Renting out property can be one of the best ways to make both passive and active income. And as with almost any other investment, high risk can lead to high reward, but how much profit should you make on a rental property?
Well, it is not so simple to answer the question.
The landlord should have a clear understanding of the market to undertake high-risk investments. But it is vital that they know it is likely that for a long period he or she will have to invest large chunks of money into the real estate before any real reward comes.
As such, it is important, as with any investment, to be patient and set your expectations realistically. If the landlord's investments are more down-to-earth, they may receive less reward, but likely much faster and their income may be steadier.
Therefore, it is up to you to decide what kind of investor you want to be. And if you were wondering how your profit levels will be determined, how much profit you are likely to receive, and what to look out for when considering investing in rental property, just keep on reading.
Firstly, let us introduce what we are talking about today- profit. In general, profit refers to a financial gain. In particular, it is the sum of money left over once all costs are subtracted from the income you, or a firm, have received.
In the case of rental property, rental profit, therefore, refers to the financial gain which remains after all the landlord's expenses are subtracted from the rental income they have received in a given period.
Before you can consider how much profit you make, considering what good investment even means is the first step. As already explained, higher-risk investments usually lead to higher rewards.
However, there are precise ways that are typically used to calculate your return on investment and help you keep the property profitable over time.
The two most popular methods for gauging profitability are Cash-on-Cash return and Capitalization Rate.
In this section, we will explain how these two methods work to help you to determine the profitability of your property.
Cash-on-Cash or CoC return is a metric widely used to calculate real estate investment profitability. Essentially, it determines annual return based on net cash invested and net operating income
Most experts advise for a CoC which lies anywhere between 8% and 12%. However, it is important to keep in mind that CoC will substantially differ depending on how you are financing your property. For example, whether it was bought by solely your savings or using a loan.
Definition Breakdown: Net Cash Invested: All the cash invested into the property, Net Operating Income: Rental income after operating expenses are deducted- this does not include interest rates and taxes
Another type of metric used to indicate the rate of return on investment is the capitalization rate.
It is calculated as net operating income divided by property value.
This metric type only accounts for the initial value of the property and does not account not for fluctuations of value over time as the market changes.
Or for additional expenses which will inevitably come as a result of owning property, such as repairs, and any other potential expenses resulting from the ownership of the property, i.e, mortgages.
Unlike CoC, there is no ideal capitalization rate as it largely depends upon the type of property and the market the property is within.
Therefore, use the capitalization rate rather as a helpful tool for deciding the possible potential of the property rather than a determinant of its actual profit rates.
Remember: However, keep in mind that this metric should be mostly used only as a consideration of the potential income of a rental property before purchasing it, rather than over time.
Although the two formulas mentioned are very good indicators to build an answer to the question; How Much Profit Should You Make on a Rental Property it is important to know that the potential level of profitability will still be dependent on numerous other factors.
Essentially, the profitability of the building will depend upon the expenses that come with being a landlord.
The rent you can charge will vary based on:
In this section, we will consider these additional factors in detail and add some tips on how best to indicate a profitable property.
Landlords typically tend to follow the 1% rule or the 1 rule in real estate as it is sometimes referred to.
Formula: Monthly Rent multiplied by 1% of Total Investment (including additional expenses, mortgage, etc.)
This has proven to be the general setting stone for an ideal rental rate within the real estate community, and many landlords follow it.
Of course, you should use it more as a guideline rather than a given formula, as your rental rate will also depend upon factors such as the location of the property, demand for it, rental rates of similar properties within the area, and many others.
When these are taken into consideration, the rate is likely to be anywhere between 0.8% and 1.1%.
You Should Know: Nonetheless, this metric is still vastly useful as it should help you create sufficient profit rates to have positive cash flow, cover all your expenses, and keep some of the income.
You should estimate that at least 40% of your rental income will be directed towards expenses on the property. These can include property taxes, insurance, property management, and any possible vacancies which are inevitable to crop up.
Now, do not forget that repairs or exchanges are always going to come up. Furniture, appliances, and decorations will face wear and tear and in some instances, your washing machine may break down. If you are to include this in your estimation, then the proportion of your rental income directed toward expenses will be even higher than the recommended 40%.
Keep in Mind: Repairs and changes will inevitably be needed, even if it's only a minor repair, try to account for those in your estimation of expenses.
Unfortunately, the expenses do not end here. There is likely to be another set of expenses that are not connected directly with the property itself.
You probably purchased the rental property using a loan, and thus there will be a set of monthly mortgage payments which need to come from the leftover 60% of the rental income.
However, if you have purchased the property using your savings, there is no need to worry about this part.
