Owning a rental property can be a great way to bring in more income, but as a landlord, it’s your responsibility to keep the property in good condition for your tenants. That means you’ll need to learn how to effectively budget for repairs and improvements large and small – and larger repairs and improvements, like replacing a roof, can be harder to budget for than smaller ones.
Many of the repairs and improvements you’ll need to make to your rental property will be unexpected. You can’t plan for a broken window or frozen pipes. But, by budgeting properly, you can at least have something of a financial cushion to protect you when these unexpected repairs do come up – and you’ll be financially ready to take on the bigger repairs and improvements, too.
Understand Your Market
Before you even buy a rental property, you should ideally understand the challenges of the market you’ll be operating in. By doing some market research, you can learn what expenses to expect in advance, and how much you can expect to lay out for them each month.
How you can find this information? Start by talking to local property managers. Most will be happy to speak with you and give you information about how much expenses like utilities, repairs, and maintenance will cost in your area, because they’re hoping you might hire them to manage your properties for you. You can also ask other landlords who own similar rental properties in the area, or even call utility companies or the tax assessor’s office to find out how much things like property taxes or water cost for the property you’ve got your eye on.
Know Your Expenses
When it comes to rental properties, there are two kinds of expenses: fixed and variable. Fixed expenses may not be fixed in the sense that they will be the same every month – things like water, sewer, trash pickup, and lawn care may vary in cost from one month to the next – but they are fixed in the sense that you can expect them to come around on a regular schedule, and you should be able to plan for them.
Fixed expenses for a rental property include any utilities you cover, rental property insurance, mortgage payments, and property taxes. They can also include HOA fees, special assessments, and property management fees. If you choose not to use a property management company, you should still include this expense in your budget, because you’re still paying with your time.
Variable expenses tend to be those expenses that you can’t plan for. These include minor repairs, as well as your property’s vacancy rate, or the percentage of time it sits empty each year. And, of course, variable expenses also include the big, expensive improvements that you’ll need to make to the property. You won’t need to call in some local roofers to replace your rental property’s roof every year, but you will need to do it once in a while. These are known as capital expenditures or capex expenses, and because of their size, they can be hard to budget for. While you can deduct these expenses from your taxes, the IRS will require you to amortize them over many years.
Set Your Repair and Maintenance Budget
There are a few rules of thumb you can use to budget for repairs and maintenance to your rental property. Many landlords use the 50 percent rule, which means that 50 percent of your rental income should go to covering fixed and variable expenses, other than the mortgage. The other 50 percent should cover the monthly mortgage payments. The leftover is your cash flow from the property. Some landlords pocket the cash flow, or use it to pay off the mortgage on the property faster, or use it to invest in additional properties.
Another rule of thumb is to save all of the cash flow towards future repairs. If you’re just starting out, this may be a good strategy, at least until you’ve saved up enough of a cushion to protect yourself financially in case your rental property needs something big.
A third rule of thumb for budgeting for big repairs to your rental property is to set aside two or three percent of the property’s value each year toward the cost of future maintenance. So, if the home is worth $200,000, you might save $2,000 a year towards maintenance and repairs. This averages out to about $166 a month.
Many landlords combine one of these budgeting strategies with a home equity line of credit on the property. A line of credit can give you some wiggle room when things get tough. It’s a valuable financial tool that can help you fit the expenses of keeping a property maintained into your monthly budget.
Budgeting for big repairs to a rental property can be overwhelming, but if you want to succeed as a landlord, you have to do it. With smart budgeting, and a little luck, you should be able to cover the cost of any repairs or improvements your property needs, no matter how major.
This article has been contributed by Tiffani Wroe.