Simple Profit Formula for Residential Investment Property
The theory contains the following hypotheses regarding expenses:
1. Vacancies and bad debt: The range is 6% to 10% of the rent charged. Other factors that affect the percentage are local demand, marketing skill in renting the property, and the rent charged in comparison to the market rent.
While some landlords figure their vacancy costs at 3% to 5%, the do not account for spending money to collect their rents as well as the cost involved in evicting tenants.
2. Insurance: Use a larger amount that what the seller is paying, because you will need to insure for a larger amount (as the property is worth more now). Use 6% of your rent for insurance costs.
3. Maintenance: On average about 11% of the rent charged will go towards repairs and refurbishing in between tenants.
4. Property taxes: Be prepared for a reassesment and a supplemental tax bill. This cost tends to be about 11% of rent charged.
5. Management: While many small residential investors tend to go with themselves as the manager, they forget to account for the cost involved. Of course, a management company would cost more for management. Redbrick Management advises to use 6% of rent as the management cost.
6. Capital expenses: This cost is for those items beyond the maintenance expense. This would be for roof replacement or other such expenses. One will probably spend 1% of the home's market value or 8% of rent charged.
Here's the rule applied in an example:
1. For a $60,000 home (for the cost of the home, take into account the closing costs and transfer taxes), you are able to charge $1,000 a month in rent or $12,000 per year. Divide that in half and $6,000 will be used for costs or expenses. Then divide the $6,000 by the $60,000 cost of the home. Your answer will be a 10% yield without accounting for appreciation.
For someone that already owns a property, they may apply the rule and figure the cost of the property to be the current value less closing costs and transfer taxes.