Now that we have established how to determine whether a property has the potential to be profitable in the first place, let's look at how much profit you will receive.
Let illustrate this with a step-by-step example:
After this is all added up, you can see that even a smaller profit per month can generate a large amount over time.
Building upon this, you might be questioning whether investing in real estate is worth it for you. However, only you can know this as it depends on the rest of your cash-flow/income situation.
It also depends upon how you want to use the investment, whether solely for profit to add to your income, use it as a source of your main income, or perhaps as a tax shelter if you are already in a high-paying job.
Lets say you would be using the given rental income as a source of additional income. Well, in that case, one can generally say that profit below $100 per month is arguably not worth it. You might think to yourself but why?
Surely any additional income is always good?
Well yes, but, when you take into consideration the unexpected expenses that come into play, then making below $100 per month may not help to cover those expenses.
The likelihood that something will break or end up needing a repair in the property, whether it be water or an appliance you need to have funds to counter for these defects.
Even if there are no major damages, fees on the property may increase, such as property taxes you have no choice but to pay- if you wish to keep your property.
However, profit above $100 per month is arguably worth investing in - $1,200 is still a sizable annual passive income.
Bear in Mind: Investing in real estate properties is solely your responsibility and is not a one-off expense.
As with any investment, being patient and setting your expectations realistically is the first step you need to take before anything else.
As there are multiple factors to bear in mind when trying to grasp- How Much Profit Should You Make on a Rental Property? , the returns you make from real estate investment may vary from one rental property to another.
Remembering to consider things like the location of properties, condition of properties, and demand for properties are some of the key aspects that can cause a variation in the amount of profit generated.
Keep in the forefront of your mind, that rental property investment is not a speedy process to generate massive profits. It's a slow process, so set yourself a clear plan and define your goals and stick to it.
Things may not go to plan the first time around, so jot down your mistakes, learn from the experience! If you are ready for your next adventure, then pick out your next real estate deal and you'll see the improvements!
Profit is the financial benefit gained from an activity like, renting out properties, that surpasses the expenses, taxes, and costs involved in the activity.
In general, there are two main metrics used to determine the financial potential of a property: cash-on-cash return and capitalization rate.
The first refers to the annual financial return of a rental property based on net cash invested and net operating income.
The second metric is capitalization rate, which refers to net operating income divided by property asset value, and is expressed in percentage terms.
Both, however, only point to the potential of a property and other factors will influence property profitability.
The general rule is that a landlord should charge around 1% of the total sum they have invested into the property per month. However, based on different circumstances, this usually varies anywhere between 0.8% and 1.1%.
You should count that at least 40% of your rental income will be directed towards expenses on the property- which does not include mortgage payments and any unexpected costs from repairs
And as profit is calculated by subtracting total costs from the rental income received, your profit levels are not likely to exceed 60% of your total rental income.
Generally, anywhere below $100 of profit per month is not worth investing in. This is because if any unexpected costs occur, you might not only have to spend all your profit on the costs but may end up enduring a loss.
When it comes to profit levels above $100 per month, whether investing in rental property will end up paying off is largely dependent upon personal circumstances and the purpose of the rental property.
There are several variables as to how property taxes are calculated. The three significant variables that go into this calculation are the assessed value of your home or property, the assessed value of other homes in your area, and the government's annual budget.
These numbers are used to determine the tax rate, also known as the mill levy.
You determine the mill levy by dividing the dollars necessary for local services by the assessed property value. Hypothetically, consider your local government wants to collect six million in property taxes.
The value of homes in your area is five hundred million. The tax rate or mill levy is determined by dividing six million by five hundred million.
The value of your home is by far the most essential variable in this equation. Various factors go into determining the value of your home.
One factor is the economy. If you were a homeowner in 2008, that same home or property was worth a lot less at that time compared to now due to the economic crash.
Location plays a significant role as well. A property in Alpharetta, Georgia would have more value than a property in Jonesboro, Georgia.
The school district is also part of this calculation, a town with a good school district will likely have higher property values. Higher property values equal higher property taxes.
High crime rates drive property values down, which in turn will mean you won't pay much in property taxes in a crime-ridden neighborhood with a poor school district.
Size and the age of the home are critical to consider when getting an appraisal for your home or property.
The factors that determine the size of home are how many rooms and how much square footage or acres the property sits on. A brand new home will have a high property value simply because it is new and has not had a lot of wear and tear or damage.
Any renovations or improvements that improve the home's functionality, size, or appearance always increase the property value. Which will mean you will pay for that on your annual property tax bill.
Also, when getting your home appraised, the appraiser will analyze current market trends and the value of similar homes or property in your jurisdiction.
