Rental properties are one of the best and prevalent investments in the real estate world. From providing stellar tax incentives and passive income to producing top-notch returns, rental properties are an excellent starting point for real estate investors.
Moreover, rental property investments help safeguard investors, as well as their money. While it is a lucrative business, there's a lot real estate investors need to understand before investing in rental properties. Here we discuss what rental property is and what are some rental property expenses you should know before purchasing your first rental:
What is a Rental Property?
A rental property refers to a commercial or residential property that a tenant may lease or rent for a specific time. The tenant may decide to offer short-term rentals, i.e., vacation rentals or long-term rentals, .i.e, 1-3 year leases. The different types of rental properties are as follows:
Residential Rental Properties
These refer to 1-4 family homes and include:
- Single-family homes
Commercial Rental Properties
These refer to an array of different kinds of properties, including:
- Multifamily, i.e., apartment complexes
- Industrial buildings like self-storage and warehouses
- Office space
- Retail space
Estimate Rental Property Expenses Before You Buy
Before purchasing a rental property, it's always a good idea to curate a list of potential recurring expenses to prepare yourself from the start.
Luckily, the process of estimating how much you can earn from investment properties is a straightforward task. However, accounting for all the various expenses may be somewhat challenging if you're stepping into the world of rental property investments. Let's figure out the various costing aspects that you'll have to budget for:
Purchasing expenses refer to the costs of buying a rental property. Here are a couple of expenditures you should keep in mind when purchasing a property:
Appraisal and Inspection
Property investors need to pay for real estate appraisals to determine the value of loans they can provide to borrowers. These vary from $300 to $400 for single-family apartments.
Moreover, home inspections may be necessary to spot any hidden issues. These typically vary between $200 to $500, depending on your property's location and size.
After purchasing a new property, real estate investors will have to worry about closing costs. Typically these start from 2% and go up to 5%.
The closing costs comprise the costs of the mortgage application, underwriting fees, and recording fees.
Some areas require you to boast special business permits. Be sure to conduct in-depth research to find any necessary rental property business permits and add the costs to your expenses.
Operational expenses refer to ongoing rental property expenses. Let's gauge the entire operational costs you'll have to factor in your budget:
Property taxes refer to rental property operating expenses. These will be included in your monthly mortgage payments but may differ state by state, as well as on the type of investment property you boast.
Upon purchasing a property, real estate investors will automatically become a part of HOA. Each member of the HOA has to pay monthly, quarterly, or annual association fees.
Typically the fees will go towards ongoing operations like maintenance of external elements of your property.
Rental property insurance is necessary to cover the unique risks that come with renting your property. Typically it includes coverage for liability costs, loss of rental income for landlords, and property damage.
Typically tenants will have to pay the majority of the utilities, including;
- Heating oil
- Water and sewer
- Trash and recycling
These expenses may be anywhere between $30 and $200 each month.
If you plan on managing the investment property on your own, you won't have to account for rental property management fees. However, once you expand your real estate portfolio, you'll want to hire a property manager to assist you in the processes.
Typically property management fees range from 8 to 12%.
Variable expenses, otherwise known as variable costs, will pop up now and then during your stay at a particular place.
On top of that, these may change over time, depending on your use of products/services and other factors. Let's discuss some of these below:
Property Maintenance and Improvements
Apart from rental property repair expenses, landlords will have to factor in property maintenance and improvement costs necessary to upkeep the home's appeal. There's also a chance your rental property maintenance expenses may be added to the property management company's total fees, whereas the other is variable.
The costs of property improvements majorly depend on your real estate investment strategy. For instance, if you purchase a distressed property, the upgrades will cost you comparatively higher than a modern rental property.
Plus, with lawn maintenance, roof maintenance, sidewalk improvements, and so on, you may have to set aside at least 1% of the investment property's value to account for annual rental property repair expenses.
Cost of Vacancies and Marketing
In some cases, it's unavoidable to have a vacant rental property due to tenant turnover. The most ideal way to control and reduce the cost is by starting when you purchase the investment property.
Moreover, to ensure a positive and steady cash flow, real estate investors should include marketing expenses in their rental rate.
Your property manager may charge additional fees, including tenant placement fees, maintenance fees, and vacancy fees.
Moreover, you may request your property management to take care of evictions. In case they do, you'll have to provide a fee for this service as well.
Lastly, if you plan on terminating your contract with your property management company, you'll be charged a fee for that too.
Tax Deductible Rental Property Expenses
Tax deductibles can easily mean the thin line between acquiring profit or losing money on a rental property. Let's find out the most extensive tax deductions:
Interest comprises money spent on mortgages, credit card interest on goods, and loans necessary to update the property.
Repairs and Maintenance
Repairs may be deducted in a year, whereas improvements have to be depreciated over 27.5 years.
Personal Property Deductions
These are used for items including furniture, appliances, and gardening equipment.
Pass-through Tax Deduction
These may reach up to 20% of the net rental income according to the Tax Cuts and Jobs Act.
Employees and Contractors
It refers to wages you may have to pay to employees or independent contracts such as landscapers, handyman, and so on.
Office and Travel Expenses
If you boast a workshop, you'll have to factor in its maintenance costs as well. Besides, you'll have to worry about travel expenses for visiting the hardware store, overnight travel expenses for long-distance investors, and tenant showings.
The Bottom Line
If you're a rental property owner, you must factor in the various rental property expenses when evaluating your budget. These expenses may vary from area to area, as well as property to property.
More often than not, rental property expenses are tax-deductibles. It means that even if you have to pay an upfront fee, these expenses will benefit you in the long-run. If you're an investor planning to nurture long-term wealth, rental property investment is the way to go.
This page last updated: March 21, 2022