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How to More Accurately Estimate Rental Property Expenses

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by Jeff Rohde, posted in Investment Strategy

While some investors do a pretty good job of calculating the potential rental income from a property, others underestimate the cost of owning a rental property. When costs are consistently higher than expected, cash flow and returns are lower.

In this article, we’ll cover the common expenses of owning a rental property, explain how to estimate rental property expenses, and how to compare pro forma to actual income and expenses for a rental property.

Key Takeaways

  • Main expense categories for a rental property include acquisition expenses, leasing expenses, operating expenses, and discretionary owner expenses.
  • Three steps to estimating rental property expenses are determining potential expenses, creating a pro forma list of expenses, and developing a budget.
  • The 1% Rule and 50% Rule are used by investors to estimate income and expenses from a rental property.


What Are Typical Expenses for a Rental Property?

Before investing in a rental property it’s important to identify all of the potential costs of owning and operating a rental property. These are the typical expenses for a rental property that investors budget for:

Acquisition Expenses

These are common expenses incurred when a property is purchased. According to the IRS, some costs can be deducted the year that they are incurred, while other acquisition expenses to purchase a residential rental property must be added to the property cost basis and depreciated over a period of 27.5 years:

Deductible Expense

  • Interest
  • Mortgage points
  • Real estate taxes

Depreciation Expense

  • Home inspection fee
  • Abstract fees
  • Utility installation fees
  • Legal fees
  • Recording fees
  • Surveys
  • Transfer taxes
  • Title insurance
  • Seller costs assumed by the buyer (such as back property taxes, sales commissions, or outstanding repair bills) 

Leasing Expenses

Most online tenant screening services give the landlord the option of requiring the prospective tenant to pay any application and screening fees. Leasing fees are generally equal to one month rent, and many property management companies charge owners 50% or less of one month of rent to renew a lease.

Leasing expenses typically include:

  • Marketing costs such as yard signage or premium placement on rental listing websites.
  • Tenant screening expenses such as a credit report, criminal background check, and eviction history.
  • Leasing and renewal fees paid to a real estate agent or property manager.
  • Eviction fees including legal notices, court costs, or money spent on cash for keys in lieu of evicting a tenant.

Operating Expenses

Operating expenses are recurring costs for owning and operating a rental property. There are two ways to more accurately estimate these expenses in a rental property. 

First, an investor can ask the property manager for typical operating expenses. An investor can also refer to the seller’s income statement when buying a property that is already being used as a rental.

Later in this article we’ll discuss some “rules of thumb” that investors use to estimate operating expenses of a rental property when historical expenses are not available. 

Common operating expenses include:

  • Vacancy expense to account for lost rental income in between tenant turns (often based on a percentage of the gross potential income).
  • Property management monthly fees (usually range between 8% – 10% of the monthly rent collected), and some managers also charge an initial setup fee.
  • Repairs and maintenance to maintain the value of the rental property.
  • Capital expenses to improve the value of the rental property – such as installing new carpeting, appliances, or a roof – must be depreciated over a fixed period of time.
  • Landlord insurance.
  • Mortgage payment and interest expense.
  • Property taxes.
  • Legal fees (such as paying an attorney to review a lease agreement or court costs of an eviction).
  • HOA dues and fees.
  • Landscaping and pest control.
  • Utilities (items such as gas and water may be a landlord expense in small multifamily properties).
  • Sales or use tax license, and local business license where required.

Real estate investors can also claim an annual depreciation expense to recover the cost of a rental property and reduce pre-tax net income. 

For example, the value of a residential property (excluding the land value) can be depreciated over 27.5 years, while the costs of upgrades such as appliances and carpeting can be depreciated over 5 years.

IRS Publication 946 explains in detail how depreciation on a residential income property works.

Owner Expenses

One of the biggest benefits of owning a rental property is that investors may expense costs directly related to the property or the real estate business. Owners can deduct expenses even when a local property manager handles day-to-day details such as tenant communication and working with vendors.

Some typical owner expenses include:

  • Continuing education (such as attending a local investor’s club or becoming a member of the Roofstock Academy).
  • Dues and subscriptions for real estate publications and reports.
  • Home office deduction, including the simplified home office deduction offered by the IRS.
  • Annual registration fee for a limited liability company (LLC) formed to hold the rental property.
  • Office supplies such as pens, paper, and printer ink.
  • Professional fees paid to a tax advisor or real estate attorney.
  • Telephone or cell phone used specifically for business purposes.
  • Local travel expense to visit a rental property using the actual auto expense or the standard mileage rate deduction of 57.5 cents.
  • Remote travel to go to a rental property in another city or state, or to attend an out-of-town seminar or meeting.


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How to Estimate Rental Property Expenses

After identifying all of the possible one-time and recurring types of rental property expenses, the next step is to estimate the costs by following these three steps:

1. Determine Potential Rental Property Expenses

While it can be tempting to ‘“ball park” the estimated expenses of owning a rental property, having accurate numbers can help to reduce the risk of making the wrong investment decision. 

