Choosing where to spend money on your rental property can make or break your investment. Whether you are managing the property yourself or using a property manager, you should have the tools to make sure your property value grows year after year.
Unfortunately, there is no perfect formula to determine exactly how much money you should spend on your rental. We will give you a few tried and true industry standards for estimating what your budget should be, but the real key to investment success is to understand your rental market, so you know which things will lower costs or raise your property value over time.
HOW MUCH SHOULD I BUDGET?
There is no perfect way to estimate what your costs will be. Everything from the age of the house, to the people renting it from you, can have a drastic effect on these numbers. You may have a whole year where your largest repair cost is a few hundred dollar toilet, only to have to replace a $20,000 foundation the next year. As a starting point, there are a few industry-standard methods of estimating what your budget should be so that you can at least get in the ballpark.
Here are some common approaches:
- 1% of the property value – For example, a $500,000 property would budget $5,000 annually.
- 1.5 Times the Rent – For example, a unit renting for $2,000 per month would budget $3,000.
- $1 per square foot – For example, a 1,500 square foot property would budget $1,500 per month. If you are in a pricier area like San Diego, you may want to budget closer to $2 per square foot.
After you choose your base budget, make sure you inspect any big-ticket items that may need to be replaced soon, such as roofs, foundations, floors, appliances, electrical, or plumbing. If any of these things are getting older, plan for them in your budget now, so you won’t be shocked by the costs in a few years.
WHERE DOES THE MONEY GO?
No matter how you land on a budget, you will most likely be frustrated by just how much it costs to maintain a rental property. So where exactly does all that money go?
Planned Maintenance – Depending on the type of property you own, you will need to dedicate money to maintaining landscapes and common areas, cleaning gutters, maintaining appliances, and whatever else is needed just to keep things in tip-top shape.
Emergency Maintenance – No matter how well you maintain things there will always be unexpected calls from tenants. These won’t always be costs you are responsible for. For example, if a toilet clogs because a toddler flushed his family of sock puppets down the toilet, then you can bill it to the tenant. However if it clogs because roots grew into the drains, then be ready to foot the bill. One way or another, you should always plan for things to go wrong.
Replacement Costs – Deciding when to update your units, and when to let them ride a little longer, is one of the trickiest decisions in the business. Patching a 20-year-old roof may save you money this year, but it could cost you thousands next year when the tenant doesn’t mention the new colony of microorganisms that have been setting up camp on the living room ceiling. If there is a universal truth for every property, it’s that everything gets old. Make sure you or your property manager keeps an inventory of which things will need to be replaced soon, and budget early.
WHAT IS WORTH SPENDING MONEY ON?
Here is the biggest question of the day. When should I fix something, when should I replace something, and when should I just leave it alone?
In some ways, this is more of an art than a science. It takes a keen eye and a lot of experience to know which things are worth spending money on. There are two major categories for these decisions, and they are both handled slightly different.
- Will it cost me more money in the long run?
If anyone knew that replacing a five-dollar toilet valve today would save them thousands of dollars tomorrow, they would do it in a heartbeat. These are the types of decisions that have to be made all the time as a property manager, and simply put, they take experience. You will never get them right 100% of the time, but knowing which things to look for can save you loads of money in the future. If you are going to go it alone, make sure you have relationships with reliable technicians that can help you understand when it’s time to spend the money. - Will it make me more money in the long run?
If you are like me, this is the fun part of an investment property. Which investments will maximize the value of your unit? A savvy investor can make thousands more each year by making the right choices.
Slow down, do the math, and avoid emotional decisions. It may seem like a daunting task to spend tens of thousands of dollars updating your rental, but if it allows you to raise the rent by even a few hundred dollars, then you can recoup those costs quickly.
The first step is to understand your local market and work on things that people in your area actually care about. Find similar homes close by that rent for more than yours, and try to figure out why. Once you have your list, sit down and calculate if the cost of improvements is more or less than the added value over the life of the investment.
Knowing where to invest in your property is part science, part experience, and a touch of luck. Make sure you have experienced advisors around you that can help you avoid huge emergency costs, and get to know your local market. Knowing which things add value in your area will keep you from wasting money on things that will never pay you back.
No matter what, your investments won’t pay off overnight. But if you plan carefully for the future, you can see huge returns on the value of your property value over time.
Choosing where to spend money on your rental property can make or break your investment. Whether you are managing the property yourself or using a property manager, you should have the tools to make sure your property value grows year after year.
Unfortunately, there is no perfect formula to determine exactly how much money you should spend on your rental. We will lay out a few tried and true industry standards for estimating what your budget should be, but the real key to investment success is to understand your rental market, so you know which things will lower costs or raise your property value over time.
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