I’ve been on my soap box lately, preaching that every man, woman and child should know the basics of rental property math.
Why? For a few reasons.
First, it’s simple math. We’re not talking calculus here, or even algebra. This is basic arithmetic!
It’s applicable, real-world, “affects pretty much everyone” stuff.
In Bellingham, WA, where we’re based, 54% of all households are investor-owned and renter-occupied. More than half the populace!
So if you’re a renter, you should know the economics of how your housing situation works.
And real estate — including investment property — is the largest asset class in the US… and in the world. In the United States, the total value of real estate is estimated to be north of $16,000,000,000,000 — the 16 trillion dollars!
(World-wide, all real estate is estimated to be worth $228,000,000,000,000).
That’s more than all the other asset classes (stocks, bonds, commodities, and cash — combined.)
So yeah, back to my point: You should know the basics of how the math works… why someone would want to own investment real estate that other people — tenants — pay to live in.
Let’s use a single family home as an example in our study. Bellingham’s most common home type is a 3-bedroom, 2-bath home of about 2000 square feet.
First, let’s look at the income that property produces in the form of rent payments from the tenant.
Our sample home is a nice home in a nice neighborhood, and we’re going to say that it rents for $2500/month — a very real number in many parts of Bellingham.
$2500 times 12 months equals $30,000 annually, so we’re going to say our “Gross Scheduled Income” is $30,000.
Now we’re going to look at the “operating expenses” — that’s the money it costs the investor to own the property, even though they don’t live there.
Operating expenses include all the various bills and payments made on behalf of the property — EXCEPT mortgage payments. These would be paid whether or not you paid cash or got a loan to buy the property.
Let’s list them out, and note that these are expenses paid by the investor / landlord:
With single family rentals in Bellingham, the tenant pays utilities (water, sewer, garbage, electricity, natural gas or propane, cable), and the tenant is typically responsible for taking care of the landscaping. So those are NOT operating expenses for the investor / landlord.
OK, if we add up those operating expenses above, we arrive at an annual total operating expense of $5600/year.
If we subtract that off our gross scheduled income of $30,000 we arrive at a total of $24,400. This is called our net operating income.
That’s how much pre-tax money you would put in the bank if you had paid cash for the house, or had paid off a previous mortgage in full.
But let’s assume you have a mortgage on the house… let’s do that math.
First, we’re going to say that our sample investment house has a price tag of $500,000.
To get a loan on an investment house, you’ll need a minimum 20% down payment, but for our example let’s use a 25% down payment, or $125,000.
So we’re going to borrow $375,000, and on that loan, because it’s a “non-owner occupied” house, the current interest rate is 4.5%.
The monthly payment on that loan is $1900… or $22,800/year.
So from our $24,400 “net operating income” we’re going to pay out $22,800 in mortgage payments, leaving us a “cash flow” of $1,600/year in year 1.
As long as you don’t have any surprises like replacing an appliance, a water heater, or a roof leak in that year, you’ll be profitable to the tune of $1,600 that first year.
In the next post… we’ll talk about the 4 other ways your rental house is (potentially) making you money, on top of that cash flow!