The secrets to an accurate assessment of investment property expenses
One of the keys to success in property investment is to accurately assess the cash flow a property will provide. Only when you know this will you be able to plan your investment finances. If the property you buy costs more in expenses than it makes in rent, you’ll have to subsidise the difference out of your own pocket.
For many investors, it’s preferable to invest in a positive cash flow property (though even negative cash flow property can make you wealthy). In my experience, the investors who run into trouble are those who haven’t properly estimated their cash flow before investing. In this article, you’ll learn how to make sure you don’t make the same mistake.
It’s all about expenses on investment property
When you are projecting potential cash flow on an investment property, you must consider all possible expenses. Forget one – or underestimate one – and you’ll be up to the proverbial creek without a paddle. There are two types of expenses that you must estimate: regular and irregular. The more accurate your estimates, the more accurate your cash flow projections.
Regular expenses on investment properties
These are the costs that you will incur every month. The great thing is that some of these costs will be passed onto the tenant. Why do I include them here, then? Because they will still have to be paid during void periods (which I cover in irregular expenses in a moment), so it’s good to know that they exist and how to deal with them.
· Council tax
It’s most likely that you will have your tenant pay this charge, but during a void period, you will have to pay it. The government recently introduced a new council tax surcharge that means owners of ‘empty’ properties will have to pay the full council tax bill while they are empty.
Again, you will probably get your tenant to pay these – why wouldn’t you? However, you will still need to pay them while the property is empty; for example, between tenants.
· Landlord insurance
Don’t be without it. Landlord insurance will cover property damage, cover your public liability if tenants have an accident on the property, and can even pay your rent if a tenant refuses to pay. Only a couple of hundred quid or so per year, and worth every penny.
· Service charges
If you are investing in an apartment in a block, it’s likely that you will be required to pay service charges. Make sure you know how much these are, when they are due, and if they are likely to increase and by how much. These will be your responsibility to pay, though you may be able to adjust the rental price accordingly.
· Property management fees
Whether or not you decide to hire an investment property manager, you should account for the costs of property management. Usually, property management charges fall in the range of 10% to 20% of the monthly rental. If you’re starting out in property investment, or have a couple of properties and manage them yourself, allow for this cost – as your portfolio grows and becomes more geographically diverse, you won’t want to do all this work yourself.
Irregular expenses on investment property
These are costs that are less likely to impact your cash flow every month. Instead, they ebb and flow. However, you must still take them into consideration. Usually, the best way to do this is to calculate them as a percentage of your rental income.
· Void Periods
Every buy-to-let property investor suffers void periods (when the property is not tenanted). Usually, this is the period between tenancies. The average void period in the UK is around three weeks and occurs every 18 months. So that works out at three weeks every 78 – or 4% of your rental income each month.
You never know what may need repairing, so estimating these costs is another tricky process. However, there is certainly a rule of thumb that says the older a property is, the more it will cost to maintain. The best way to estimate this cost is to think about what might go wrong – and what isn’t under warranty – and then allow for this. Include in this estimate the costs for regular maintenance, such as electrical testing and gas safety certificates.
Here's an example: if you calculate an annual maintenance bill of £600 and your monthly rent is £1,000, your maintenance costs are 5% of your rental income per month.
These are the big-ticket items. A new roof. A new kitchen. Replacing the central heating system. They again depend upon the age and condition of the property you buy. While new build properties shouldn’t need such major spending, it’s best to allow for a cost in your projections. If you consider 5% of your monthly rental as the cost of future improvements, you can set this aside. When the electrics need rewiring in 20 years, you will have the money to do so.
How do you estimate expenses accurately?
Another mistake that property investors make (especially beginners) is to guess the cost of expenses. They may base their estimates on the costs of their own home, or another property they own in a different area. Don’t make the same mistake.
It’s not difficult to make accurate estimates of expenses. All you need to do is ask!
· Ask local letting agents and property managers
Phone local property managers and ask them. They’ll be happy to help – they want your business!
· Ask local authorities and utility companies
You want to know what the council tax is – ask! The same with average utility bills. Go direct to the source and get the exact information you need.
· Ask other property investors
Ask local property investors for their experience. Ask the local letting agent for a couple of referrals – and then ask the property investor about the expenses they incur.
Calculate your investment property expenses
Now, all you need to do is add up the regular costs (first discounting those that you will pass on to the tenant) and calculate the irregular costs. Don’t forget to add back in the regular costs during void periods.
Total your regular and irregular expenses, and you have an accurate assessment of the total expenses associated with your buy-to-let property.
Your investment property is a box to make money. Making an accurate assessment of your property’s cash flow is essential to your success as a property investor. Which is why we discuss this in detail during our property investment consultations with investors. To book yours, contact Gladfish today on +44 207 923 6100. You could soon join the hundreds of investors we have helped to build profitable property portfolios.