Frequently I see the topic come up in real estate investor and landlord forums, “How much if anything should I save to cover the expenses of my rental?”. The answer is often the subject of heated debates, but in reality, there is no perfect answer. This month we shed some light on the topic of Income & Expenses with rental property.
When you own a rental property, there are some obvious ones which are typically included in your mortgage (if you have one) such as Principal, Interest, Insurance, Taxes, Mortgage Insurance, etc. So if your total mortgage payment is $2000 a month, and your property will produce $2100 a month in rental income, you should be in the clear right? Not so fast. Many new landlords forget that a home by it’s very nature is impermanent, meaning it will always deteriorate back into the earth over some period of time. The accounting concept (and huge real estate investor perk) ‘depreciation’ accounts for this on your tax return, by allowing you to deduct a percentage of the property’s value every year to account for it’s inevitable deterioration.
So, what’s a responsible landlord to do? The answer, in short, is to save some money for a rainy day. Most seasoned landlords will save a percentage of their monthly rents for items like maintenance & repairs, Capital Expenditures (or CapEx), property management, and reserves.
Maintenance & Repairs are typically small “wear & tear” items like leaky toilets & faucets, patching a roof, and drywall repairs. But maintenance may also include services that are necessary to maintain a home, like lawn & snow services, annual HVAC tune-ups, and gutter cleaning.
CapEx usually involves large repair, replacement, or expansion projects. The line between repairs and CapEx can become blurry, so consult with your accountant and attorney, as the differences could affect you come tax time. CapEx can include items such as appliance replacement, a new roof, replacing an HVAC System, adding an addition, and so on.
Next, Property Mangement. Some landlords choose to go it on their own, which can be great if they have prepared, and approach it as a business, unfortunately many landlords do not. Enter the role of a property manager. The property manager’s responsibilities and duties is also a topic of much debate, however, in short, a property manager should do just what their name implies… manage your property! Ideally a property manager handles all of the hassles of landlording to the extent that the communication between owner and property manager is limited to sending payments, monthly, quarterly, and annual reports, and notifications of concerns or executive decisions. This frees up the owner to spend there time doing more important things.
Lastly is the concept of reserves. If you have managed to put away enough money for Maintenance & Repairs, Capital Expenditures, and Property Management, Congratulations! You are already more responsible that 80% of landlords. Reserves, however, is a practice very seldom utilized by the vast majority of landlords – and it just so happens to be the one practice that can save a landlord from financial demise during an unforseen circumstance of bad-luck. Consider this, you have been putting aside 20% of your rental income for all of the items which we have previously discussed, yet this year your roof starts to leak, the A/C goes, then the hot water heater, you have to undertake an eviction, and the water main out front bursts in December and the city requires you to pay for it. Sounds far fetched, but years like this occur to every landlord at one point or another, and typically only the financially prepared ones survive with their property intact. Now consider that for the 3 years prior to this catastrophic event, you had been placing 5% of your rental income into a separate reserve account for a rainy day? In our example of the $2100 a month rental unit, that would equate to $3,780. Definitely not enough to cover it all, but enough to help you weather the storm.
In summary, it’s always best to save some for a rainy day, how much exactly is a good discussion for the real estate professionals on your team. A little prior preparation can make all the difference.
About the Author:
Brandt Tingen is a Real Estate Agent specializing in Commercial and Residential Sales & Leasing in the District of Columbia and the surrounding areas in Maryland & Virginia. Mr. Tingen also owns a property management company and manages Commercial and Multifamily property in DC.
Contact: (703) 674-6777
The purpose of this article is not meant to be construed as advise of any kind. Consult with your own Real Estate, Legal, Tax, Property Management, and other required professionals before making any decisions including but not limited to Real Estate and Financial matters.