Even though the appraiser will take the value of similar homes or properties in the area into consideration, this does not mean two properties in the same area will have the exact same value due to a host of reasons.
Remember: This is how you calculate property value for taxes: Assessed Value = Market Value x (Assessment Rate / 100)
Earlier, we went over what property taxes are and what variables go into calculating property taxes. If there is one thing we can all agree on, it is the fact that no one likes to deal with that significant annual expense when it comes up.
But it is something you must accept if you plan to own a home or property, and if you do not pay your property taxes when they are due, severe consequences can occur. If you are wondering where your money goes, stay tuned.
Governmental agencies such as schools, law enforcement, DOT workers, and emergency services such as hospitals and ambulances have to be paid for somehow some way, right? These services and the employee's salaries are all paid for by taxpayers like you and me.
If there were no money to pay for these services, we would live in a world twice as chaotic as we do now. Social services such as welfare, unemployment, and social workers such as school counselors and therapists are also paid for by money from the taxpayers.
Construction and repairs to the roads we drive on, libraries, and fire protection are all covered by this money.
Sewage, trash pick up, and community maintenance is essential from just a public health and safety perspective.
The money obtained from the taxpayers is what makes it possible for these services to run. If you do not pay your property taxes, you are taking the risk of your home or property being seized, foreclosed, and auctioned off.
Life is hard, and we all face financial hardship at some point in our lives unless you were very fortunate. If you cannot pay your property taxes and make no efforts to alleviate the issue, the government will take serious action against you that will have lingering effects for many years to come.
There is an action you can take to reduce the amount of property taxes you must pay. For example, you can arrange to enter into an abatement, deferral, or repayment program.
You can also challenge your home's assessed value.
We will go more into depth as to how you can challenge your home's assessed value. Property taxes are based on the taxable value of the home or property.
The taxable value can be based on the fair market value, full value, or actual value. Every state or jurisdiction has a specific process for challenging or appealing the property's assessed value.
Typically, you make your appeal after you receive the bill for your property taxes.
To win your appeal, you have to prove the market value given to your property is not correct. Some states or jurisdictions require you to pay the bill first then appeal.
If any discrepancies are found, you will then receive a refund. Be sure to follow the procedures for making an appeal in your state or jurisdiction properly to reduce your chances of losing the appeal and increasing your chances of winning your appeal, and save your hard-earned money.
Every jurisdiction or state has implemented a tax abatement or exemption program. Qualifications for these programs are based on age, disability, income, and personal status.
Senior citizens, older homeowners, and veterans are entitled to tax abatement or reduction. Other than that, you usually would have to apply and show proof of eligibility.
Tax abatement or reduction is not possible if you are behind on your property taxes.
They may also place a federal lien.
Tip: If you are unable to pay your property taxes you can apply for property tax relief.
Various factors will cause your property tax bill to increase. Renovations such as an extra room or bathroom, a hot tub, or a patio will cause your property taxes to rise.
You will gain more satisfaction with your time at home, but it will come at a cost. Your property taxes can also increase without making any changes to your property or home.
The more desirable your home becomes, the higher amount you pay annually on your property tax bill. The city hall may also play a significant role in increasing your property taxes.
If your local city hall is facing budget discrepancies as a homeowner, you are on the hook to make up for the loss.
The economic impacts from Coronavirus have created a problematic situation for local governments. Homeowners and property owners have been affected by this complicated scenario.
A recent study indicates that homeowners in Nashville have seen a thirty-four percent increase in property taxes to combat the pandemic's monetary challenges on the economy. In some jurisdictions, because of the pandemic, local governments have offered property tax relief.
Some states even have restrictions in place to prevent property taxes from increasing too much or too rapidly.
When you make a mortgage payment, often you more than likely are paying property taxes. Most of the time, mortgage lenders estimate your annual property taxes and integrate them into the monthly payment.
Whatever the amount is built in an escrow account, you do not have to go any further when your taxes are due.
Regardless of whether your property is paid off or not, you are still obligated to pay property taxes. There are several ways to go about paying it.
If it is not already integrated into your mortgage payment, you can pay online. You can also pay over the phone with a credit or debit card. The final option is to mail a check, but this can be lengthy in the time.
Taxation based on the ownership of property has been implemented since ancient times. The concept of modern taxes comes from British and European landlords and landowners.
In the fourteenth and fifteenth centuries, a taxpayer's ability to pay was determined by ownership and or the property's occupancy.
In due time, property taxes were eventually regarded on the physical property itself and not ownership or occupancy. The United Kingdom developed a system of rates based on the property's annual value.
The growth of property taxes closely relates to economic and political conditions to come.
