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You can also deduct your mortgage interest, but not the portion of the mortgage payment that's principle.
A few things to consider off the top of my head:
- Is the property going to cash flow or at least break even early on? If not can you cover the extra expenses
- Is the location attractive for appreciation and ease of renting?
- Is there equity tied up in the property that you will need in the near future? Converting to an investment property should really be a long term play so if you think you may need that money in a couple years it may be better to just sell.
- Are you prepared to be a landlord, and if you're hiring that out to a management company make sure to include their expenses in your budget
The big one that is the most helpful come tax time is the passive loss rule. You'll make too much to apply it, but you will get it back when you sell, assuming the property appreciates.
Figure out how much rent you can get for the property.
From that number subtract:
Mortgage
HOA
Insurance
Taxes
Vacancies and collection- Depending on your area, usually 5% -10% of the gross rent will be lost
Maintenance - minor repairs and new paint/carpet, etc. between tenants
General reserves - You'll need to put away money each month to pay for big items as they break, such as, heat/a/c, roof, appliances, water heater, and major tenant damage.
Opportunity cost - what would your equity being doing for you if it wasn't tied up in the rental
Management fees and/or rental costs
Utilities - any utilities not commonly paid by the tenant, and make sure you will not be held responsible if tenants leave an unpaid bill
Then, add back in tax savings.
The other thing to consider is the "return of", when you sell the property. It is very difficult to predict what the property will be worth when you sell it. Even if you're in a hot market, there's no guarantee that prices will remain stable or escalate.
Finally, don't even consider renting if you can't handle the destruction, that at least one of the tenants, will wreck upon "your home".
Figure out how much rent you can get for the property.
From that number subtract:
Mortgage
HOA
Insurance
Taxes
Vacancies and collection- Depending on your area, usually 5% -10% of the gross rent will be lost
Maintenance - minor repairs and new paint/carpet, etc. between tenants
General reserves - You'll need to put away money each month to pay for big items as they break, such as, heat/a/c, roof, appliances, water heater, and major tenant damage.
Opportunity cost - what would your equity being doing for you if it wasn't tied up in the rental
Management fees and/or rental costs
Utilities - any utilities not commonly paid by the tenant, and make sure you will not be held responsible if tenants leave an unpaid bill
Then, add back in tax savings.
The other thing to consider is the "return of", when you sell the property. It is very difficult to predict what the property will be worth when you sell it. Even if you're in a hot market, there's no guarantee that prices will remain stable or escalate.
Finally, don't even consider renting if you can't handle the destruction, that at least one of the tenants, will wreck upon "your home".
You should also add back in the principal payment, which is not an expense.
After accounting for all of the above, what kind of returns do landlords expect from their cash sunk into the property?
For e.g. Lets say I put in 100K for downpayment, and have equity worth 200K. After factoring in ALL COSTS and TAX BREAKS, how much do landlords get on their investment in the bay area ( thats where I am)
Check out the BiggerPockets forums. They can answer all your questions in much more detail. Great group of people over there.
In short most turnkey RE investors don't make much starting out. You'd be lucky to cover costs for the first few years. The magic happens in the appreciation of the property and pay down of the mortgage. For example, on a rental property I'm familiar with, mortgage is $1100 rent is $1200, not much room for error if the property sits vacant for a few months, HVAC goes etc, but of that $1100 mortgage $500 is principal pay down. That is increasing your net worth by $6000 a year without taking any sort of profit off the top (just a bonus). That will only go up over time.
A buddy of mine rehabs duplexes, gets 'em for dirt cheap and puts some money into them, then refi's to a 15 year and pulls the equity out of them and buys another. He makes money on rent after accounting for 20% vacancy rate, things breaking etc because he puts sweat equity in them but the bonus is his tenants are buying his homes for him. He does well with this because he spreads his risks around many units.
I am just going to throw two things out there, which you probably already know. Having read some of you are other posts, you sound pretty similar to me.
If you are int he Bay Area, as I am, consider that rent control is pretty powerful. If you are renting single family, that's unlikely to be an issue, but the biggest thing about rent control to me is not that youc an't raise interest YoY, but that you can only raise it by 10% to pass on capital improvements. Being in the process of completing home reno myself in SF, I have to tell you that the process is a huge pain and it is very expensive. One large capital improvement project in a rent controlled building and I think you are screwed.
Beyond that, I think that buying an investment property in BA now is pretty risky, because of how high the market is. You would lock in a low interest rate, but you would have a high mortgage due to high prices.
Finally, i will give you a personal example. My dad (in a southern state) bought his primary home at the bottom of the market. His current mortage payment per month is $450. He remarried and moved out and he rents it out for $1000 per month. He does the repairs himself, and has had to replace the carpet and also fix the roof. I think that would be considered a home run by landlords and I still think his probably made a tiny income over the past 4 years (when he started renting it out).
We briefly considered buying our old building 3 years ago when it came for sale, because we knew we would get evicted. After we did the diligence, we realized we probably couldn't handle it.
1. does the math work? if it does DO IT! but then........
2. if you had the amount of equity in cash in your hand would you buy your property?
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