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Real Estate Investment - Beware the Expenses!

Jul 31, 2008
Anyone who knows me is aware that I am a huge advocate of real estate investing. I firmly believe that when done responsibly, real estate investing is one of the single greatest drivers for wealth available to anyone. The key is responsible investing! That means you don't use those nasty little things called ARMs, you do your due diligence and you certainly don't buy past (or even at!) your means. But all of that stuff is for another article. What I want to talk about today are those real estate investment costs that you must make sure you account for before purchasing any property!

1. The Mortgage Payment: I am sure you already know what this is, so I won't insult your intelligence by explaining it to you. But I will reiterate a point I made above - Just because you can afford a certain mortgage payment does not mean that you should. It makes a lot more sense to find a house that is a little less expensive than what you can afford and put the money you save into another investment. I guarantee that you will be able to find a house for just a little bit less, that you will like as much as the more expensive one you are looking at.

2. Taxes, Taxes, Taxes: Do not underestimate your taxes. If you are serious about buying the house and have a pretty good idea about what you will end up paying for the property then approximating your monthly tax expense is not difficult at all. Determine what the tax rate is for the area you will be purchasing the property in and multiply that rate times the approximate purchase price of the house. For a house valued at $200,000 with a 1% tax rate you simply take .01 x $200,000 = $2,000. Then to determine what that comes out to per month you just divide $2,000 / 12 which equals $166.66 per month. That wasn't too hard now was it? For my investments I like to establish a range based upon my best case and worst case scenarios for what the purchase price might be. For instance if I believe that I will be able to purchase the house for a price between $190,000 (best case) and 210,000 (worst case) then I would calculate my taxes for both of those scenarios.

3. Vacancy Allowance: If you are planning on turning this property into a rental, you better factor a vacancy allowance into your calculations. That is, for how many months in a given year do you expect your rental property to be vacant? This number can be difficult to determine because it can fluctuate dramatically depending on the area you are located in, if you happen to know people in the area who manage rental properties ask them what their vacancy allowance is for the area. If not, a 5% - 10% allowance is a good rule of thumb. Personally I hate taking random estimates, I will if I have to, but I prefer to see if I can find some local property managers willing to share their experience with me.

4. Insurance: This expense is another no brainer. The big thing you want to check here is to make sure that you are not under-insuring the property. Yes getting less insurance than is necessary will save you some money monthly, but if tragedy strikes and you need to rebuild the home, you will never forgive yourself for not purchasing adequate insurance. Do not take the risk of under-insuring your property, it's just not worth it.

5. Maintenance and Repairs: Homes, just like anything else must be maintained and occasionally repaired. The plumbing might need some work, a leak might spring in the roof, or you accidently kick a hole in the wall. Not to mention that the grass out front will not cut itself. Figure about a 10% allowance for this basic upkeep expense. This number can fluctuate pretty wildly depending on how old the house is. My sister for example owns a home that was built in 1911. Repairs are much more likely to be necessary in that house than in a newer home.

6. Utilities: If you are going to live in this house then this is an obvious expense you need to account for. If it is going to be a rental you need to determine what you will pay for and what the renter will pay for. In my area the renter pays virtually all of their own utilities, but in some areas the property owner covers a lot more. This is something that you will have to determine for yourself in order to stay competitive.

7. Bad or Uncollectable Debt: If you are going to be living in the home this number does not concern you. But if you will be renting it out you should consider that there may be times when your renters will skip out on you. This allowance can be tricky to determine, it depends strongly on the area and type of renter your property will attract. I allow a lower allowance for single houses compared to what I allow for multi-resident properties (apartments, multi-plex properties, etc.) A good rule of thumb is set an allowance of 5% based upon the annual income of the property. Overtime you will be able to adjust this number to reflect the economic reality of the area you are invested in.

Remember just because a property looks like a good investment, it can quickly turn sour if you have not done the proper research and taken the time to calculate all of your real and potential expenses into the equation. You will find many circumstances where an investment that originally looked good is not that good after all. More importantly, all of these expenses are negotiation points! Use these various factors to drive the price of the property down to an even more favorable place.
About the Author
Joshua Niemeyer is the publisher of IncentiveSearch.com, he writes about a wide variety of topics including business development, marketing, investing, finance, web development and more.
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