Rental property profit

  You're considering buying an investment property. Maybe you've watched the price come way down, you think you are able to pick it up cheap, rent it out to cover your expenses, and then sell it when the market bounces back. In order to figure out how much (if any) annual profit you will make from a potential rental property you first must calculate or estimate the total potential rent. This is calculated by taking the projected monthly rent for the property multiplied by 12 months. If it is a single family house or condominium it will be one monthly rent, if it is a 2-4 family property you need to add up the rents for all units to get the total monthly rent. If the property is already rented you might get a good idea of the monthly rent. If not, then you can get ideas from what other similar properties are renting for. Check newspapers, online listings, or maybe even question the local realtor.

  OK, you've got an idea of how much potential annual rent you can expect from the property. Next you should deduct for vacancy and rent loss. This term refers to annual rent that is lost due to either the property be vacant for some portion of the year (perhaps it took a month to find a tenant or a couple of weeks from the time one tenant moved out and the next one moved in) or from rent loss due to a tenant flat out not paying all or a portion of the rent (this does happen sometimes, even with what appear to be great tenants). Typically a 5-10% vacancy and loss estimate is reasonable but check the local market. Are there lots of competing properties listed for rent? Are there many vacant properties in the neighborhood or condominium complex? Check with local realtors for their opinions as well.

  So far we have total potential rent - vacancy/rent loss = expected annual rent

  Next we need to deduct the expenses on the property to see what (if anything) is left.

1. Property taxes: The property will likely have town and/or county property taxes each year. Check with your local tax office to find out the amount.

2. Association fees: If the property is a condominium or in some sort of homeowners association there will be homeowners fees. Also, check to see if there are any current or expected special assessments in addition to the regular homeowners fees.

3. Management fees: If you plan to use a property manager to look over the property or be in charge of renting the property for you there will be a fee. The local realtor can be a good source for this one.

4. Exterior maintenance: This is an area that many investors do not take into account properly. There will be costs involved for snow removal, cutting the grass, maintaining the landscaping, painting, trash removal fees, etc (for a condominium these may be included in the monthly association fee).

5. Interior maintenance: In general, tenants are responsible for cleaning their units but there will still be expenses for interior items such as appliance repair, flooring, painting, plumbing issues, leaks, etc. If it is a building with common areas or hallways there is an expense for maintaining those areas. These are often difficult to estimate but make sure you do count something appropriate as an expense.

6. Insurance: The property should be insured. This includes not only for the building and it's contents but also proper liability to cover yourself if someone gets hurt on your property. Contact an insurance agent to get a quote.

7. Utilities: If the tenants do not pay for some or all of the utilities (heat, hot water, public water, public sewer, electricity, cable, electric, phone, etc), those expenses need to be counted.

8. Replacement reserves: Another often overlooked item is replacement reserves. This refers to setting aside an amount to cover long term things such as roof, siding, driveway, appliances, etc. If an item (say a roof) has an estimated life of 30 years and would cost $9,000 to replace, $300 per year should be set aside to cover that future expense. Use this formula for each long term item to estimate the total amount that should be set aside and hence counted as an expense.

9. Miscellaneous: As carefully as you plan for everything, there will likely be things that come up that you don't anticipate or cost more than you thought so set aside some money under the miscellaneous/unplanned things.

10. Mortgage: Did you plan or taking out a mortgage on the property? Did you want the property to cover your mortgage payment too? If so, add that mortgage payment as an expense. Be careful not to double count property taxes if they are already included in your mortgage payment.

11. Return on your cash investment: If you paid cash for the property, is there a certain amount of money you would like to make each month as a return on your investment? If so, count this as an expense in the analysis.

   Ok, you estimated the total potential rent, deducted for vacancy/rent loss, then deducted all the estimated expenses.  You now have the potential net profit.  If this number is positive, you are anticipating a positive cash flow on the property, if it 0 you are at the break even point, if it is a negative number you are anticipating a negative cash flow (in other words you expect to lose money each month).

  Once you have your number you can make a more informed decision on whether or not this property could be a good investment or not.