How to Budget for Rental Property Vacancy and Repair Costs
By Kerry Curry, B2R Contributing Writer
Single-family rental property investors, especially those new to the business, typically underestimate their variable expenses, the biggest drivers of which are vacancy and repair costs.
It’s certainly easier to estimate fixed costs such as the mortgage, insurance, utility bills and taxes. Typically, an investor can get some expense history from the property seller or from public entities that track this information.
Estimating variable expenses in your annual property budget such as vacancy and repair costs is far more challenging, but it can be done.
Accurately forecasting variable experiences becomes easier over time as a real estate investor learns the patterns of what items need repair most often and what repairs typically cost in the markets where they invest.
They also will get a better feel over time for how long it takes to lease a property. Outside factors, such as the local jobless rate and economic climate can play a role in vacancy rates.
Estimating Vacancy Costs
There’s no magic formula that says an investor should always expect one full month of vacancy per year, or that the investor should set aside a particular percentage of gross income for vacancy expenses.
Vacancy rates vary across property types and neighborhoods. Investors should talk with other investors with similar properties in their area to become better informed on what the local vacancy rate is.
Estimating Other Expenses
However, there are some basic benchmarks that can be considered. Zillow, an online marketplace for residential real estate listings, notes that operating expenses typically make up 35 to 80 percent of the gross operating income. If operating expenses are calculated below 35 percent, then there’s a chance that something may be wrong with the investor’s calculations, it says.
Zillow estimates that a good rule of thumb for maintenance expenses is 1 percent of the property’s value per year. An investor on BiggerPockets says his repair expenses, averaged out over the year, equal about 5 percent of his monthly rental income.
Besides typical upkeep, a contingency fund should be established for emergencies such as a major repair to the heating and air conditioning system, the plumbing system, the foundation or the roof.
For those investors who anticipate turnover during the year, a “make-ready” cost should be budgeted for minor repairs, possible interior painting and professional cleaning.
While investors are in the rental property business to make money, they must also balance that goal against the need to keep their property in good condition in order to attract high-quality tenants. They must be cognizant of not getting into a situation of deferred maintenance, which ultimately could lead to higher tenant turnover costs.
Estimating the Cap Rate
Before ever buying a property, investors should do a bit of math to figure out the cap rate and whether buying the property makes good financial sense. The higher the cap rate, the better the annual rate of return. In figuring the cap rate, be sure that your expense estimate includes vacancy and repair costs.
There are also tax implications related to repair costs that should be explored.
If investors do their homework, they can do a better job of making accurate variable expense estimates, which ultimately will allow them to more accurately estimate their real estate investment income. Better estimates will ultimately lead them to investing in those properties that have the best opportunities for strong returns.
B2R Finance offers rental investors innovative lending products to help unlock equity from existing portfolios and provide the cash needed to build rental portfolios nationwide. For more information about how B2R can help you obtain rental property financing, just call 800-227-8107 or visit http://www.b2rfinance.com/apply-now and follow us on Twitter @B2RFinance.
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