Figuring the cash flow on rental properties seems pretty simple, but many people do not include all the expenses they should. Each rental property will need maintenance and be vacant at some time and these costs must be accounted for. I own 16 rental properties and I have a goal to buy 100 rental properties by 2023. I make a lot of money on my rental properties, but I have to make sure I account for all the expenses to ensure I make as much as I think I will. Vacancies and maintenance must be factored into an investor’s expected returns even if a house is completely repaired and your area has low vacancies.
Why are vacancies and maintenance important to factor into cash flow?
Cash flow is the money you make on rental properties; my cash flow calculator helps investors determine how much they will make on rental properties. You will notice my cash flow calculator has a place to enter vacancies and maintenance. When you own rental properties, you may not have a lot of vacancies or maintenance every year. But in some years, you may have so many vacancies and so much maintenance you will make you wonder why you ever bought rental properties.
If you plan for the bad years that may have a lot of vacancy and maintenance costs, it won’t hurt as bad and you will still make money on your rental properties.
How do you account for vacancies on rental properties?
Vacancy is the time you own a rental property when it is not rented or you are not collecting rent. Vacancies will happen when a tenant moves out, a tenant stops paying or you can’t rent a property as soon as you hoped. Not only will you not be collecting rent during vacant months, but you will also have to pay utilities on the home (if the tenant normally pays utilities).
One of the most costly scenarios when owning rental property is if you have to evict a tenant or they stop paying rent. It can take months and thousands of dollars to evict a tenant. On my rentals I have been lucky that I have never had to evict anyone, but at some point I will.
Even though I have never had to evict anyone, I have had problems with tenants not paying rent on time. One of my tenants in rental property number 6 had to have heart surgery and could not work. He fell behind in rent, and I did not have the heart to evict him. We worked out a deal where he moved out, but he owed me over $3,500 in back rent when he moved out. This is actually a fairly cheap problem when you have a problem with a tenant not paying rent. If you have a tenant who won’t pay rent and won’t leave, you could pay much more for an eviction.
Why do you have to factor in maintenance on rental properties?
I repair all of my rental properties before I rent them. When my properties are first rented they most likely will not need very much maintenance, because they are repaired. However, I also buy homes that are 30, 40 or even 50 years old. Although I repair homes before I rent them, I am not rebuilding a house and things will break. I don’t know what will break or when it will break, but things break. Tenants also may break things for you and you still have to fix them.
How can you decrease the maintenance costs on rental properties?
My cash flow calculator figures maintenance costs based on how old a house is and how much rehab has been done. The more work that a house has done, the less maintenance it will need. The newer a house is, the less maintenance it will need because the major systems are of better quality and will last longer. I prefer to buy rental properties that are 50 years old or newer because they have a much smaller chance of needing major work.
The most important factor when keeping up with maintenance on rental properties is the quality of the tenants and over site of the landlord. The better the tenants take care of a home and the more a landlord keeps tabs on their property, the less maintenance there will be. The rental houses I have seen that are in the worst shape were rented to the same tenants for years and the landlords never checked the house to see the damage being done.
Why do you have to figure so much money for maintenance on rental properties?
Even if a house does not need any maintenance done for years, a big expense could pop up and wipe out all the savings. A roof could cost $5,000 to $10,000 and that will wipe out a lot of rental profit. A tenant could trash the paint and carpet in a house, which could easily cost $5,000 or more. The big repairs are why we account for maintenance in our returns, even if a house may not need any other repairs for years.
How much money should you plan on spending for vacancies?
The tricky part about accounting for vacancies is deciding how much money you need to allocate for future vacancies or evictions. A good rule of thumb is 10 percent of the rents should be considered the cost for vacancies. 10 percent would be just over one month’s rent and will account for a vacant month plus any utilities and other costs you incur while the home is vacant. On my rental properties I have been very lucky and proactive to get my houses rented right away after a tenant moves out. My vacancy rates are also very low in Colorado, and I have seen about a 5 percent historic vacancy cost.
How much money should you plan on spending for maintenance?
Planning for maintenance costs is very difficult to do, because you never know what will break or how well a tenant will treat a home. In my cash flow calculator, the maintenance costs on my tiered scale range from 5 percent to 30 percent of the collected rents. The 5 percent is for a house that is almost new and all the systems are in great condition. The 30 percent is for a house that is 100 years old and has not had the systems upgraded or any recent remodel completed. The maintenance costs will vary greatly depending on the type of house you buy, the age, the condition and how well it is taken care of.
How do you figure the total cash flow on rental properties?
Rental property number 1
This rental is paid off and does not have a mortgage, although I do have a line of credit against it that I use for fix and flips.
Rent $1,400 a month
Taxes $60 a month
Insurance $50 a month
Maintenance $140 a month (rent times 10 percent for maintenance)
Vacancies $70 a month (rent times 5 percent for vacancies)
HOA Fee $13 a year
Total cash flow is rent minus all of these expenses which equals: $955 a month.
If I had a mortgage on this property, which I did when I first bought it, my cash flow would be $955 minus whatever the principal and interest payments would be. It is also important to remember that most lenders will escrow the taxes and insurance. Escrow means they include it in your mortgage payment so make sure you are not counting them twice if the lender is including those costs in your payment.
When I bought this house, I paid $96,900 for it in 2010 and my payment at the time was about $350 for principal and interest. That would make my cash flow about $600 a month with that mortgage payment included.
The money you will make on rental properties is not the rent received minus the mortgage payment. You have to account for many more costs that may not occur for years, but when they do occur they will be big. When you plan to buy rental properties you must make sure you can pay these expenses when they come up. A good first step is to save much of your cash flow in the beginning to build up an emergency fund. Do not spend that money unless necessary.