Some of the ways investors determine potential rental property expenses include:

  • Contact an investor-friendly real estate agent

Unlike most agents who help people buy and sell a primary residence on the MLS, an investor-friendly real estate agent understands what real estate investors are looking for. 

They understand financial performance metrics such as ROI and cash on cash return, and may be able to share the details of recent deals that they have worked on, including what the operating expenses of a rental property in the local market really are.  

  • Speak with local property management companies

Another good way to estimate rental property expenses is by speaking with several local property management companies.

Select property managers who have a portfolio of rental properties similar to the one being considered for purchase, such as a single-family rental home or small multifamily building. That’s because expenses may vary based on the type of rental property. 

For example, owners of multifamily property sometimes pay for utilities such as water or gas that are master metered, then pass the expense through to the tenants as additional rent. On the other hand, tenants in single-family rental homes usually pay for their utilities directly, which can help to keep rental property expenses on a house lower.

  • Network with other rental property investors

Asking other landlords how they estimate rental property expenses can provide observations that a beginning real estate investor may not have thought of.

While some real estate agents and property managers may tell an investor what they want to hear in order to get a new client, most fellow investors are more than willing to help a newcomer out by sharing real-life experiences.

2. Create a Pro Forma List of Expenses

The second step in estimating rental property expenses is to create a list of the one-time and recurring expenses along with the estimated costs

Common rental property expenses include:

  • Acquisition costs, such as mortgage down payment, closing costs, and inspection fees.
  • Marketing, tenant screening, and leasing fees.
  • Recurring operating expenses like property management, repairs and maintenance, mortgage payment and interest, landlord insurance, property taxes, and HOA fees.
  • Variable expenses such as vacancy costs when the property is between tenants and capital repairs such as the future installation of a new air conditioning system or replacing the carpet.

3. Develop a Budget

The third step in estimating rental property expenses is to develop a pro forma budget to help determine if the property will generate a positive return. 

A basic monthly pro forma for a single-family rental home might look something like this:

Property price = $150,000

  • Projected gross rental income = $1,500
  • Vacancy loss at 5% = $75
  • Effective gross income = $1,425
  • Repairs at 5% = $75
  • Property management at 8% = $120
  • Other expenses (pro rata property tax, insurance, etc.) = $300
  • Projected monthly cash flow or net operating income (NOI) = $930

After you’ve calculated the pro forma cash flow or NOI, the next step is to add in your monthly mortgage expense to determined your before tax cash flow:

  • NOI = $930
  • Mortgage expense = $476 (principle and interest only)

Before tax cash flow = $454 per month

Keep in mind that it’s not uncommon for a rental property to have negative cash flow from time to time. 

For example, if a home is vacant when purchased and needs to be rented, leasing fees, routine repairs, and normal operating expenses can create negative cash flow for the first few months. 

On the other hand, if a budget shows that estimated operating expenses for a rental property are consistently greater than the projected rental income, it probably makes sense to look for a different property to buy.

This recent post on the Stessa Blog explains more about how to create an accurate pro forma in real estate. 


Tips for Estimating Rental Property Expenses

One of the advantages of being a remote real estate investor is that there can be hundreds of good rental properties to choose from in different markets across the country. 

To help narrow down the list of homes to investigate further, investors use the 1% Rule and the 50% Rule to estimate rental property income and expenses:

1% Rule

The 1% Rule in real estate is used to estimate the potential gross income a rental property could generate based on the purchase price. If a property costs $100,000 to purchase, the gross rent should be at least $1,000 per month, according to the 1% Rule. 

50% Rule

The 50% Rule states that normal operating expenses – excluding the mortgage payment – for a rental property can be estimated to be about one-half of the gross rental income. If the gross rental income is $1,000 per month then the estimated operating expenses could be $500 per month.


woman using spreadsheet

How to Keep Track of Rental Property Expenses

There are three main ways investors keep track of estimated and actual rental property expenses:

  • Spreadsheet such as Microsoft Excel, Numbers, Google Sheets, or OpenOffice
  • Generic accounting software like Quicken and QuickBooks
  • Rental property software such as Stessa

While a spreadsheet or off-the-shelf accounting software may work fine at first for tracking expenses, manually entering every invoice paid can take a huge amount of time. 

Stessa was designed by real estate investors, for real estate investors, and helps to make rental property finances simple by automating income and expense tracking. 

After setting up a free account and entering the property and banking information, an investor can use the Property Details page to create a pro forma expense column to compare actual expenses side-by-side with the pro forma budget.

The pro forma data automatically feeds into the owner Property and Portfolio Dashboards, providing the raw data for calculating key performance metrics, and helping to take the guesswork out of estimating rental property expenses.


Final Thoughts on Estimating Rental Property Expenses

There are numerous potential advantages to owning a rental property, including passive rental income, property value appreciation over the long term, and tax benefits like depreciation. However, it’s important to always keep an eye on the bottom line by accurately estimating rental property expenses. 

After identifying the typical expenses of a rental property, costs can be nailed down by speaking with an investor-friendly real estate agent, a local property manager, or fellow real estate investors. The more accurate estimated rental property expenses are, the greater the likelihood is of owning a rental property with healthy returns.

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