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How should I budget for a rental property?
One of the most common mistakes and common reasons for a rental property to fail as a rental property is because of a lack of budgeting from the investor, a lack of understanding of what is going to be necessary in order to keep up the property and things that will happen just because it is a rental property that they haven’t planned for. So oftentimes when there are expenses or there are things that happen where there’s a lack of budgeting and planning, there’s a lot of frustration about it, and possibly even a lack of cash flow.
So we’re going to dive into four areas that we want to make sure that you’re budgeting with your rental so that you can see that it’s a source of peace as well as when something happens, you’re planning on it, you’re prepared. That’s what you want to do.
First one is maintenance and repairs. The second one is vacancy. The third one is property management. Finally, unexpected items.
Let’s dive into maintenance and repairs. So the thing that we hear sometimes from our investor clients is when they’re looking into buying a rental, they may not quite understand what to budget. But when we ask them the question: What is your maintenance budget? And they say I really don’t want to spend much on maintenance. I really don’t want to put a lot into this property. Or if something breaks, just have the tenant fix it. Or if something breaks, just let it go. That’s just a recipe for disaster and a recipe for failure, as you can imagine.
So a proper budget is between 8 and 12 percent of the rental income, the gross rental income. You should plan on spending and even reinvesting into the property from time to time because you’re going to have months that you don’t have maintenance, and some months where it’s a little bit larger. But reinvesting into the property, similar to a retirement account, you’ve got to put money in to get money out. With your rental property it’s very similar. The tenant’s putting money in. You’ve got to put a little bit as well to keep up that property and make sure that it’s running smoothly and running well. Now when you have this budget in place, and something happens, you know you are prepared for it and it’s not a frustration anymore.
Second category is vacancy. There’s going to be periods of time, and hopefully your property management solution, whether that’s you or a property management company, or us, were able to keep that vacancy time down. But plan on budgeting about 3 to 5 percent of rental income over the course of time towards vacancy. You may have a tenant, especially in single-family homes where there’s less turnover, you may have a tenant in there for 3, 5, 6 years and then you have two weeks or a month vacancy. Keeping that in consideration and budgeting that on the front end as you’re looking into an investment property to make sure it’s still pencils out.
Property management. So this is really important, even if you plan on managing on your own, you’ve got to budget for it. We’ve had clients that were self managing, then they had a serious illness come up or they had a job transfer, they had a different situation where they now couldn’t manage it themselves. They had to turn it over. If they were prepared, if they had a budget for property management, then it’s not a source of frustration. Again, it’s not a concern. They were prepared and planned on doing it.
If you have a budget for it and you have an increase in that cash flow, then it’s more that you can put towards any loan balances that you have on it, or you can stockpile your reserves, which is our next category. So property management, 10 percent of rental income plus leasing costs. That’s an appropriate budget. Now, there’s companies that won’t charge a 10 percent management fee, but oftentimes it will be a 7, 8 percent and it will have all these different add-on fees, leasing fees or lease initiation fees, renewal fees, inspection fees. Typically it all kind of adds up to 10 percent of rental income plus leasing. So that’s an appropriate budget for property management.
Unexpected. So, there’s going to be things that will just happen. Unexpected is in quotations because we expect the unexpected. The unexpected is going to happen at some point of time. If you have a rental property for 10 years, there’s going to be a tenant that loses their job. There’s going to be a tenant that causes some damage. There’s going to be some issues that happen. If we have a reserve and we’re prepared, then again, where there’s preparation, there’s also peace. We don’t have to stress and worry about it.
A proper reserve is three times the monthly income. So you’ll have a separate bank account, and we can even hold that if you’re one of our clients, have a separate bank account where if something happens, a large repair, we can pull from that reserve. So $1,500 rent, we get a $4,500 reserve that we have set aside. So when something unexpected happens, we’re not pulling from Christmas money or vacation money to be able to make it work and that’s where we’ve seen a lot of frustration, when people are not prepared with this. As an investor, be savvy, be educated and be prepared.
If you have any questions with this, feel free to reach out to our team. We’re more than happy to help you out.