Few questions in real estate investing have straight-forward answers. However, “Is it OK to break even on a real estate investment property every month?” is one of them. And the answer is: YES!
But there is a twist again. The answer is “Yes” only in the short term. In the long run, your goal should always be to make profit. And the bigger the profit, the better.
A real estate investment property is a long-term investment. Unlike other types of investments, in real estate investing just breaking-even in the short and even medium run is fine because large profits might be awaiting you in the future. Let’s look at the question of breaking even in real estate and its answer in more details.
What Does Break Even Mean?
In simple terms, to break even on your real estate investment property means that the amount of income which your property generates for you is equivalent to the size of the costs which you need to pay for this property. In other words, your cash flow has to be zero so that you are breaking even on your income property.
Related: 5 Ways To Create A Positive Cash Flow Income Property
The main numbers which you will need to consider here are:
- Rental income
- Operating expenses: taxes, insurance, property management, maintenance, etc.
- Mortgage payments
If your rental income is able to only cover your operating expenses and loan payments, you will break even. Remember that when searching for new rental properties to add to your real estate investing portfolio, you should consider Mashvisor. The Mashvisor investment property calculator will supply evidence-based estimates of all these figures, while providing you with the possibility to customize them if you have a serious reason to believe your future property will differ significantly from other properties in the local market.
Related: Why An Investment Property Calculator Tells You More Than Just Numbers
What Is a Break-Even Ratio?
When talking about breaking-even on a real estate investment property, there is one number that all investors should consider – the break-even ratio. The break-even ratio is an analytical tool which helps you decide whether to go for investing in a particular income property or not. In specific, using a basic formula, the break-even ratio calculates the occupancy rate which allows a real estate investment property to break-even. This basic formula is:
Break-even ratio = (Total operating expenses + Total debt service)/Gross operating income
So, to arrive at the break-even ratio, you need to add all operating expenses to the loan repayments and divide the sum by the rental income.
Be careful when making the calculations because you should factor in the tax deductions to which you are entitled as a landlord. These include deductions related to interest, depreciation, insurance, repairs, supplies, travel, employees, and legal fees among others. All possible deductions are important because they might make all the difference between losing money on your rental property and breaking even.
Let’s look at an example:
Total operating expenses = $6,000
Total debt service = 12 x $1,600 = $19,200
Gross operating income = 12 x $2,500 = $30,000
Break-even ratio = ($6,000 + $19,200)/$30,000 = 84%
This means that your real estate investment property needs an occupancy rate of 84% to break-even. Once you know this number, the decision is easy. If you expect your property to attract tenants for at least 84% of the time, then go for it. If, on the other hand, you don’t think that you will be able to rent it out for that much time, it’s better not to buy. While it might be hard for you to estimate the expected occupancy rate for a particular investment property, Mashvisor provides you with an estimate of this rate for both traditional and Airbnb rental strategy for any of the thousands of properties available on our website.
Related: 7 Tips to Achieve a High Airbnb Occupancy Rate
What If a Real Estate Investment Property Does Not Break Even?
That’s a big NO NO. While some real estate investors might still argue that settling for a property that just breaks even is not a good idea, it is conventional wisdom that you should not buy a rental property that won’t be able to cover its expenses. Then you will be making loses, which is not the idea of investing in real estate or in any other kind of commodities.
What If a Real Estate Investment Property Just Breaks Even?
As we said above, that’s OK, at least in the short run. But why is it fine to settle for a property that does not generate you any profit? Well, there are two basic reasons:
1. Increasing Rents
In 99.9% of the cases, rental income is expected to increase over time. Due to population growth, inflation, and economic growth, rents are set to go up in the medium and long run. Sometimes even in the short term. At the same time, once you’ve signed the mortgage contract, your monthly loan payments will remain the same. Operating expenses will also rise but less than rents. This means that your real estate investment property will provide you with more and more income while expenses will remain relatively unchanged. So even if your property is initially just breaking even, it should be able to start bringing profit soon.
2. Appreciation
As the population is growing and markets are getting busier and busier, real estate properties appreciate in value. There are many factors such as the land, the location, local development plans, the physical structure, the overall economy, and interest rates which determine the real estate appreciation of any property. This means that you can actively search for income properties that are expected to appreciate significantly over the course of the years. So, appreciation is the second reason why buying a real estate investment property which is just being able to break-even in the immediate term is OK. As the value of your property goes up, you will be able to sell it for a considerable profit in a couple of decades.
Related: 6 Things to Know about Real Estate Appreciation
So, what you should take away from this article is that you should never turn down a real estate investment property just because it breaks even (rather than offering profit). It is OK to buy an income property that is able to only cover for its expenses in the short term as long as you have solid reasons to believe that this will change in the future and your property will start generating income. Still though, if you can instead find a property which you can afford and which provides profit since the beginning, it might be a better idea to go for it.
