Cost of Owning a Rental Property: What Homeowners Need to Know

Many investors use rental property investing as their ticket to financial freedom. However, property investing is not a hands-off investment where you can simply buy a property and receive cash for years to come. There are expenses associated with owning a rental property and knowing what those costs are is a helpful factor in determining future success.  

Despite being one of the few investments that investors can calculate the expected returns quite accurately on, plenty of new investors lose money because they underestimate the actual cost of owning a rental property.  

In this article, we’ll talk about the costs associated with owning a rental property and how much you should allocate for them. You’ll learn how to budget for these expenses and we’ll give clear examples of implementation.  

Purchase Cost

The first expense that you need to consider is the purchase cost. Investment properties typically require a larger down payment than owner-occupied properties. Lenders typically require 20% or more as a down payment if you’re planning to rent your property from day one. 

So if you’re planning to buy a $250,000 house, you should secure at least $50,000 as a down payment. You’ll also have monthly mortgage payments to consider once you have secured the initial amount. You should know these figures before you buy the house so that you can easily take them into account during financial planning.

If you have yet to take out a loan for a rental property, there are several mortgage calculators which will give you a decent estimate of your monthly mortgage payments. 

Assuming that you have the downpayment covered, let’s look at the other costs of owning a rental property.

Costs of Owning a Rental Property

The cost of maintaining a rental property varies depending on several factors, but most rental property owners estimate the aggregate expenses to be around 50% of monthly rent. These include repairs, maintenance, taxes, insurance, and other property costs. 

Let’s break down each cost and how they’re calculated. For example, let’s use the same scenario as before and assume you bought a $250,000 rental property. Now imagine that you rent it out for $2,500 a month:  

Repair and Maintenance Costs

For new property owners, repairs and maintenance often become unforeseen expenses since they don’t hit every month. But, preparing for unforeseen expenses is one of the most important skills you need to learn as a rental property owner.

There are rules of thumb that seasoned property owners follow when it comes to accounting for repairs and maintenance: 

• $1 per Square Foot Rule: One easy way to account for your repairs and maintenance costs is to save $1 for every square foot. If you’re renting a 2,000-square-foot single-family home, you should save $2,000 annually for repairs and maintenance.
  
  OR
• 1% Rule: Repairs and maintenance typically cost around 1% of the property value per year. As an alternative to the first method, set aside 1% of the property value annually to account for maintenance costs.
  
  OR
• Rent Rate Reserves Rule: Save 10-15% of rental income for ongoing and unexpected maintenance costs.

While these rules are a step in the right direction, there are no guarantees when it comes to these costs. Several factors could affect the cost of repairs and maintenance for every property. 

Such factors include high turnover rates. When a renter leaves, property owners may need to spend on new paint, flooring, and other repairs in order to market the property and attract new renters. The shorter a renter stays in a rental property, the more owners have to spend on repair and maintenance. 

Another factor is the age of the property. Newer homes require little to no repair while older homes may need frequent maintenance work. In either case, saving for unexpected costs from day one is a good practice for all property owners.

Vacancy Allowance Cost

Although vacancy rates may be seen as a lack of income rather than an expense, ignoring the cost can easily result in financial loss.

To calculate the cost of vacancy, calculate your vacancy rate and multiply it by your expected annual revenue. For example, if your vacancy rate is 4% and you rent your property for $2,500 a month ($30,000 a year), the cost of vacancy is $1,200 a year. Divide that by 12 and that’s $100 a month or 4% of your monthly rent.

The average vacancy rate in the US in the first quarter of 2022 was 5.8% but your vacancy rate may be higher or lower depending on location, price, and the quality of your renters. 

Experienced property managers recommend that you check out the comparable vacancy rate in the area and include it in your calculations before buying the property. This will help you paint a better picture of the potential income of a rental property. 

Property Insurance Cost

Unlike the previous cost we discussed, property insurance is fixed and can be easily calculated. 

Insurance for rental properties is on average 25% more expensive than a homeowner’s insurance. The best way to know the cost of your property insurance is to get a quote from your local insurance companies. 

Experienced rental owners and property managers recommend that you get at least two quotes from different insurance companies and compare them to get the best deal. Ask about the different types of policies, pricing options, restrictions, and what they include. 

To get the monthly cost for insurance, simply divide the premium amount by 12. For instance, if you’re paying a premium of $1,500 annually, your monthly insurance cost is $125 or 5% for a property that rents for $2,500. 

Property Taxes 

Like property insurance, property taxes are straightforward. Your annual property tax depends on the assessed value of your property and your jurisdiction’s tax rate. 

Every jurisdiction sets its own tax rate so it’s important to check it out before investing in a rental property. To calculate the monthly cost of property taxes, simply multiply the assessed value of your property and the property tax rate in your jurisdiction. 

For example, if the assessed value of your property is $250,000 and the property tax rate in your jurisdiction is 0.51%, you can expect to pay $1,275 annually. Divide that by 12 months and you’ll pay $106.25 per month.

Taking our example of a $2,500 monthly rent, 4.25% of it goes to property taxes. 

Property Management Cost

Whether you hire a property manager or not, it’s a good idea to take property management costs into account for two reasons:

• You never know when you will be unable or unwilling to manage your property
• It’s a labor expense. You or someone else would manage your property

Property management companies, like Poplar Homes, typically charge a management fee of between 6-8% of monthly rent and the equivalent of a half month’s rent for placing renters on your property (other companies may charge an equivalent of a full month’s rent). 

So if you have renter turnover every two years and you’re renting your property for $2,500 a month, placing a tenant costs $52 a month or 2% of your monthly rent. 

To calculate the property management cost, simply add 6-8% of your monthly rent and 2% for tenant placement and that’s up to 10% of your monthly rent or $250 for a $2,500 a month rental property.

Other Expenses

Of course, there are other smaller expenses that could easily get unaccounted for. Travel, bookkeeping, and miscellaneous expenses are just a few examples. 

Some homeowners budget 2-4% for these types of expenses. Now there’s no guarantee that this budget gets used up, but it’s good practice to be prepared for anything. 

Putting it All Together

Now that we’re familiar with the individual costs, it’s time to put them all together. Given the example we’ve consistently used above, the breakdown of costs in percentages is as follows:

As you can see, the total cost of owning a rental property is 37-46% of the rent which, not surprisingly, almost fits the 50% rule we’ve discussed above. 

Note, however, that these values depend on several factors including the location of your property, the price of your property, how much you rent your property for, and the service providers you choose. 

Another factor could be the quality of your renters. As a general rule, you save more by having long-term quality renters which you can find by conducting a thorough tenant screening.