If your buyers are considering an investment property, help them be realistic with their expenses in order to find a purchase price that will generate the best return on investment.
Investors, especially first-time buyers, need to understand everything that goes into owning a rental home beyond the mortgage payment. A good real estate investment should generate a minimum 8 percent return after initial expenses, according to Nathan Miller of Rentec Direct, a national property management software company. So, your investor clients need to start by setting up a budget.
An Investor’s Budget
Investors should allocate for standard homeowner expenses like mortgage, taxes, insurance, and utilities. These are typically fixed expenses. Another area of an investor’s budget should include maintenance expenses. Home maintenance expenses are not fixed and can be one of the trickier expenses for which to plan.
Additional landlord expenses may include funds to pay a property manager, if your investors go that route, to take care of the tenant and day-to-day management tasks. If the investor decides to self-manage the property, he or she should consider the time it will take to manage the property as part of the budget.
Let’s break down each of the categories to get to the bottom line of an investor’s budget.
Depending on how much your buyer puts down and what type of home loan they are working with, mortgage rates range from 3 to 4 percent interest, according to national average data from Freddie Mac for July 2017. Mortgage payments are one of the most reliable expenses to budget in a home purchase.
Property taxes vary by state, county, and city, with the average American household spending $2,149 on property taxes for their homes each year, according to the U.S. Census Bureau. While property taxes can change due to local levies, they are generally considered a fixed expense for an investor’s budget. There are several tax benefits for real estate investors, including appreciation and several deductions.
Insurance policies designed specifically for renter-occupied homes will protect an investor from financial loss and obligations associated with a rental property. Oftentimes, a standard homeowner’s policy is insufficient for an investor’s property. Landlord insurance can include dwelling coverage, liability coverage, personal property coverage, loss of income coverage, flood coverage, acts of nature coverage, and legal fee coverage.
An investor can expect to pay about 25 percent more than you would for homeowners insurance for a basic policy, with rates varying according to your geography, property age, deductible, coverage limits, and more, according to realtor.com®.
Rental property owners can decide which utilities to cover and which to defer to the tenant. If a rental agreement requires a tenant to cover all utilities like water, sewer, electricity, trash services, cable, and internet, an investor will improve his or her profit margins. However, some municipalities require that the owner of the home pay for certain services, like sewer, so it’s worth double-checking.
In some instances, even without city requirements in place, it will make sense for an investor to provide certain utilities for the renters. For items like trash, sewer, and internet, these can be planned, fixed expenses, while water and electricity can vary based on usage.
Home maintenance for rental properties can be one of the hardest expenses to budget. The reason property maintenance is difficult to estimate is the variability of this expense category. A landlord may spend $200 in one month for a leaky sink, $0 the next month, and $500 the following month on an appliance repair. Over time, maintenance expenses tend to average out but a smart investor will create a generous estimated budget in order to prepare a reserve fund to cover unexpected bills.
Wells Fargo suggests that “most homeowners need to spend 1 to 2 percent of the purchase price of their home every year for routine maintenance projects, such as window replacement and roofing repair.” Rental property owners tend to spend slightly more on home maintenance and repairs on renter-occupied homes, since tenants don’t invest the same level of care as a homeowner might.
6. The Bottom Line
Most categories within an investor’s budget will be based on a percentage of a home’s purchase price, like mortgage, taxes, and insurance. Other expenses can be estimated based on the management style an investor chooses and how much maintenance a home will require. Give your buyer an idea of this budget equation for a profitable investment as a starting point for an investment property purchase price.
While brokers and agents are not required to walk buyers through the process of becoming a great landlord, a successful real estate professional will be knowledgeable of good investor practices and serve as a resource to their clients. You will establish confidence in your buyers and build trust in your relationship.