Rental property expenses can quickly become a problem, but only if you have not budgeted properly.
Many of the expenses you’ll encounter while renting out a property are fixed. You know what your mortgage payment is, you know how much the insurance bills will be, and you know where your property taxes land. If there’s an HOA fee, it’s likely the same every month, and the pest control contract has a fixed price as well as the landscaping contract you have in place.
But then there are the variable costs, which can make budgeting more difficult.
How much will you spend on maintenance in a given month or year? What about vacancies? Suppose there’s a catastrophe? The wildfires rushing through the Los Angeles area this year have demonstrated just how unreliable even the best-planned budget can be. You simply never know what might happen.
The meticulous planning and budgeting matters, however. It helps you keep expenses down. It allows you to earn more on your property and to have a better sense of where your best chances are to grow as a real estate investor.
To ensure your investments are profitable, it’s critical to create a comprehensive budget that accounts for both predictable and unexpected costs.
As Los Angeles property management experts, we help owners and investors budget for future acquisitions as well as existing investments. We’ve put together a guide to walk you through the necessary budgetary steps. Plan for these rental property expenses so your real estate investment stays financially sound.
Understanding Rental Property Expenses
Which rental property expenses are you prepared for? Which might surprise you?
Rental property expenses encompass a wide range of costs that impact cash flow and long-term profitability. Let’s take a look at what you need to understand about rental property expenses. Here are the most common expenses to plan for:
- Mortgage Payments. For many investors, a mortgage is the largest fixed expense. Don’t forget to factor in property taxes and insurance, often bundled into the payment. This will depend on how you’ve financed your property. If you happen to have paid in cash, you won’t have to budget for mortgage payments.
- Property Taxes. Property tax rates vary based on location and size. Research the local tax obligations or consult with a tax professional in your area. You want to anticipate how much your property taxes will be and how the payments will be structured. Remember to deduct these property taxes on your federal tax return.
- Insurance. Protecting your investment with landlord insurance is non-negotiable. Basic policies cover property damage and liability, but additional riders may be required for specific situations (flood insurance and earthquake insurance, for example).
- Maintenance and Repairs. Regular upkeep is essential to maintain tenant satisfaction and property value. Allocate 1%–3% of your property’s value annually for unexpected repairs. Or, set aside 10% of your rental income every month. There has to be a reserve so you’re not caught off guard by large repair needs.
- Property Management Fees. Smart investors will tell you that property management in Los Angeles is essential when you’re renting out a property. Depending on your management team and your property needs, you can expect to pay 8%–12% of monthly rental income. This service can be invaluable for stress-free, streamlined operations and it’s also tax-deductible.
- HOA Fees. Properties in communities governed by a homeowner’s association (HOA) require monthly fees. Be sure to research the terms in advance.
- Vacancy Costs. No property is perfectly rented year-round. Use a conservative estimate of one to two months of lost rental income annually for budgeting. Hopefully turnover won’t take that much of a cut out of your ROI, but it’s better to be prepared.
- Legal and Accounting Services. Professional advice for contracts, evictions, and tax preparation can save you bigger costs down the road.
- Marketing and Leasing. Advertising your property and conducting tenant screenings incurs minor but recurring costs.
These are the most common expenses that rental property owners have to deal with. Your own expense list will depend on your property, your financial situation, and your future plans.
Unexpected Expenses in Rental Property Ownership
No matter how well-prepared you are, unexpected costs can arise. From emergency repairs to tenant disputes, these challenges can create sudden financial demands. Experts recommend setting aside a reserve fund to better prepare for these things. Upgrades and updates, for example, may be necessary during a turnover period. A lawsuit or a claim because of a security deposit mistake could cost you thousands.
How to Build an Effective Rental Property Budget
Creating a realistic budget is a key step toward profitable property ownership. Here’s how to structure yours:
Step 1: Calculate Fixed Costs
Start with your unavoidable monthly expenses, such as mortgage payments, insurance, and property taxes. Fixed costs are your baseline and must always be covered by rental income.
Step 2: Assess Variable Costs
Variable expenses—such as maintenance or legal fees—fluctuate, so it’s wise to estimate on the higher side. Consider past repair records or consult property managers for accurate insights.
Step 3: Plan for Vacancy
Factor in potential downtime between tenants. A conservative estimate is a 5%–8% vacancy rate annually.
Step 4: Build a Reserve Fund
Unexpected expenses happen. Create an “emergency fund” to cover unforeseen costs without disrupting your year-long budget.
Step 5: Analyze Rental Income
Compare your potential rental income with total expenses to calculate a cash flow estimate. A positive cash flow is a sign of a healthy investment.
Step 6: Regularly Revisit Your Budget
Markets change, tax laws evolve, and properties age—all of which can impact your expenses. Reassess your budget annually to account for these variables.
Budgeting for rental property expenses isn’t anyone’s favorite part of investing in real estate, but it’s an essential skill for any investor who wants to remain profitable. By carefully tracking expected costs, setting aside reserves for the unexpected, and leveraging the right tools for expense management, you’ll build a resilient investment portfolio.
We’re here to provide additional tips and strategies and to help you budget. Please contact us at Earnest Homes, and we’ll talk about your specific properties.