Property taxes were a good source of revenue for local governments in pre-commercial agricultural areas. As the Revolutionary War approached, the colonies had a tax system that made war against the world's leading military power impossible.
How taxes were structured varied from colony to colony.
Several types of taxes existed at this time: capitation taxes, property taxes, faculty taxes, and tariffs on imported or exported goods and services.
During the colonial war, taxes were increased. Settlers who lived far away from local markets became angry that they were being taxed on a per-acre basis and not on the property's value.
Light land taxes and heavy poll taxes favored landowners in southern colonies. By the end of the 1800s, thirty-three states changed their tax system to tax based on value, not per acre.
The thirty-three states that changed their system are included in the following list:
1. Illinois
2. Tennessee
3. Missouri
4. Arkansas
5. Florida
6. Lousiana
7. Texas
8. Wisconsin
9. California
10. Michigan
11. Virginia
12. Ohio
13. Minnesota
14. Kansas
15. Oregon
16. West Virginia
17. Nevada
18. South Carolina
19. Georgia
20. North Carolina
21. Mississippi
22. Maine
23. Nebraska
24. New Jersey
25. Montana
26. North Dakota
27. Washington
28. Utah
29. Idaho
30. Kentucky
31. Wyoming
32. Washington
33. South Dakota
The appeal of uniformity politically in states west of the Appalachians was powerful. The uniform tax on all wealth was appealing to settlers supporting the Jacksonian ideas of equality.
The general property tax applied to all wealth with no exemptions.
This new general property tax was administered by local officials elected to determine the property's market value, figure out the taxes necessary to raise the amount levied, collect the taxes, and send it to the government.
Due to the reforms on the taxation system, the taxpayer would pay for the services they enjoyed the most in proportion to their wealth.
The United States developed the tax and administration system the way it did to bring in revenue for the local government.
States usually divided themselves into counties, each responsible for administering laws. Citizens of states could organize municipalities, school districts, and many other societal organizations.
The result was a large number of overlapping governments got formed, many of them in rural areas. Sales and income taxes did not bring enough revenue for the local governments, so the taxes people paid on property helped alleviate this issue.
Fun Fact: After 1066, William the Conqueror created an early form of land taxation.
We have covered a lot in this article. Hopefully, you have a better understanding of how property taxes are calculated and why we pay them.
It is essential that as a future or current homeowner or property owner, you understand these things. Failure can result in a world of financial hurt.
If you cannot pay your property taxes, don't panic. There is a way and many options to prevent the chaos and economic disaster that can come from not being able to pay your property taxes.
Also, as a home/property owner, it is essential to know how and when to pay your property taxes and see that you could deal with an increase in the amount you pay annually for property taxes due to various reasons.
Homeownership can be scary if you do not know what you are getting into, especially when dealing with property taxes. If you are a first-time buyer, it is advisable to seek the help of a financial professional to ensure that you do not make a fatal mistake that can put you in financial ruin.
So, you've been wondering “ is it better to rent or buy your new home? Well, this is just the article for you.
To make it simpler, we have divided it into two parts financial benefits and non-financial benefits.
The financial benefits include, as you might have realized, all things finance from not having to pay maintenance costs or repair bills, accessing otherwise expensive amenities, not having to pay property taxes or down payments, all the way up to allow for better and more secure budgeting options.
The non-financial list is a little more fun and includes the freedom you gain to travel and move around, the additional quality you can gain, and the much better and more popular locations you can live in, places you might have not been able to reside in otherwise.
Key Insight: Look at both the financial and non-financial benefits together
Additionally, we explore the financial commitment you have to make, and whether sometimes it may be better not to make the big investment as it has additional risks attached. Both renting and owning a place is a commitment, but in different ways and in different degrees.
So, how exactly does renting beat out homeownership? And what factors come into it? Read on to find out 10 financial and non-financial benefits of renting a home that you should consider before making your move.
One of the biggest benefits of renting a home is that there are no additional maintenance costs or repair bills. When you rent a property, it is the landlord who is responsible for all maintenance, improvement, and repairs.
This means that if an appliance stops working, or even if your roof starts to leak, you can just call the landlord and he is required to take care of it. Not only is this less hassle for you, but can possibly save you a lot, and we mean a lot, of money.
Key Insight: The Landlord is responsible for maintenance and repairs
Another financial benefit of renting is having access to amenities that would otherwise be an enormous expense.
If you enjoy luxuries such as a fitness center or an in-ground pool, but do not have the money to afford them yourself - considering not just the installation costs, but also the maintenance costs, then renting may be the answer for you.
