Profiting From Real Estate Investments An Investor Newsletter From HomeVestors Of America, Inc. By Marcie Geffner / Vol. 2 No. 13 11/07/2007 Understanding Operating Costs One of the classic mistakes that novice real estate investors often make is the failure to properly anticipate and budget for operating costs. While rents may be sexier and more exciting than expenses, overlooked or unexpected costs can turn a profitable investment into a money-loser. That's why it's important to anticipate and plan for costs ahead of time: Every dollar saved is another dollar that can drop to the bottom line. A helpful tool to get started is a simple operating budget that might include: Fixed expenses that occur every month such as interest, association dues, management fees, maintenance, yard work and utilities Variable expenses that occur periodically such as minor repairs, legal fees, and advertising and refurbishment after a tenant vacates the property Predictable quarterly or annual expenses such as insurance premiums and property taxes, and Contingency funds for unanticipated cost increases, major repairs or lengthy vacancies. Expenses that will be paid for in bulk should be allocated in the budget to the individual properties so that costs are associated with rents. For example, suppose an investor who owns 10 rental houses plans to make quarterly trips to a warehouse store to purchase cleaning, maintenance and yard supplies. Rather than budgeting those expenses to just one property, the total cost should be divided equally, or on some other appropriate basis, and budgeted for each property where those supplies will be used. A similar method can be used to budget insurance premiums, property taxes and other costs that may be paid quarterly, semi-annually or annually. Divide the annual total by 12 months and the number of properties to figure out how much should be budgeted for each property each month. Like many aspects of property management, a good operating budget is both an art and a science. It's important to use hard numbers, yet also be flexible enough to accommodate inflation, cost increases or unexpected events that may push costs higher. Foolish investors budget for best-case scenarios and then hope and pray that nothing goes wrong. Smart investors budget for reasonable realistic expectations or even worst-case scenarios and are then prepared for whatever happens. High tenant turnover and lengthy vacancies can be among the most costly expenses of rental property ownership. That's why careful selection of responsible tenants is key to controlling operating costs. It's sometimes more profitable in the long run to tolerate a few extra weeks of vacancy costs upfront in order to secure a good tenant than it is to accept a marginal tenant to gain a few extra weeks of rent payments. If good tenants are scarce, higher advertising costs should be incorporated into the operating budget. A good resource for more information about operating costs is IRS Publication 527: Residential Rental Property. This publication explains rental income and expenses, including depreciation, and contains a handy list of the types of expenses that may be deducted on federal income tax returns. Copyright 2007. Marcie Geffner. All rights reserved. No part of this article may be used or reproduced in any manner whatsoever without written permission of the author. COMING NEXT ISSUE: How to buy short-sale properties. The Investor e-Newsletter is provided free by HomeVestors of America, Inc. Listen to the HomeVestors Real Estate Investors Hour each Sunday at 8 a.m. on WBAP Radio, click here to listen. HomeVestors of America HomeVestors®, the "We Buy Ugly Houses®" company, is now in 35 states and has more than 270 franchise offices. Learn more about owning a HomeVestors franchise by registering for our Webinar, held each Tuesday at 4 pm CST. Register at www.homevestors.com, or at this link: http://www.homevestors.com/fran_info_events.php If you have a question, comment, or an idea for our newsletter, please click here. <back | printable version