Time for another round of Answer the Reader’s Mail: “How Much Will This Cost?” Edition!
David from Atlanta asks:
“In your (income property) post, you mention “Mortgage, Insurance, Taxes, Water, Trash, Repairs, etc. = $950 per month”. I realize the example is hypothetical, but in real life, how would you determine these costs?
“Is there some official city website that details cost of services (trash, taxes, etc), or do you have to keep your fingers crossed and wait for the bills to start coming in to see if everything balances positively?”
Here’s my answer. Please note that water prices, trash prices, and insurance rates vary based on your location.
The numbers I’m using are specific to Atlanta. You’ll have to adjust for the nuances for your own city/town.
Mortgage
That’s the easy part. Go to mortgagecalculator.org . Assume your interest rate, right now (early 2012), will be 3.5 to 4 percent if you have good credit, but keep an eye on rate changes. If you’re cash-out refinancing a home, add about 1 percent to the standard mortgage rate.
Remember: If you put 20 percent down, you won’t have to pay private mortgage insurance (“PMI”).
Insurance
Multi-family houses need commercial insurance, which is pricey. My multi-family house is insured for $300,000, even though we bought it for $225,000. (We insured it for the amount it would cost us to rebuild it). We pay $3,000 per year, or 1 percent of the home value.
For a single-family home, I’d cut that insurance price roughly in half, since you’ll have “residential” insurance instead of “commercial” insurance. In Atlanta, a single-family home insured for $130,000 should cost $800 to $1,000 per year.
Water
We paid $350/mo for water when we bought this house. Five people lived there, which means water cost $70 per person per month.
After installing low-flow toilets, shower heads, sink aerators, etc., we got it down to $250 per month, with an extra person living in the house. That’s only $41 per person per month.
Atlanta has some of the most expensive water/sewage rates in the country. You’ll pay far, far less in most other cities.
Trash
This will vary based on your city. We pay $33/month for a single-family home. My triplex costs $100/mo for trash ($33 per unit * 3 units), because the City of Atlanta regards each unit as a separate home.
Not all cities insist on charging multi-unit houses as “separate” houses, so research the policies of your particular city.
If you have more than 4-5 units in a single building, it’s often cheaper to just forgo the city trash services, and rent a dumpster through a private company. (Assuming your city allows this.)
Repairs
Depends on the age/condition of the house! No rule of thumb there.
Assuming a “perfect” house, a general rule of thumb is 1 percent of the purchase price per year. You won’t literally spend that each year, but that’s how much you should “set aside” for those once-in-a-decade things like replacing the roof, replacing the water heater, etc.
It’s good to set aside a nice “rental property emergency fund” for home repairs and maintenance. The water heater can burst at 2 a.m., or the dishwasher can overflow, ruining the carpet, or any number of other things can go wrong.
Many people don’t like the idea of cash “sitting” in their savings account, earning a return that’s so low it can’t even keep pace with inflation.
I’d rather forgo some returns so that I can maintain a strong emergency fund. The more houses you own, the more likely something will go wrong. Stash a few thousand bucks in a savings account to bail you out of an unexpected situation.
Property Management
This usually costs 8 to 10 percent of the rental income, plus one month’s rent per year.
Some property managers only charge one month’s rent “per lease signing,” so if they sign a tenant to a 2-year lease, you only pay one month’s rent per 24 months, plus 10 percent ongoing. You’ll have to negotiate this with the manager you hire.
You can always manage it yourself, as I do. (Although this takes time – and time is money. If you manage it yourself, you should “pay yourself.”)
Looks like a good comprehensive examination of owning rental property. Some of the expenses are very difficult to project. One of the many reasons owning rental property can be such a hassle.
@Dr. Dean — It’s nice to keep a solid margin of error. If you’re looking at a property that — in the most-likely-case-scenario — will cash flow $100 a month, I’d skip over it. Even a slight miscalculation (an insurance rate hike, a water rate hike) could put that property into negative-cash-flow zone. I usually do 3 calculations: best-case, medium-case and worst-case scenario. If the worst-case scenario still leaves a little margin-of-error wiggle room, then I’ll go for it. Otherwise, I’ll skip it.
Wow water is expensive for you! We pay around $55 every THREE months. I guess I’ve been taking our low rates for granted!
@Michelle — My goodness, the water/sewage rates in Atlanta are insanely expensive. The neighboring county (DeKalb Co., Georgia) mandates, by law, that each household have 1.6 gallon-per-minute toilets or else they’ll cut off water supply to your house. Isn’t that crazy? I’ve never heard of that. I guess the drought here has been pretty bad for the past few years ….
Great post. In our rental property agreements, we add a clause that requires the tenant to pay the first $50 of damages each month (no rollovers) — it’s not about saving money but, instead, making sure the tenant has some skin in the game for maintaining the property. This clause has definitely reduced the number of calls we receive for small items and we’ve found that tenants are OK with the clause once you explain the rationale.
This is a very good and very useful breakdown of costs. I recently met a young woman who claimed that water is free; she just hadn’t realised exactly how much and what bills she pays every month.
I’d thought about buying rental properties before and I never knew when to budget for in terms of repairs & maintenance, I’d always heard horror stories about renters trashing places… 1% for repairs seems reasonable though, if you don’t use it, you can roll it over to the next renter.
In terms of the management company vs. yourself, how much time do you estimate you spend managing the property? The standard rate appears to be 10% here.
@Jim — The standard rate in my area is also 10 percent of the monthly rent, plus the first month’s rent of any given lease. If your property manager signs the tenants to a standard one-year lease, that means you pay 1/12 of the rental income upfront, plus 10 percent ongoing. If they sign a tenant to a 2-year lease, though, you only pay 1/24 th of the rental income upfront, with the same 10 percent ongoing!