Many middle-scale to upscale apartment complexes include such luxuries without any additional charge to tenants. Such luxury is likely to be unavailable even to condo owners, who would need to pay monthly fees for access to them.
Another significant financial benefit is that you, in comparison with homeowners, do not have to pay property taxes. The rate of tax varies from county to county, and is based on the estimated property value of the house and the amount of land, but can sometimes reach up to thousands of dollars annually, which can be a costly expense to some homeowners.
Lenders generally require renters to pay a security deposit, usually worth as much as a month's rent, when it comes to upfront costs. If the renter has not damaged any rental property, the deposit will likely be returned to them after they move out.
On the other hand, when it comes to purchasing a home with a mortgage, as most do, the initial down payment is likely to be around 20% of the property's value.
Of course, this also results in having equity in the home, meaning that the value of your house is likely to slowly increase as a result of all your investment.
This increase in the value of your house can renters never experience, however, if you do not have money for a down payment, you are likely to be, at least for now, better off renting.
One of the best things about renting is its financial security through consistent spending each month you simply know what your rent is going to be. What is more, the majority of landlords offer long-term tenancies.
This means that renters can also benefit from long-term consistency, with costs being pre-planned and maintained at the same level for the whole duration of the tenancy.
This is likely to have a very positive impact on your budgeting each month you will have a fixed cost of rent, and the rest of your disposable income can be planned to suit the rest of your lifestyle. Homeowners on the other hand do not benefit from this security.
Whilst the mortgage rate stays the same each month, and so does the service charge if you live in a block of flats, unexpected charges are simply just part and parcel of owning your own home.
The maintenance costs will vary, depending on what is broken, and are almost an endless list of possible additional costs, such as:
All these would be covered under your rental contract, but when you have your own place, it is all on you. So, in this case, really take into account the disposable income you have and whether it would not be more beneficial to have all such unexpected costs covered.
Key Insight: The top financial benefits of renting are access to amenities, no down payments on a house, and a clearer insight on your monthly costs-which relates to a simpler way to budget.
Now that we've covered all the financial benefits, let us explore the ones that cannot be paid for. And amongst these is first in line flexibility, which is simply unmatchable by owning a home.
Most rental contracts are around 12 months long, which means that if you want, you could change a home every year.
This provides unmeasurable freedom you can explore new parts of the city, the country, or move abroad! Additionally, you can experiment with different apartment layouts, decorations, and price points to find the best choice for you.
Not to mention, you will not be weighed down by mortgage payments and can hand out your notice almost any time, depending on the contract type.
This a point that adds to the access to amenities. Essentially, renting has the possibility of giving you a home of a better quality than you could afford to buy.
Let us illustrate by an example. If a person with an annual household income of $80,000, which is double the average salary in America, wanted to find an apartment in Brooklyn, New York, he would generally struggle to find any place he could buy which was liveable.
If he was renting, however, he could afford a large apartment of a high standard, possibly even with luxuries in the building, such as an in-ground pool or a fitness center.
Therefore, if the quality is what you are searching for, renting may just be the right option for you.
Additionally, renting allows you to live in more sought-after places than buying would likely do. Let us stick to the London example. Take for example Benthal Green, an area of London within walking distance of East London's iconic Brick Lane or the vibrant Shoreditch, and only minutes away from Oxford Street by subway long story short an incredibly popular near-center area.
If you wanted to buy a home there, the average price fluctuates at about £536,000, which is at least to most far too expensive (unless you have £110k sat in your bank for a deposit of course). Renters do not have the same price barriers. Average rents in Bethnal Green are at about £1,900/month, a significantly lower price in comparison.
This price difference opens doors for a whole new range of residents, who can now afford to live in a popular London area they might have not otherwise.
Buying a home is an investment, and as with all other investments, it carries risk attached.
When your home is rented, you do not need to worry about the market crashing and putting you underwater on your home.
Or that you will have to pay a costly home repair which will wipe out your whole savings account, not to mention not having to worry about whether your home is gaining or losing in value, in case you will be selling it later.
The biggest risk of renting is usually just how happy you will end up being with the home you chose, and that is a risk most of us are willing to make.
Key Insight: The non-financial benefits can be as simple as peace of mind, being that there is less risk attached than owning the property. Also. depending on your income--renting enables you to be in a more desirable location.
Small things such as chipping paint or yellowing grass are obviously far from being the end of the world. However, admittedly, they can still ruin your day, and as they pile up with time can actually make house owning a big responsibility.
When you are just renting your place, you do not have to think twice about any of these.
So, if your chosen Sunday plans involve hanging out with your friends or reading with a glass of wine, rather than climbing up a ladder and clearing leaves out the gutter, then renting may just be the better option for you.
