Both words “passive” and “income” strike a warm and inviting chord as many real estate investors would attest. The idea of letting a tenant pay the mortgage and simultaneously produce income for the landlord feels like a good equation. One newly minted property owner enjoying an after-expense cash flow of $500 per month on one property reasoned that owning ten homes of similar value would allow her to leave her $60,000-a-year office job and not take an income hit. On paper it seemed to add up, but on closer inspection, not so much.
Positive cash flow is far better than breaking even or renting at a loss, but the delta between the mortgage due and the rent received should not be construed as “income.”
Consider the obvious deductions:
• Unless you have the time and ability to be an on-call maintenance person, or the one who advertises the property, conducts background checks, and collects the rent, you may use a management company to do these things. Expect to pay 8 to 12% of the monthly rent.i
• Homeowners’ Associations (HOAs) exact their dues. Investopedia contends for a $200-a-month average. In resort areas and based on amenities, the fees can be much higher.ii
• Professional cleaning companies are especially essential to vacation rentals. They dust the furniture, empty and clean refrigerators and stoves, wash and change linens, mop, and vacuum floors, replace light bulbs and paper products, etc. The cost varies for services rendered. For year-round rentals, similar companies do “deep cleans,” and may also paint, shampoo, or replace carpeting, etc. (For non-vacation rentals, a portion of the monthly cash flow must be devoted to making the unit tenant-ready after an occupant vacates).
• And then there are unpredictable expenses, such as repairs to the plumbing, electrical, A/C, furnaces, hot water heaters, garbage disposals. Some of these may even require full replacement. The same holds true for parking lots, driveways, sidewalks, and roofs, as well as lawn care, exterior painting, and pool repair.
All of the above underscore the importance of devoting much of the positive cash flow to a robust reserve fund.iii
Now, is it safe to consider the rest of the money as “income?” Not so fast. The landlord must plan for those days or weeks when a unit is bereft of tenants or for the tenant who
i Kilcrease, April. What Do Property Managers Charge? Roofstalk, April 8, 2021
ii Chen, James. Homeowner Association Fees, Investopedia, April 27, 2021.
ii Mallison, Kate. How Much Cash Does a Landlord Need for a Reserve Fund? Tellus. August 28, 2019
needs to be evicted. In either case, the landlord bears all the expense with reduced income, coupled with attendant legal fees for the eviction process.
These remarks are not intended to dissuade an investor from buying rental properties. Not at all. They are intended as a caution to those tempted to conflate cash flow with income.
Randall E. Davey, CAP® is a financial advisor with Guide Advisors, Inc. In certain circumstances, he may offer insurance as a sole proprietor or through Guide Advisors, Inc. He resides with his wife, Bonnie in Mesa, Arizona. Randall can be reached at firstname.lastname@example.org or by phone at 425.478.5668.
Insurance and advisory services are offered through Guide Advisors, Inc., a Registered Investment Advisor in the State of Washington and other jurisdictions in which it may conduct business. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any State other than the states listed above or where otherwise legally permitted. All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. The information contained in this material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed.
Guide Advisors, Inc. 19125 North Creek Parkway, Suite 120, Bothell, WA 98011 206.486.2477