Tuesday, 27 November 2012

Investing in property: How much will you pay for non-interest expenses?

Recently a reader of this blog asked to me do a post on what the expenses associated with running an investment property were like.  This post will deal with that issue.

It will not, however deal with interest expenses.  Although this is the biggest expense associated with an investment property it is too hard to generalise about because it all depends on:

  • How much you pay for the property
  • What sort of gearing you use (i.e. a higher gearing will result in a higher interest cost)
  • The interest rate you are charged on the loan
  • How fast you pay the loan down
All of the above are not related to the property per se but rather with how you finance it and repay your loan.

While other charges will also typically be related to the individual property (e.g. the age of the property and the condition that it is in will determine what your maintenance expenses are) it is much easier to generalise about this and the costs associated with these.

When I discuss the costs below I will talk about them as a percentage of the rent I receive.  Note that this is only indicative and what I receive for my investment property and you should remember that every property will be slightly different.

Property management expenses (7% of gross rental)

This amount is a negotiated rate and includes GST.  I have posted before on how you can negotiate this rate with your agent down.  Note that this is the total amount that I paid to my agent - some people think they are paying a certain percentage but then end up getting stung on things like advertising, leasing and other miscellaneous fees.  

Paying between 5.5% and 8% is pretty standard for a property management fee.  If you are thinking about investing in property and are looking to add up all the expenses go down to your local real estate agent and find out what they charge.  It will always be a percentage of gross rent.

Maintenance expenses (~1%)

This will vary drastically from year to year. I have been pretty lucky, however and have had few issues.  This however was a function of the property I bought - I was willing to pay a little more for a property with few issues and then deal with all the relevant problems upfront before I leased it out.

In a previous post I recommend doing all the necessary maintenance up front and working out what can be left for later.  If you're thinking about how much maintenance expenses will cost you I would not assume something this low - I would choose a number more like 5% of gross income per annum. 

Rates and council fees (~9%)

As a landlord you will be paying the council rates as well as the water rates associated with the property (note that you do not pay for the water usage but rather the connection charges).  This will vary from property to property and from council to council.  My charges have been pretty steady at 9% so I feel confident using this number to forecast into the future.

If you are thinking about calculating this for yourself remember that your council fees are dependent on the value of your property.  If you are buying a high value, low yield property then this charge will be higher as a percentage of rent than if you bought a cheap, high yield property. 

Insurance (~4%)

Insurance costs me about 4% of my gross income.  The price you pay for this can vary greatly and it is always worth negotiating every time it comes up for renewal - I save hundreds of dollars by doing this every year.

I have done posts before on how to negotiate your home insurance and why it increases so much.  Modelling for 4% or 5% insurance costs is an appropriate number to use.

Total cash expenses (~21% of gross rent)

My total cash expenses for the last financial year came to 21% of my gross rent.  Note that this number is a 'run rate' type of percentage.  That is your expenses will typically be much higher in your first year of ownership because you are bringing the property up to scratch and have things like legal fees that increase your expenses

I should re-iterate that your interest cost will totally dominate your expense line.  However many people when thinking about property investment totally forget that there are a fair few expenses associated with running it and that you really only have 75% - 80% of your gross rent to help pay it.

Why didn't I include depreciation? 

You may have noticed that one of the big expense line items that I didn't include above was depreciation (which for me is ~20% of gross rent).  This is because it is a non cash expense - you do not pay anything when you claim it (however you receive the tax benefit of the deduction).  

The tax deduction component of depreciation could almost be considered in the income line because you do receive this money back from the government however I have been conservative and not included it.

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