Monitoring your incoming and outgoing expenses is essential to managing any real estate property. Property owners risk overestimating profits without proper analysis or accounting for specific losses. In the long run, poor budgeting skills could be the beginning of a disastrous investment.
However, anyone with any experience in property management knows that expenses can differ from one month to the next. Thus, given the nature of real estate, how does any investor properly account for and prepare for such expenses? Do minor remodels or roofing repairs count? Here’s how to budget operating expenses for a rental property.
What Are Operating Expenses
Before we go further, we should adequately define operating expenses.
To put it simply, operating expenses are recurring costs that property owners must pay consistently to keep their businesses running. These fees could be frequent, like weekly or monthly; they can also be annual dues. Tracking operating expenses can be tricky because they’re often many and can easily slip your mind. Thus, they can appear as hidden rental property costs, slowly affecting your profits.
Common Operating Expenses
- Property taxes
- Property insurance
- Wages and salaries
- Maintenance and repairs
- Landscaping fees
- Legal and accounting charges
How to Budget Operating Expenses for a Rental Property
- Analyze the Real Estate Metrics
Before you purchase a rental property; you should analyze its metrics carefully. Some specific tools can help you estimate and predict how much it would cost to keep a property running and how much you should charge to stay afloat. For example, an estimate of your cash flow would tell you how much you would have left over after deducting your operating costs from the gross income.
- Talk to Local Property Owners
Another way to accurately budget operating expenses is to talk to local property owners around you. If you’re new to the neighborhood or long distance landlord, this could be a good tip. Property owners with the same rental type within your vicinity would often have the same expenses. Thus, they can give you an accurate breakdown of how much they spend on electricity, insurance, and other running costs. This method also allows you to compare prices among landlords using different services.
- Contact Your Utility Company
Contact your utility company if you want a more accurate estimate of your utility costs. Even if your rental agreement stipulates that tenants cover utilities, it would still be a good idea to know how much it costs. After all, that could also affect how much rent you can charge per month.
- Track Your Expenses Meticulously
Finally, you can also budget operating expenses by tracking your previous records. This tip is convenient if you haven’t built the habit of doing so. You can start by making a spreadsheet of all possible operating expenses. Besides the ones we’ve outlined earlier in this article, you may also include others that fit within the scope of an operating cost.
Many of these costs would remain the same on a month-to-month basis. For example, wages, insurance, and utilities rarely fluctuate. Professional Property Management of Northern Virginia agrees that rental property expenses should be monitored to maximize income.
When you know how much you spend per month, you can add a little allowance for months with more unexpected repair needs. This total can help you budget more accurately in the coming months.
What Is Not Included in Operating Expenses
- Mortgage Payment
Despite mortgage repayments being a recurring cost, including them under your operating expenses is inappropriate. Debt servicing falls under its unique category. Since financing terms differ from investor to investor, you should not include your mortgage payments under operating expenses. Some investors also make this mistake by deducting their interest payments from their cash flow. But this habit is also incorrect.
The rule of thumb for most things is that they lose value the older they get. The same logic applies to houses, and the government recognizes this. Thus, the IRS legally allows homeowners to deduct a certain percentage of their total property value from their income over the years. The calculation for this fee is quite complex, but it’s vital to remember that such fees aren’t part of your operating expense.
- Income Taxes
Income taxes are quite different from property taxes and are not included in your operating expenses. Since this income is independent of your property’s ability to generate profit, financial experts do not consider them a running cost.
We hope you found this article on budgeting operating expenses for a rental property valuable. If you’re having trouble identifying and calculating your operating costs, you can hire an expert to help you.
A professional property management company can oversee your business’s financial aspects, including analyzing and budgeting. Thus, they can help you keep better tabs on your investments and ensure you make more profitable decisions.