon in this article? We’d love to hear them! Share in the comments below.
