If you are in the real estate business, you will know that it’s one of a kind careers where you can predict the return on investment. If you are a non-experienced or a novice real estate agent, you might be thinking everyone can guess an estimate of the ROI, but we aren’t talking about estimates, are we? We are, for a change, talking about the exact or close to amount prediction of your ROI. Unlike many other businesses, the calculation of rental cash flow isn’t hard or as the young ones say rocket science. It’s relatively simple, and yet many still get it wrong. The prediction of the rental cash flow will become a breeze if you understand the following factors. Once you get hold of the rules to calculate the rental cash flow, you will be able to avoid many bad investments in future.
Rental Income and Exact Predictions – How is that Possible?
We all know that house values are impacted by the ups and downs of the market; they are always fluctuating. So, how can one predict the rental cash flow in such situations? Well, the answer is pretty simple. No matter how good or bad the market condition is, the rent rate stays the same.
For instance, the rent fluctuated from $947 in 2008 to $912 in 2011 when the market was experiencing a downfall. The difference is only $36; this is how the rental cash flow is predictable.
Apart from fluctuating markets, there is also the matter of vacancies? How can a landlord predict rental cash flow when there are vacancies? That’s pretty simple as well. Calculate the average vacancy rate of the neighborhood units and add that to a small budget set aside for such changes. Now you will say that there is also the matter of expenses? But these two are predictable. Here’s how you can predict the looming expenses of rental properties to predict the rental cash flow.
Predicting Rental Property Expenses:
Apart from the mortgage, there isn’t any high expense for the landlord on a monthly basis. However, every so often, these landlords experience massive and irregular expenses, like vacancies, repairs and such. Smart landlords accurately forecast the long-term average of such expenses. This helps them create a budget every month. So even if you don’t have an expense like this in one month, you will be all set in the nest because of your savings.
Maintenance depends on the condition of the house as well as the kind of tenants you have, but there are some regular bit and pieces like refreshing the paint between tenancies, changing old or ton carpets or fixing cracks and leaks.
These minor maintenance hacks are necessary to keep the property in good shape. These are kind of fixes that won’t make or break the property by instead maintain the look of it. The estimated cost of such maintenance fixes is about 5% of the rent.
Repairs & Capital Expenditures:
While maintenance doesn’t do much for the property, capital expenditure and massive maintenance can increase the lifespan of your property. Hence they are essential. For instance, replacing cracked roof or old furnace comes under capital expenditures whereas, patching up an old roof is more like a repair then capital expenditure. Understanding the difference between the two will help you save the right amount in your monthly budget. Capital expenditure, as well as repairs, are estimated at 8% of the rent.
No matter how prime your location is or how high-ended your property is, it will, at some point, experience vacancy expense. It’s only a matter of time, so it’s better to be well-prepared in advance.
On yearly turnover, the unit must experience a month of vacant period for repainting, advertising, marketing as well as repairs and fixes. This will constitute an 8% vacancy rate. Luckily, doe most landlords, yearly turnover aren’t most common. More properties see two or three turnovers in five years. The estimated cost of this vacancy expense is 4 to 6% of the rent.
Management Costs and fees:
Even if you are managing the property yourself, you still need to calculate the cost of property management fees. Why! You must ask? Well, there are several reasons why? You never know when you will feel like throwing in the towel and hiring a property manager, isn’t it better to be prepared?
What if a health crisis arises and you will have to hire a property manager? Or what if you get to busy to manage all your rental units properly? These are few of the many reasons why you will need to hire a property manager in time. And why you should prepare in advance regarding the cost of hiring a property manager. The estimated cost of property management fees is around 10-15% of the rent.
Property Tax Expenses:
Regardless of your mortgage taking care of the property tax issue, you should add this to your rental income calculations. The estimated cost is around 5-12% of the rent.
Mortgage payment also covers the landlord’s insurance payments, but if it doesn’t, the estimated cost of that is around 4-8% of the rent.
Estimating Market Rents:
Market rents should be calculated before buying the property. You can easily do that by logging into Rentberry. This free online web will help you compare the properties close by and give you a sense of what other local units are charging. However, it’s advised by the experts to spend some time in the neighborhood to proof your research.
You can easily do this by attending as many open houses as you can, or by acting as a local renter. Think as they do, what are they expecting from the unit? What amenities are they looking for? How do these amenities impact the rent? Are these standard amenities or luxuries?
Once all the steps are estimated, here’s how you calculate the rental cash flow prediction:
- Monthly rent $2,000
- Maintenance $100/month at 5%
- The capital expense as well as repairs $160/month at 8%
- Local vacancy rate $80/month at 4%
- Property management $240/month at 12%
- Tax $250/month
- Insurance $167/month
- For travelling and other administrative expenses $60/month at 3%
The sum of all these expenses is $1,057/month. Taking this out from the rent leaves you with $943/month in cash flow. You can also use a rental income calculator online to run all these numbers for error reduction.