There are a ton of expenses with owning a rental property. A lot of investors like to throw around numbers like they budget 10% of gross rents or a fixed amount like $100 per month. These numbers may work in a perfect world, but they also may not be enough.
In this article, I am going to outline how much money other investors are budgeting for expenses, to help you decide what is best for you.
Let's first start with defining some of the expenses you are going to have when you own a rental property. You have two types of expenses, fixed and variable.
The fixed expenses are:
Your mortgage payment
The fixed expenses, you are going to have every month. Property insurance and taxes generally increase over time. But, if you get a 30 year, fixed-rate mortgage when you buy a property, the mortgage payment will stay the same for the entire time you own the property.
Figuring out the fixed expenses is fairly straight-forward.
The variable expenses are going to fairly unpredictable.
The variable expenses are:
Larger capex items that are going to be replaced over longer cycles (examples are roofs, water heaters, HVAC, appliances)
The variable expenses are going to vary based on the condition of the property, the market that the property is in, seasonality, and market cycles.
For example, a property that is in a hot rental area may rent quicker and have less vacancy than a property that is in a less desirable area.
Some investors will do a rehab on a property when they buy it, they will generally have fewer repair expenses than a property that is in poor condition and hasn't been updated in some time.
Over time, everything in a property is going to wear out, or need to be replaced. It is a good idea to set money aside so that you are prepared when unforeseen expenses come up.
Below are some of the strategies that investors use to budget for expenses.
The 50% rule says that the expenses to operate a property will be half of the income. For example, if you bring in $1,000 a month in rental income, you will want to set aside $500 a month for expenses.
This includes all expenses both fixed and variable.
The other $500 would go to pay your principal and interest portion of your mortgage payment. Whatever is left over is your cash flow.
If you don't have a mortgage, your cash flow would be $500 a month.
Another way that some landlords budget for repairs is to set aside 1% of the purchase price in a savings account.
For example, if the property was purchased for $200,000, you would have $2,000 set aside at all times to cover anything that may come up.
Some landlords will adjust this to 2% or 3% of the purchase price to have a bigger buffer.
Save all cash flow
Some landlords don't spend any of the cash flow that the property produces. Instead, they put everything in a savings account to cover future expenses.
Their goal is to not spend the cash flow today, but their goal is to get the property paid off and to live off the cash flow when the property is owned free and clear.
Some landlords with larger portfolios have told me that they don't budget a set amount. They know that if they have $20,000 or $30,000 a month left over after they pay their fixed expenses each month, that they will be able to cover just anything that comes up.
They will have a general idea that a roof may need to be replaced in a few months on one of their properties. They can very easily put a little money aside for a few months to have the cash available when it's time for the expense.
If you are just starting out, be careful not setting money aside. This strategy really works best for experienced investors with large, stable, portfolios.
Line of credit
Having a line of credit on one or more of your properties is always a good backup plan. You never know when you are going to get hit with several large expenses back-to-back.
You want to make sure you are able to survive tough times, and a line of credit will give you some breathing room if you get hit with some big expenses.
There are always going to be expenses when you own a rental property. Make sure that you are prepared to handle them.
It's always a good idea to have access to cash when an emergency comes up.
If you want to see the spreadsheet that I use to budget for the expenses, you can download it here.
If you want to learn more about how to buy your first rental property, check out my program Rental Income For Beginners. It will show you everything you need to know to buy your first rental property. You can learn more here.