Whether you own rental property or you plan on buying your first rental, you need to be clear on what it means to be a landlord.
Your first responsibility is to accurately evaluate a prospective property. Be sure that your property is suitable to carry all costs and provide the required return. What should you consider when determining if a property will be worth your investment? If you are financing the property either with a traditional bank financing or a private source, your monthly mortgage payment will be used as a cost to evaluate your return and should be added to all other costs. Your return will be based on the actual cash you contribute to the transaction, down payment and closing costs.
For the purpose of calculating returns, we will assume that the property in question is in good condition and a tenant is in place. To calculate returns, you must accurately consider all costs including property taxes, property insurance, management fees which is usually a percentage of annual rents, estimated vacancy factor (8-10%), annual maintenance (8-10%), HOA dues if applicable, and mortgage payments if financed. Start with your annual gross rent (monthly rent x 12), then subtract the total annual costs to arrive at your net operating income. This is the cash flow you will be receiving annually. Divide your net operating income by the total of cash invested. This will give you your net cash on cash return. If the return is what you are looking for, then proceed with your purchase. If it is not, resist the urge to try to “make” a deal unless the seller is flexible on their sales price. There is no room for error when calculating.
Home sales price of $49,900
Vacancy rate of 8%
Management fees of 8%
Maintenance cost of 8%
Monthly rent of $650.00
Annual rent: $7,800.00 ($650.00 / month x 12 months)
Expenses: $ 460.00 annual taxes
$ 360.00 annual insurance policy
$ 624.00 annual management fee ($52.00 / month x 12 months)
$ 624.00 annual vacancy ($52.00 / month x 12 months)
$ 624.00 annual maintenance and repairs ($52.00 / month x 12 months)
Total annual expenses $2,691.00
$7,800.00 (Annual rent) less $2,692 (Annual expenses) = $5,108.00 (Annual cash flow)
$5,108.00 (Annual cash flow) divided by $49,900.00 (Cash sales price) =10.24%
10.24% is your annual cash of cash return.
Your second responsibility is to retain adequate reserves to address any issues that may arise. You must be sure that a property is in good condition, and it is your responsibility to be sure any deficiencies or repairs are addressed immediately. Beyond being responsible for repairs and maintenance, you want to insure your tenants are content and appreciate your responsiveness. This is one of the best ways to retain tenants long term, which ultimately creates more cash flow and helps eliminate losses in turnover.
Property condition makes a great impact on rental price. Tenants will see the value and be willing to pay higher than market rents. Simple things like paint color, counter tops, vanities, toilets and appliances can make a hugh impact.
By providing a clean, warm property, you will draw excellent tenants.
Your third responsibility is your lease. After you have chosen a suitable property and ensured it is in excellent condition, it’s time to rent the unit. The cornerstone of your experience with your tenants is the lease agreement. This will outline, in writing, what is expected of your tenant and what you will provide during their tenancy. Note: Be sure to check with an attorney to see if items can be included in the lease. I recommend using your state’s Realtor’s Association Lease with your personally added amendments. Most courts are going to be familiar with the standard form, and if an eviction is necessary, you will find a magistrate much easier to deal with using forms they know. Any requirements or forbidden activities should be outlined in detail and specific.
Fourth is to be sure to address difficult or slow paying tenants swiftly. Depending on the laws in your state, tenants usually have a grace period before a late fee is due. Do not, for any reason waive this fee. If rent is not paid by the earliest day that the eviction process can be started, proceed immediately. You can always dismiss the case if they pay you and include reimbursement for your costs and time.
If you fail to enforce the rules set in place, you can be sure your tenant will continue to push the limit further and further.
By following these principles, you will help ensure your properties are profitable for years to come.
As always, we wish you happy and profitable landlording.