Credit: jen on flickr
A while back, in my first Becoming an Accidental Landlord post, I laid out the very basics of how the math of owning a rental house has worked for me. Since my wife and I are starting to think about buying a second house to rent out, it seemed like a good time to follow up with a more detailed look at the numbers behind making this work.
Doing the math
If it doesn’t cash flow, we don’t want it. The reason to own rental property is for it to return a profit to you. If it’s not going to do that, I’ll leave my money in the stock market (even if it is all over the place right now). I’ve seen some arguemnts by people who are willing to own houses that don’t have positive cash flow, thinking that the house will appreciate in value, and they’ll make huge profits when they eventually sell the house. That’s not the game I want to play. I want the house to be putting money in my pocket every month (well, on average anyway).
So when you’re looking at a potential house to buy, you need to be confident that it will be profitable to rent out. The biggest numbers in the equation are obviously: 1) how much will the mortgage payment be? and 2) how much will it rent for?
To get in the ballpark on the first question, you can use a lot of the online real estate sites like Zillow. If you know house price and interest rate, you can get a pretty good guess on what your monthly payment will be. To estimate the second answer, you can do the same thing: sites like Zillow or trulia will give you an estimate of local rental prices. If Rent In is more than Mortgage Out , you’re in the right ballpark, and you can proceed to get better estimates for both of those numbers. If you aren’t at a positive number now, it’s time to look for a different house, or maybe a different area, because the numbers aren’t going to improve once we start adding in all the extras.
So let’s refine the numbers. You can call your bank and pre-qualify for a loan. They’ll be able to give you an estimate of your monthly payment based on your actual credit score and current interest rates. You also need to factor in taxes, whether you let the mortgage holder pay them (my preference) or you pay them yourself.
To refine the rental number, you need real local information. Zillow estimates are probably very good on average across the nation. But what really matters is what similar houses are renting for in THAT neighborhood. For this, I ask my rental agent. My rental agent is going to handle a lot of the day-to-day details of the house once I buy it. She finds the tenants, runs background checks, writes the rental contract, collects the rent, and sends it to me. And since she does this all day long, all over town, she knows what houses are renting for better than anyone else. Of course, all this comes at a cost. The typical rental agents I’ve seen charge 10% of the rent payment each month. Some also charge an additional fee of 1 monthly payment per year, and some don’t. Obviously this has to be factored into your cash flow equation. Some people prefer to handle all this themselves, and keep that money. Since our goal is passive income, the less of the daily details I need to chase down, the better. Our agent has done a fantastic job of getting quality tenants, and I’m happy to pay for that.
So we’ve got got a good handle on the 2 biggest numbers in the equation. Coming up next we’ll look at the smaller numbers that can sneak up on you and bite you in the butt.