If you’re reading this, then I assume that you fall into one of two categories; either you own a rental property, or you’re interested in owning one. If so, then the information in this article is vitally important. There are many ways to calculate your return on investment that go into much greater detail, but this breakdown will give you the quick and dirty for your unit by giving you the cash on cash return. If you own a property you need to be aware of exactly what your unit is costing you and not just the sticker price. After we identify the needed information we will crunch some numbers on a Missoula residence.
First, let’s look at the four areas of information that we will need.
1) Income: This is the actual income generated by your unit. The most obvious of which is the rent. This also includes items such as coin op laundry, storage units, etc.
2) Expenses: These are the things you pay out money for. These include taxes, insurance, utilities (electric, water, sewer, garbage, gas, etc), HOA fees, lawn care/snow removal, repairs,
capital expenditures (setting aside money for large future repairs), vacancy (setting aside money preparing for vacancies), and your mortgage.
3) Monthly Cash Flow: Income – Expenses
4) Cash on Cash Return on Investment: What kind of percentage is your money earning? How much money did you spend to acquire this cash flow? To find this you must first figure out how
much money you spent on this property. Add up items such as your down payment, closing costs, remodeling budget, etc. These items add up to your total investment. Then, take your
monthly cash flow multiplied by twelve to get your annual cash flow. You then divide the annual cash flow by the total investment. This number is your cash on cash return.
Now it’s time for a real-world example.
The numbers here are for a 3 bed, 2 bath 1200 square foot townhome built in 2009 here in Missoula. It has hardwood floors, granite countertops, nice paint, and a garage. Nothing super fancy, but a nice home. Let’s break down the numbers.
Income: Similar houses in Missoula are renting for about $1300-$1400/month. We will assume you get $1350. There are no additional income sources for this property.
Expenses: Oh boy, here things get interesting. The listing price for this home is $210,000. With a 30 year mortgage at 4% and 20 %down ($41,980) that’s $802/month. We can guestimate insurance for this size and age of home at about $60/month. Missoula is a little ridiculous when it comes to taxes, and by looking at county records we can estimate the taxes at about $200/month. Now let’s account for everything else. Assuming you have the tenants pay for electricity and heat, that leavs you with a $30 garbage bill, a water/sewer bill of $45, and HOA fees of $30. Somebody must mow the lawn and remove snow, so to be conservative, let’s say $50 a month on average. Next, eventually you are going to need a new roof, hot water heater, furnace, etc so let’s set aside $75/month for that. Finally, you must always account for vacancy. If you have a great rental and you market it properly you could hope for less than one month vacancy per year, so we set aside $113 ($1350/ 12 months).
Well now, that number is quite a bit different than the standard Rent – Mortgage= Profit equation people often use.
Cash Flow: Income – Expenses. $1350-$1405= -$56
Cash on Cash Return on Investment: Now let’s add up what you spent to acquire the property. You had a down payment of $41,980, assume the selling paid the closing costs, and you did not have any remodeling. Your annual cash flow is -$56×12= -$672. Now, -$672/$41,980= -$1.6% return. Obviously, we now know this isn’t a very good rental unit. If you hadn’t crunched the numbers and assumed the stereotypical Rent-Mortgage = Profit, you would be in big trouble. This isn’t even accounting for the management fee if you had a company take care of it for you.
I hope this helped you understand the costs involved with owning a rental unit. Sometimes it’s better to sell than to rent it out. Granted, this doesn’t account for your internal or overall rate of return, but it gives you an idea of the things you should account for. If you would like to see what we can offer please visit our Owners page. If you found value in this, please like and follow us on Facebook for more info.