If you have the financial means, buying rental property may sound like an easy way to make extra income: purchase a house, rent it out, and relax as the profits roll in each month. Unfortunately, many would-be investors go into the home rental process without preparing a budget or fully understanding all the costs involved.
“The novice investor thinks that [managing rental property] is very easy,” says Neil Uttamsingh, a real estate agent with RE/MAX and author of the blog FirstRentalProperty.com. “The reality is it takes a lot of dedication.”
For example, you’ll have to decide whether you’ll serve as the landlord or point of contact for your rental property. Then, you’ll have to decide who will take care of repairs, how to deal with tenants, and how you’ll cover costs when the property is empty.
The answers to many of these questions will come from experience, but others can be identified and planned for in advance. Knowing the full costs of owning and managing a rental property before you buy may give you a better shot at a successful investment.
Rental Property: Basic Costs
When choosing your rental property, you’ll want to be sure to spend plenty of time evaluating the options available. Even if you’re tempted to splurge on what may seem like the most attractive space for renters in the hopes of making up the costs later, think twice about going too far outside of your budget.
“[Property is] the most expensive part of it,” says Lucas Hall, founder of Landlordology.
And a larger sales price doesn’t just mean a larger mortgage payment each month. You may pay higher closing costs as well as higher property taxes, property insurance premiums, and maintenance costs.
Until this property is paid off, you’ll be responsible for these payments, potentially on top of the mortgage for your own home.
In addition to the mortgage, there are also standard real estate property taxes and insurance premiums to consider. Your tenants may pay their own renter’s insurance, but as the property holder you may also need to obtain dwelling or landlord’s insurance to protect you in the case of fire, vandalism, or other problems.
Then there are the costs to get the property ready for move-in, what Hall calls ‘tenant-proofing’.
“You fix everything in the house so that you don’t have to maintain it over a short period,” he says, in addition to setting up any utilities not paid for by the tenants, including standard services like water and garbage removal.
The goal is to have as many of these costs as possible recouped by the rent you collect each month. But you should add up all of the basic expenses mortgage, insurance, real estate property taxes and maintenance costs first, so you know what your liability is. As the property owner, you will be responsible for any costs that go unaccounted for at the end of each month.
And don’t forget income taxes. In most cases, any money you earn as rent (beyond your expenses) will need to be reported as income.
Rental Property: Lesser-known costs
When it comes to rental property, there are always extra expenses that crop up you might not have planned on paying. The largest unaccounted for costs generally result from surprise repairs, whether you handle the maintenance yourself or hire a handyman or outside company. Some months there may not be many issues but there’s always the chance that the water heater will break down, the pipes will freeze and burst, or the toilet will back up.
“All of those things will eventually break and you need to be prepared to put a new one in,” Hall says.
You also should take your renters into consideration. You might think you’ll have an easy time filling your unit, but what happens when the house or apartment stays empty for a month or more?
Vacancies may be difficult to avoid because you aren’t looking for just anyone to fill the empty space. You’re searching for good, reliable tenants who will pay their rent on time every month. Unfortunately, this search can take time and just because your building is empty doesn’t mean your expenses stop.
“The owner has to pay those costs of operating the property,” Uttamsingh says. “That sneaks up on people.”
While you’re planning your budget, you may consider setting aside enough money to cover the property expenses for one to two months on your own in the event finding a tenant proves difficult.
Without a tenant you might also have to pay for ads or listings to find a renter or to perform a credit check on a promising applicant.
“For a first-time landlord, they probably won’t expect how much work has to go into quality tenant screening,” Hall says.
Is owning a rental property right for you?
Ultimately, buying a rental property means devoting a lot of time and money, as well as choosing the right house, finding reliable tenants, and ensuring your bills get paid on time. If you are unable to make that commitment or to develop and manage a budget, owning a rental property may not be for you.
“I think people have unrealistic expectations,” Uttamsingh says. “They want to buy a property and do no work and become rich.”
However, a little effort can pay off immensely. If you put in the time to find reliable tenants and you are responsible managing the rental property, many of these costs may be lowered. A happy tenant can stay in the same property for years, meaning you won’t need to repeat a long search or cover expenses during a vacancy.
“Then you’re taking your vacancy costs to zero,” Uttamsingh says. If tenants are reliable, you also may not have issues with missing rent, further reducing your operating costs. Insurance and tax expenses won’t go away, but over time your mortgage should.
When in doubt, plan for the worst, hope for the best, but always stay aware of your financial commitments. Understanding the costs involved in owning and maintaining a rental property is the first step to seeing your rental venture succeed.