You have hidden expenses and unexpected challenges lying in wait if you are planning to become a first-time landlord. One of the first challenges is deciding whether a property is worth buying in the first place. You want the purchase price of the house to be at or beneath market value, of course. But the monthly payments will have the biggest impact on profitability, so the type of loan you qualify for makes a huge difference. Your decision should include figuring up all possible expenses, including estimated maintenance and repairs.
Profit and Expenses
Multiply the expected monthly loan payment of the property by 12. Add the expected annual cost of property taxes, homeowner association dues and hazard and liability insurance and record that total. Hazard and liability policies are essential to protect you from disastrous property damage and from lawsuits by tenants or their guests. You won't have much control over what is done in or on your property after you rent it to an outside party, so insurance is a necessity, and not a luxury.
Calculate the annual cost of any utilities, such as water, electricity, gas or trash service, that you plan to pay on behalf of the tenants. Add that to the other annual expenses.
Calculate annual maintenance and repair costs and add these to your annual expenses. The rental that doesn't sustain some damage from tenants is one that isn't occupied. You will need to make repairs and deep clean the house every time someone moves out. Deposits will cover some of this, but it's best to keep a fund for high-dollar fixes such as a new refrigerator or hot water heater repairs. Try to project costs for both long-term maintenance jobs such as a new roof and short-term recurring costs like yard care.
Divide your total annual expenses by 12 to get monthly expenses. This is the minimum amount of rent you would need to receive to break even.
Add the monthly amount you hope to pocket after expenses. This is the amount of rent you would need to charge to generate a monthly income.
Ask the seller or listing agent to provide information about rental value if the house has been rented in the past. This will get you close to what the house will probably rent for, but it might be more or less than what you can get if major changes -- for better or worse -- have been made.
Peruse local rental offerings, preferably in the neighborhood or community you are considering. List them top to bottom with notes beside them to indicate amenities and utilities that are included for the rental price. Choose listings that are close to what your prospective purchase would offer. These would include the number of bedrooms and bathrooms, size of the house or yard, presence of neighborhood amenities, like desirable schools, and recent remodel features, such as an upgraded kitchen or new carpets.
Add up the rental amounts on your list and divide the total by the number of offerings on the list. This gives you the average rent for a house like yours in the same market, or neighborhood, and gets you close to what you would be able to rent the house for.
Compare this to the amount of rent you need to receive to cover expenses and generate a monthly income. If the estimated rent payment is too little, ask yourself if you can live with a smaller profit or if there is something you can change in the house to make it worth a higher rent. Think of the latter as an addition to the price of the house and consider carefully whether the upgrade will pay for itself over time. Other options include looking for a cheaper loan or persuading the owner to sell for less. If you can't make the cash flow work without burdening yourself with extra expenses or risk, it might be best that you pass on that particular house. There are many affordable homes on the market and chances are good that you can find one that better suits your plans.
- Research local laws and regulations that limit your option to raise rent, especially if the house is currently rented. Some states and municipalities have rent controls or other limits on how much rents can be adjusted and rental terms changed. Most will allow the new property owner to renegotiate rental terms, but others will not. The amount of control you have over costs and income will make a difference to your success or failure as a new landlord.
Billie Jo Jannen is a politics and lifestyle columnist in rural San Diego County and a senior copy editor for Demand Media. Her writing and editing career spans 23 years, and she specializes in border and environmental affairs. Jannen's eclectic education includes engineering and horticulture, and she represents the Rural Economic Action League in regional economic development planning.