Rental Income & Expenses
In short, rental income is the rent a landlord gets from his or her tenants. However, there is far more that goes into it. If you were wondering what are the factors which help determine how much the landlord charges his or her tenants, and what are the costs included in the rate, then keep on reading. We will break down what is rental income and the costs that go into determining rental rates.
What Costs Are Factored Into Rental Income?
As described already, rental income refers to the amount of rent a landlord receives from their tenants. This includes not only charges for the space rented, but also for the use of any furniture (furnished rentals) and charges for any additional services the landlord may provide. These can include:
- Cleaning of communal areas
- Hot water
- Repairs to the property
Rental income can vary for each landlord and each property they rent out. There are variations in services provided, each property varies in size, some locations are hotter than others, and so on.
Determining the Rate of Rental Income
Determining what rental rate should be charged can be difficult. To remain attractive, the rate of the rental property cannot be too high. Also, for the landlord to remain profitable all the costs, both fixed and variable, need to be taken into account. So, what goes into calculating a competitive rental rate?
The Current Property Value
The first thing to consider-- is the current value of the rental property. The current property value is not the same price that it was initially purchased. Due to inflation and the rise and fall of market prices, the current value is adjusted to match the current market conditions.
There are online home estimators, such as Redfin or Zillow's "Zestimates", which can calculate an estimate of the current value of the house. However, hiring a professional appraiser will result in a more accurate price.
While an online platform is easier to use, it will only focus on the past value of the property and, admittedly, a few other factors. On the other hand, a professional appraiser will also focus on all upgrades and changes done since the sale of the house.
Therefore, if the house has been renovated since its purchase, whether from the outside or from the inside, it might be a good idea to invest in a professional appraiser. Understanding the property’s value will help determine the rental rate, as the landlord can get an idea of the worth of the home in comparison with other rental properties in the area.
Look at Comparable Rentals in Your Area
Start by doing your due diligence by looking at the available rental properties in the same area as you.
Analyzing the rent rate of these properties can be one of the best tools to help estimate the ideal rental rate. However, it is crucial that those properties truly are similar – after all, a different rent rate will be charged for a one-bedroom apartment than for a whole one-family unit.
When comparing rents and developing your own comparable rent report here are some generic steps to take:
- Browse other rental properties in your area on Craigslist, Onerent, Zillow, and other available listing sites.
- Find the rentals that are similar in size, number of beds/baths, and amenities. Please Note: If your property has modern upgrades or has been newly remodeled, this may be a good reason to increase the price.
- A good rule of thumb is to create a list of 5-8 comparables within your area. Write down the highest and lowest rents on your list and calculate the median rental price.
- Determine what your pricing strategy is going to be. Will it be aggressive – higher rates, at market rates, or conservative – lower rates?
Tip: When creating a comparable rental property report--the more data the better. This means compare at least 5 relevant properties.
The 1% Rule
Property investors frequently reference the 1% rule before purchasing a property to rent out. Essentially it states that a landlord should charge 1% of the price of the property as the baseline rental rate. For example, if the rental property is worth $250,000, the monthly base rent should be $2,500.
The Demand for Rental Property
The demand for a rental property in the area is another important factor. In order to get a good idea of what the demand is for your rental property you would have to look at:
- The number of listings in your area. If the market is oversaturated then demand will generally be lower as competition will lower the prices. Whereas, if your rental only has a few competitors then it is fair to assume there will be more demand.
- Demographics is another factor to consider. This would be made up of population data such as gender, age, general migration patterns, disposable income, and growth of population. The demographic profile of a real estate market can help you understand not only the general rental demand but also the specific types of properties with the most demand. For example, in a market where there is a high number of millennials, there would be a higher demand for rental properties. Millennials prefer to rent over buying properties.
- Price to Rent Ratio shows which is more affordable, renting or buying, in a specific area. A high price to rent ratio would mean that buying a home would be more expensive than just renting a home. This would indicate that there are more renters in the area and that the rental demand would be higher.
- The job market will have an influence on rental demand. If there are new job opportunities in your area the demand for rentals generally goes up.
- Tourism has a strong effect on short-term rental demands like AirBnB's.
Rent Rates and Seasons
Something to also consider when deciding the rental rate is the current season.
While the spring and summer often attract more tourists and students searching for apartments for their upcoming academic year, increasing the demand for rental property, fall and winter tend to be calmer, often with vacancies, unless the rental property is in a winter tourist destination such as in the mountains.
Therefore, it may be a good idea to research the rent rate variations within the year, and change or tweak the price accordingly.
Key Insight: Depending on where you live geographically speaking fair market rental rates will fluctuate. This is particularly strong in short-term rentals such as AirBnB's.
The Effect of Rent Control Laws
The next factor to consider, and this is applicable only to a few of the US states, are rent control laws. In a few states in the US, there are laws controlling how much a landlord can charge for their rent and by how much this rate can be changed per year.
Further, in the states which employ such laws (set locally by the city or town), it is crucial to research the particular location in question. The rental control states include:
- New Jersey
- New York
- Washington, D.C.
Next, it is essential to estimate an approximate maintenance cost figure. The maintenance cost will be subtracted from the rental income received, together with taxes and other costs (such as Homeowners Association Fees, mortgage costs). Maintenance costs will determine the profitability of your rental.
Tip: It is best to look at your maintenance costs over a longer period such as a year. This will give you more of an accurate figure because you can average the costs out per month.
While we have already talked about the costs of renting property, one thing we have not mentioned and which absolutely needs to be taken into account is the cost of vacancy. Generally, your rental property will never be 100% occupied.
Whether this is merely for a week before another tenant moves in, or for a longer period of time due to a lack of demand, vacancy is unavoidable. The landlord needs to make sure that they can maintain the property absent any tenants, without incoming cash and solely from his or her own savings.
