Optimism is good, but when it comes to buying a rental property, it’s better to be realistic. The promise of what investors call “unearned income” is enticing, but it’s important to be aware of how much of your tenant’s rent check will be eaten up by overhead.
That’s why every potential buyer of a rental property needs a business plan. When you look for financing, a well-thought-out plan will improve your standing in the eyes of potential lenders.
First, determine your initial outlay, or what it will cost to acquire the property and get it ready for tenants. This amount, minus whatever down payment you have, is the amount you will need to borrow. It includes:
- the purchase price of the property
- any renovations and improvements, including permits
- a home inspection and/or appraisal
- the real estate agent’s and lawyer’s fee
Then you’ll need to estimate your monthly expenses, or what it will cost to maintain the property:
- mortgage and interest payments
- property taxes
- utilities (not including those expenses you’ll charge tenants)
- administrative costs (office supplies, transportation, etc.)
- management fee (if you’re hiring someone else to look after the property)
- maintenance and upkeep
- classified advertising
This total will tell you how much rental income you’ll need to make the property profitable. This is fairly simple if you’re just renting out one apartment, or even a whole house. If you have several units to rent, your market research may take some time. You’ll have to compare your figures with rents for similar properties in your neighborhood to see if you will be competitive. Your city may also have regulations that limit how much you’re allowed to charge.
Once you’re confident that your rental income will exceed your operating costs, you’ll want to consider the long-term outlook, or how the numbers will change over the life of your investment. Consider factors such as:
- the appreciation or depreciation of the property
- interest rates on your loan
Of course, these are difficult to predict accurately. As long as you understand your city’s rent control regulations, you should be able to forecast how much your rental income will rise over the years.
There are some common pitfalls in rental property business plans. Perhaps the most common is underestimating the amount of money you’ll spend on maintenance and upkeep. Your monthly estimate should budget for the major repairs that will inevitably come your way. Remember, too, that tenants don’t always pay on time. Think about how your cash flow will be affected by a late check or two -- will you need a line of credit to sustain you, and can you afford the interest charges that accompany it?
A spreadsheet can give you a rough tally of these figures. Once you’re ready to look for financing, you may want to purchase books or software with business plan templates to make your document look more professional, and to make sure you haven’t left anything out.