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When you first look into the financial benefits of owning a rental property, it can be difficult to assess exactly how much money you will be taking in, and how much money you will need to spend to maintain the property. There are many things that go into proper a cash flow analysis. Below we share some key points you should consider when analyzing the financial benefits of a rental home or calculating an accurate break-even analysis.
What is cash flow?
You can determine your property’s cash flow by looking at the income the property brings in, after subtracting the expenses that the home brings. Each property will be different, with several factors coming into play.
What expenses should I consider?
The most important part of creating your cash flow analysis is to not underestimate the cost associated with owning a property, which can be all too common. There can be a variety of expenses associated with owning a rental property, and it’s essential to consider the costs associated with a property prior to purchasing it. Consider maintenance costs of keeping the property in good condition. Repainting the house, pest control, getting the interior rent-ready, landscaping needs, and ongoing maintenance are all expenses that should be expected and planned for. Despite these not all being monthly bills, they will come up throughout owning a rental property and should be factored in.
More consistent expenses include the cost of legal help or a property manager, HOA fees, utilities that the tenant will not be paying, and the mortgage payment. While some property owners prefer to self-manage their properties, hiring a property manager can save money in the long-run. Especially if a self-managing landlord is not up-to-date on industry knowledge and laws, they can find themselves with fines or legal expenses down the road.
You should also plan for vacancies at your property. There will likely be short periods of time, at a minimum, between renters. During this time, you will not bring in rental payments and should not plan for that income during those times.
What is a rental property budget?
There are many different expenses to consider when it comes to owning a rental property. We recommend that all of our clients budget 5% of annual gross rental income for repairs on the property, 5-10% for capital improvements depending on whether or not there is an HOA involved, and an additional 2% to account for vacancies at the property. These are good estimates to help budget expenses for the rental property.
Generating an accurate cash flow analysis
Once you have determined the expenses that the property will bring, it is time to complete your cash flow analysis. Generating an accurate cash flow analysis can’t take place without knowing how much you will be charging for rent. The monthly rent price of a given property can differ based on the location of the property, condition of the home, number of rooms, and what other rental units of similar size and quality are priced at locally. While you may know what you want to charge for rent, this may not always be the final number.
If you don’t have a set number for rental income, it is best to be conservative and round down. This will ensure that you do not find yourself in a poor financial situation down the road.
If you are interested in looking at your cash flow, you can view a free cash flow analysis calculator, here. While you should complete a more thorough analysis yourself, taking a look at free tools online can help you understand what to look for and how to accurately calculate expenses.
Don’t forget about the tax advantages
There are definite tax advantages when it comes to owning a rental property, and this is a common reason many investors choose to begin investing in real estate. One of the biggest tax breaks in real estate involves the depreciation of a property. Depreciation can be applied when the cost of the asset (in this case, the property) will be useful for one year or more. Residential properties are depreciated by 27.5 years and can divide your cost by that number to determine your depreciation expense. For a rental property to be depreciated you must own the property, use it to generate income, and have a use for the home for more than one year. Smaller costs, such as maintenance costs or supplies to care for the home can be deducted at one time.
There is also a cost segregation study that may be beneficial in some cases. Cost segregation studies help to identify assets and reduce depreciation time for tax purposes. If you are interested in a cost segregation study, we recommend contacting your CPA.
When you create a cash flow analysis, being thorough is key. Take your time to consider each area that may have a cost associated with it before making any final decisions. If you are interested in learning more about how a property manager can assist you and help you reduce costs down the road, reach out today by visiting our contact page.