The way most people who own property calculate cash flow is by subtracting the mortgage payment from the rent amount. At first, the number looks alright until something goes wrong with the building, there’s a vacancy among the tenants or property taxes increase by 15% from last year. The problem is not the predictable costs. Non-recurring costs tend to ruin all of the calculations you made at the beginning.
What does tenant turnover really cost
Tenant turnover is probably the most expensive event that a landlord faces. However, landlords commonly underestimate how costly this process is. Cleaning fees, painting, new locks installation, re-listing the property for rent are all quite obvious expenses. However, they do accumulate. On average, each time you have to deal with tenant turnover the direct cost is around $1,750 – not including the loss of income from the time when there is no tenant living in the property. With a 21-day vacancy period for a unit that rents for $1,800/mth, you lose $1,260 in income. So, the overall cost of tenant turnover might easily become over $3,000. And you won’t see these costs in your financial spreadsheet if you run a rather simple one.
CapEx versus routine maintenance – what’s the difference?
There is a significant distinction between fixing a leaky faucet (operating expense) and replacing a water heater (capital expenditure or CapEx). CapEx is an expense related to the purchase of an asset. For example, roofs usually last from 20-25 years, HVAC units – from 15-20 years, and water heaters – from 10-12 years. Without setting aside the money for the replacement of these items each month, you don’t have any real cash flow, because you earn less than projected. You have recorded profit, but didn’t take into account the capital expense of purchasing a new system, which builds up as old systems in your property wear out.
If you have a proper rental property financial statement, the distinction between these two will be clear. If you don’t differentiate, your net operating income becomes distorted and it can cause mistakes in making decisions concerning property sales or refinancing.
Don’t forget about the taxes and insurance
Property tax assessment and landlord insurance may look like fixed expenses in your report. However, both of these expenses can change over time. In some markets, property tax assessments are reassessed and may increase significantly without much warning. A 15% rise in the assessment means that you get the unexpected increase in property tax amount. Thus, you don’t see it in the financial projections and it decreases your cash flow.
Landlord insurance is more expensive than homeowners’ and rising reinsurance costs around the world push it upward too. So, if you haven’t updated your insurance policy in two years, there’s a chance that you may be either paying too much or not insured enough. It means that you need to check the price annually and update the spreadsheet accordingly.
Utility costs in landlord-paid properties
In a multi-unit property or single-family property where you are responsible for covering water, electricity or sewer costs, you may not notice the increasing cost of the utility bill. An irrigation leak, a toilet running in a vacant apartment and lighting changes during different seasons can add $50-$150 to your monthly bill without anyone noticing it.
These $50-$150 per month can become $600-$1,800 per year that is gone without giving any additional value. That’s why you should audit landlord-paid utilities once a month and compare the cost with the same period of previous months. Any deviation in the normal seasonal fluctuations of the bill must be investigated.
Costs associated with legal and compliance procedures
This type of expense usually surprises many landlords because it’s infrequent and unpredictable. Registration fees, renewal of business license, requirements of habitability inspections – everything depends on your location. And missing one deadline can cost you more than the actual registration fee. You’ll have to pay the penalty for your mistake. Evictions also fall into this group of expenses. Even if you have an uncontested case, you have to pay for the court fees and carry the cost of the tenant until the process is complete. In a contested case, this sum can quickly grow. And even though you can’t calculate these expenses in advance, you shouldn’t forget that they appear relatively frequently.
Self-management expenses
Self-management feels free because you don’t pay any management fee. But the absence of a fee doesn’t mean that the work doesn’t still need to be done. Protracted lease cycle means that there is slower marketing, fewer vendor contacts and inefficient tenant screening. Paying retail prices for contractors instead of property management vendor prices makes the maintenance cost higher. Late rent collection leads to delay in cash flow. And after taking into account all these expenses, it becomes clear that “saving” money on the management fee doesn’t make sense.
It’s exactly the moment when working with a professional management company pays off. Platforms like AtlisPM.com combine financial reporting, vendor management and leasing operations into one package and it’s the type of infrastructure which turns expense tracking into a real picture of your property performance.
Base your financial calculations on the real cost
As long as cash invested and cash returns are reliable numbers, the cash-on-cash return is a relevant metric. However, to make those numbers reliable, you should take into account tenant turnover costs, set aside money for capital expenditures, check if taxes haven’t increased recently, protect yourself from rising utility costs, take care of the legal expenses and make sure that the property management is efficient. Landlords who are surprised by their numbers usually use an incomplete model of finances.
Tighten the reporting, and the surprises will become smaller.
