Understanding Fixed Expenses in Rental Properties

By Scott A. Stanfield

The expense categories outlined in the first article of this series can be broadly categorized into fixed and variable expenses. Fixed expenses are consistent and predictable costs that remain unchanged, making them straightforward. On the other hand, variable expenses are less predictable and fluctuate, directly impacting the operations of your business.

Key Fixed Expense for Rental Properties

Fixed expenses for rental properties include:

Mortgage Interest: This refers to the interest component of your loan payments for purchasing the rental property, representing a significant portion of monthly mortgage payments in the loan’s early years.

Property Tax: Annual taxes levied by local governments based on the assessed value of your property. Reassessments can lead to tax bill adjustments. This process can occur on a regular schedule, such as annually or every few years, or it may be triggered by specific events, such as significant improvements to the property, a change in ownership, or substantial shifts in the local real estate market. The outcome of a reassessment can lead to an increase, decrease, or no change in the property tax bill.

Property Insurance: Covers financial losses related to property damage or destruction. Premiums can vary widely, typically seeing average annual increases of 3% to 5%, with higher risks areas experiencing greater increases.

Property Management Fee: A fee for day-to-day property operations management, typically 8 to 10% of the rent collected.

Home Owner’s Association fees (HOAs): Monthly or annual fees for community maintenance and amenities.

Business Plan Considerations

While fixed in the short term, expenses like mortgage interest decrease each month and property taxes will fluctuate over time. However, their predictability for extended periods facilitates easy inclusion in budgeting. This predictability enhances our ability to efficiently evaluate potential property purchases, giving us a competitive edge. For efficient property evaluation, I recommend using a purchase calculator, like the one available on my website in the startup kit.

- Property Tax Nuances: Property taxes can significantly impact your financial projections. If the purchase price is substantially higher than the previous assessed value, expect an increase in taxes. Adjust your financial forecast to account for this potential increase. Note: Forgetting to budget the property tax expense based on the purchase price can result in a profitable property losing money every month.
- Anticipating Reassessment: During periods of significant property appreciation, anticipate a reassessment that could increase your taxes. You have the option to contest these assessments. My approach is to use the sales prices of comparable properties as evidence. I select three properties picked specifically to help assemble a compelling case for a lower assessment.
- Choosing the Right Property Insurance: Work with an independent insurance broker to ensure you receive the best coverage at the lowest cost. Annual reviews can help adjust coverage to meet your changing needs while controlling costs. Utilizing the services of a good insurance broker can save you money. It can also save you considerable time because a broker can handle notifying your lenders of the changes.

Conclusion

The criteria and strategies discussed here aim to minimize fixed expenses and maximize the profitability of your turnkey rental business. By incorporating these considerations into your business plan, including the use of efficient tools like a purchase calculator and understanding the intricacies of property tax and insurance, you can enhance your business’s financial performance.

Thanks for reading,

-Scott