As such, it is good to charge a rate that, when it comes to it, will allow the landlord to cover the costs of their property without making any rental income.
Estimating the Cost Figure: How Much of the Rental Income Will Be Spent?
Now that we have established the factors which come into play when estimating the rental income figure, we must also talk about one of the factors mentioned – namely, the overall costs.
Only after this sum is subtracted, and the number of tenants paying rental income is taken into account, will the landlord actually know their profits - i.e., how much they have made. So, what costs does the landlord have to take into account?
Essentially, the costs can be put into four main categories:
- Costs allocated to protecting the property itself (security)
- Costs maintaining the habitability of the property
- Costs that arise as a result of owning the property
- Taxes and any additional fees which have to be paid
The Costs of Security
While maintaining good customer service should be a priority to the landlord, protecting the property itself is as important.
Whether this means installing a camera system to help against possible intruders who might vandalize the property or getting a full alarm system, a proper security system will definitely take some money from your budget. Security is very important when it comes to your property.
Taking Care of the Tenants and Property
This is likely where a large sum of the budget will go. Maintaining your property and keeping your tenants safe and happy has many facets.
First and foremost, taking care of their safety, through installing carbon monoxide and smoke detectors, investing in proper lighting, fencing of the property, installing window guards if necessary (for child protection), properly securing the handrails in the apartment stairwell (or homes front steps), and so on.
Connected with this is maintaining a clean environment, from hiring cleaners to taking care of the common areas, keeping the property mold-free, to considering pest control to eliminate rats, roaches, and other pests which may threaten the tenants’ safety.
Perhaps the most obvious step is to take care of any possible repairs which might be needed within the apartment. From addressing issues such as:
- The building structure of the home from the foundation to the roofing and walls
- Maintaining working windows
- HVAC systems
- Fixing a dishwasher
- Changing lightbulbs
It is essential to always have enough savings to take care of any sudden issues which may arise as a result of owning a home, in order to always maintain a comfortable and high-quality stay for the tenants.
Key Insight: A new roof can average $7,000 to $20,000. So it is good to keep up with roof maintenance and get your roof inspected every 3-5 years.
The Costs of Owning the Property
This might include expenses such as paying the mortgage, the utilities (such as water, sewage, gas, and others), and landlord insurance.
Essentially, there are costs that have to be paid solely as a virtue of owning the property, and they can often involve large sums of money – therefore, it is crucial to be careful and always consider how much will have to be paid each month.
Tax Rates and Any Additional Legal Costs
Next, the landlord must consider the amount of tax that will be subtracted from their income. While rental property taxes can be a little more complicated than your typical income taxes, they still need to be understood and taken care of.
Although this article will not go into all the nitty-gritty of rental income tax, in short, it is important to know that rental income, as almost all other income, is taxed by the government.
However, another important thing to keep in mind is that, unlike most ordinary income, rental income provides a vast variety of deductibles that can be extrapolated from the income. These tax deductions include:
- Costs of cleaning and maintaining the property
- Advertisement costs
- Landlord insurance premiums
- The property manager fees
- Services such as utilities
- Property taxes
- Legal and other business fees related to the ownership of the property
Further, rental property income allows for a very specific tax deduction - the “depreciation expense.” This occurs as a result of buying and improving a property over its “useful life” (the estimated number of years the asset is likely to remain in service – for a residential rental property this is 27.5 years and for a commercial one it is 39 years).
Unlike other income, real estate has a useful life span longer than a year, and therefore the rental property tax is also deducted in this way – meaning that ultimately the amount of tax paid can be significantly decreased.
For example, after buying a residential rental property, the cost of acquiring the property (subtracted by the value of the land) can be divided by 27.5 (or its reasonable lifespan) to determine the depreciation deduction per year (in addition to other deductibles, as previously mentioned).
Key Insight: If you are entering tax season for the first time as a landlord, hire an experienced accountant. They will be able to make sure you are getting the most out of your eligible deductions while keeping you from making earnest mistakes.
Additionally, any extra legal costs associated with the property are included in this category. These can involve costs such as the Homeowners Association Fee (HOA) and others.
As the HOA fee is the most typical, we will briefly outline its purpose. The Homeowners Association Fee is a monthly fee that must be paid by landlords owning certain residential properties (mostly condominiums, but sometimes also single-family homes in certain areas). The HOA in turn collects these fees and creates a fund that can help with the maintenance and improvement of the properties included within the association.
The funds typically cover costs of maintaining common areas (such as lobbies or elevators), and in many cases also the costs of some utilities (such as water).
Understanding Rental Income – An Overview
In conclusion, rental income is the rent a landlord gets from his or her tenants. The rent is usually set by the landlord themselves based on various factors such as demand, location, season, the value of the property, and others, although some states have regulations preventing the landlord from setting the rental rate too high.
When determining the rent rate, the landlord also has to consider the costs of maintaining the property and keeping the tenants satisfied, so that when these are subtracted, the landlord can still receive a profit from his or her work.
What is rental income?
A payment that you would receive for the use or occupation of a property you own.
What is considered rental income for tax purposes?
The abbreviated answer is that rental income is generally taxed as ordinary income. If you are in the 24% marginal tax bracket and have $8,000 in rental income to report, you will pay $1,920.
How will the IRS know if you have rental income?
If you have any unreported earned rental income, the IRS can find out through a tax audit. After all, the goal of tax audits is to confirm that income was reported correctly.
What costs are factored in rental income?
Fixed expenses include:
- Heating/Natural Gas
- Property Taxes
- HOA Fees
How Much Do Landlords Make?
The answer is it depends! As a landlord your pay will be based on how many rentals you have, the type of rentals, and the location of your rentals. There is no cap for how much you can make as a landlord!
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