There you've done it. You have taken the plunge and next step towards your financial freedom. You've invested in real estate. While this is a positive and exciting endeavor, it's not without its risks and drawbacks. After all real estate is typically a long-term investment plan, and will take years before you actually start seeing a profit. While this may seem discouraging at times, it actually is a safe way to ensure your future and increase retirement options. However, often times, new real estate investors are not aware of the hidden and potential expenses that can come when investing in real estate. In this article, we will outline for you the most common unknown expenses in the industry.
First, we'll start with the big 3. The first of these three is maintenance expenses. A lot of times, new real estate investors will only put a number like $600 a year for maintenance on their cash flow statement for a rental that is renting for about $1000 a month. However, in reality maintenance will run at least 10% of the yearly rentals cost. So, in this scenario a new investor is actually budgeting half of what they should be for maintenance. And, if the building is old, you can expect as much as 20% of the rent in costs, until repairs are under control.
The second of the first big 3 expenses is management expenses. On average a typical property manager will charge between 8% and 10% of rents to manage property. If you're in a multi family apartment situation, rents can be as little as 4%, but it does add up. So, always budget a minimum of 10% when it comes to managing properties. This even includes if you're going to manage the property yourself. You wouldn't work for someone else for free. Therefore, don't work for yourself for free either.
The third major expense is a vacancy expense. No matter how great of a landlord you are at some point you will experience a vacancy. And if you have a single family home you're either 100% occupied or 100% vacant. So, you’ll want to keep aside about 5% of the rent to account for a vacancy. The reason for this 5% is because even if you're only vacant for 2 or 3 months, just every 5 years, you will have still used up this expense allocation.
There are several other “smaller” expenses that you'll need to know about. And by smaller we don't necessarily mean monetarily smaller. Rather just expenses that aren't as often considered. For instance, you want to take into account permits and fees. Nowadays many cities are jumping on the real estate license bandwagon. Often times they will charge around $50 a year per rental. And in places like Minneapolis it can cost up to $7000 a year for vacant building permit. Crazy right?
Another common expense that often isn’t considered when planning your real estate budget is tenant-screening charges. To screen tenants and do all of the background checks necessary to clear them, can add up. So, you can either cover these costs by charging the tenant, or somehow include them into your monthly rents. You can also choose to bite the bullet on this expense to bring in your renters. Just make sure if you do, you keep track of how much you’re spending.
Advertising can also take a major chunk out of your wallet. Yes, there are many forms of advertising that are free. But, you may want to put in an ad in a paid format. The reason for this is you can tend to draw better tenants. Also, by investing in advertising you can utilize tools such as RealEstate Virtual Tours that can help you save time in your tenant search process. For instance, Real Estate Virtual Tours allows the tenants to review the rental before actually physically seeing it. This may cost you some money, but in the end will save you time effort and potential money for running background checks, because it eliminates renters who aren't serious.
Evictions are also another big expense. Unfortunately the evictions can tend to get very messy. And can make you lose years worth of rent. So, take into consideration of holding back at least 5 months worth of rent to cover the cost and of an eviction. This will help cover the costs of legal expenses, repairs, vacancy, lost rent, and advertising.
Other expenses that you can incur the real estate investment are tools, if you're planning to do your own maintenance. Banking charges, because banks like to charge fees to businesses. Office expenses, because when you have a rental you need a solid computer to run your company, as well as a decent printer. Plus you'll need to print leases, notices, and all sorts of letters. Also, you'll need to keep track of all your expenses, which will often require some form of QuickBooks or TurboTax. And of course there's insurance. Yes you know about property insurance, but what about liability insurance for your business? You want to make sure you have this insurance in place as a safety net in case anything was to go wrong.
All in all real estate doesn't have to be a scary endeavor. In fact it can be very liberating and a good investment plan. You just need to make sure that you are well informed and understand all of the costs that go into real estate investment. If you can learn to be savvy and expect the unexpected, you'll set yourself up for future success.