Today we’re going to talk about the expenses that you need to consider before you start an investment property. We could divide the expenses in three different categories: We have the financial expenses, the operating expenses and the business expenses.
We know that some people have the luxury to be able to invest in cash, but some others, most of us will have to use a mortgage in order to invest in real estate. A mortgage is considered an expense, but not the entirety of the mortgage. The way the mortgage works is that every time you make a payment, you are paying principal and you’re paying interest.
Some mortgages will include property taxes, they will include insurance, which is what they call escrow. Let’s focus on principal and interest. For example, you can be paying a thousand dollars towards a mortgage payment, but out of that $1,000, only $100, it’s going to go towards the principal, and $900 could go towards the interest.
Buying Properties: Principal and Interest of a Mortgage
Between principal and interest, which one is considered an expense in your investment portfolio? Definitely not the principal. Why is the principal not considered an expense? Because it is a repayment of the debt. It’s something that you acquire and you have to give it back. Interest on the other hand is a cost. It’s the cost of doing business.
In order for you to get access to a mortgage and get money to invest in real estate, you have to create a win-win situation for the bank, for the lender and that’s via interest rates.
If they’re lending you money and they don’t have the option to use that money to do anything else, they will want to make sure that they’re also reaping the benefits of that investment. That’s why they get to charge interest.
Expenses when you invest in a property
The financial expense that you have when you invest in property will be interest rates. On the operating category, you’ll have:
- maintenance expenses. For example, you have a building complex and you have to clean up common areas. You have to clean up the aisles and the benches. You also have to cut the grass and do the snow removal. All of that, it’s considered a maintenance expense.
- You will also have to worry about property management fees unless you manage the property yourself.
If you are investing long-distance or maybe you’re a busy person because you have other things to worry about and you don’t mind investing in property management, that’s another fee that you’re going to have to take into consideration.
That could vary somewhere between 6% to 12%, sometimes even 15%, depending on where you are located or where your investments are located. Percent means the percentage of the rent.
- Another expense that you should take into consideration are: utilities.
Some places do offer to cover utilities. For example, if you have an Airbnb, that’s one of those rental business models that you can not afford to just simply charge the guests in this case, not the tenant, but the guests for every single thing. That’s something that you have to incorporate.
That will vary depending on the type of investment property that you have. If you have something that is considered long-term, you might not include the electricity, but you could include water or natural gas because if you live in a cold state.
- Vacancy rates: That can also vary depending on the type of investment that you have. The vacancy rate that most people use, assuming all factors remain normalized is usually 5%.
If you have a model of investment like Airbnb, or if you have your rentals in one of the lowest income areas that could require more management-intensive work to manage your tenant, then typically the vacancy rate can go higher, sometimes even 10, 12, sometimes even up to 15%.
Lastly, under operating costs, there’s also repair. Sometimes you have to do some repairs because if something breaks, that’s just part of doing business.
If you decide to put your properties into an LLC. An LLC itself has fees that you have to pay. They are:
- The registered agent fee, which is a fee that you have to pay to use the address of an office in order for you to be able to have access to an LLC in the event that you are renting out of state.
You definitely don’t want to use the address of your property because you don’t want your tenant having access to that type of information. In order to do that, what you do is that you pay a fee for a registered agent, so you can use their address and create your LLC.
- We also have the yearly renewal fees. The renewal fees vary per state. Depending on the state that you’re in, you might have to pay more or less. In addition to that, you also have to pay business taxes.
If you want to know more about this topic, you can enter our free webinar. All you have to do is click here, show up to the class of the webinar with a pen and pencil and notebooks so that you can take notes and learn a lot.
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