This is a chapter taken from the upcoming comprehensive guide titled, Market Cycles: How Investors Can Survive (+ Thrive) in a Turbulent Economy. If you would like to sign up for early bird access to this comprehensive guide, please sign up here.
There are two types of costs that real estate investors have. Hard costs are the ones you can see, while soft costs can be difficult to spot and also surprisingly expensive.
Real estate expenses should always be systematically analyzed and optimized from time to time, especially during a down market. Here are the 10 best ways to locate potential savings within your real estate portfolio.
Before we begin, ensure you understand the investing metric operating expense ratio (OER). This will give you a great idea of which properties you should focus on first and where the low hanging fruit is for expenses.
#1: Vacancy is your biggest expense
Vacancy is the single biggest expense that many landlords frequently overlook. According to the National Apartment Association (NAA), tenant turnover costs – including lost rental revenue – range between $1,000 and $2,500, and even more if you need to make capital repairs.
So, it makes good business sense to keep your turnover as low as possible.
One of the easiest ways to reduce vacancy is by keeping your rents slightly below market. Every dollar counts for tenants, especially in today’s economy. If the market rents in your area are $950 per month and your property is priced at $940, the odds are your property will stay 100% occupied year after year.
Patrick Carlisle, Chief Market Analyst at Compass notes that “Ultimately, vacancy is the biggest “expense” in a down market, so keeping tenants and re-renting vacant apartments quickly is key.”
Carlisle continues, “Most other expenses are relatively fixed, and smart landlords already manage them firmly. Of course, if your older building still has central heat, changing it to separately metered heat is almost always a worthwhile investment.”
#2: Who pays utilities?
There are three ways to handle utility payments with a rental property:
- Utilities are included as part of the rent
- Rent plus a separate charge for utilities
- Tenants pay utilities directly
Each method has its advantages and disadvantages, and can also depend on how strong or weak the rental market is. Before choosing an option, it’s a good idea to create different pro forma scenarios for each choice to ensure you’re maximizing your ROI.
#3: Utility optimization through technology
Passing through utility costs to your tenants can keep your cash flow high, but may also have the unintended consequences of rising vacancy. Fortunately, there are several easy ways to help keep your utility expenses low, as well as utility fees your tenants pay directly:
- Perform regular, energy-efficient maintenance work such as sealing windows and weather-stripping doors, and installing window coverings to block the afternoon sun.
- Smart property technology devices (proptech) ENERGY STAR certified thermostats that automatically adjust to your tenants’ living patterns, and moisture sensors that use Wi-Fi to send instant notifications when excess water is detected.
- Sustainable landscaping to conserve water and energy, and reduce runoffs.
#4: Lower property taxes by contesting your assessment value
While property taxes are inevitable, that doesn’t mean the county tax assessor is always right. The assessment process usually begins by estimating the value to your property for tax purposes – and that’s the #1 area where mistakes can occur:
- Review the tax data of your property on the county assessor website, and compare the lot size and livable square footage to your most recent appraisal.
- Compare the taxes on your property to comparable properties in the same neighborhood as yours, then zero-in on the discrepancies.
- Appeal your property taxes using the window of opportunity between your notification of assessed value and the date property taxes are assessed.
- Consider using an attorney who specializes in property tax appeals, since they know how the system works.
#5: Refinance if possible
Your monthly mortgage payment takes a bigger bite out of your cash flow than any other routine property expense. Because mortgages are usually at a fixed-rate and payment over the long term, it’s easy to take this expense for granted.
However, having a trusted mortgage broker review your current financing structure could help you to save literally thousands of dollars in interest payments over the long run.
If you’ve owned your existing property for several years, you may be able to conduct a cash-out refinance, increase your capital reserves, and lower your monthly mortgage payment all at the same time. See here for more information on mortgage options for landlords.
#6: Optimize tax deductions
The tax code in the U.S. is extremely friendly to rental property investors. In order to optimize your tax deductions, begin by setting up a good record-keeping system. Many real estate investors are using Stessa to automate income and expense tracking, and export tax-ready financials.
Some of the biggest tax breaks and deductions you can take on a rental property include:
- Deduction of normal business and operating expenses from net income, such as interest and property tax payments, repairs and maintenance, property management and professional fees.
- Depreciation expense is a non-cash deduction used to reduce taxable net income without reducing your real net cash flow.
- Capital gains can be deferred by conducting a 1031 exchange to relinquish one investment property and replace it with another of the same or equal value.
If you haven’t reviewed it already, check out our comprehensive tax guide to help you best optimize your returns and prepare for tax season.
#7: Preventive maintenance
Conducting regular preventive maintenance on your rental property is like changing the oil in your car. The longer you wait, the greater the odds are your engine will need to be replaced.
Proactive preventive maintenance tasks that can save you thousands of dollars in rental property repairs include:
- Semi-annual servicing of the heating and air conditioning system
- Keeping doors, windows, and attics caulked
- Visually checking for leaks under the sinks, in the laundry room, and outdoor faucets
#8: Find cheaper labor
In the rental property business, cheap labor doesn’t mean hiring inexperienced people. For example:
- Bookkeepers can easily be replaced by online, cloud-based financial management systems like Stessa.
- Choosing a handyman who charges by the project instead of billing by the hour can keep repair costs low.
- Let your service people know you’re willing to give them all of your business in exchange for providing you with reliable work and a volume discount for repeat business.
#9: Question each expense
Although there are plenty of good reasons to use rental property financial calculations such as cash-on-cash return and the 1% rule, one of the biggest drawbacks is that they lump income and expenses into two big numbers.
Even if your property has solid cash flow, make it a routine practice to drill down and analyze each line item of your monthly P&L for ways to cut down on operating expenses and increase your property value.
For example, if your rental property is in a market where cap rates are 6%, saving $10 per month (or $120 per year) can increase your property value by $2,000:
- Cap rate = NOI / Market value
- NOI / Cap rate = Market value
- $120 (additional NOI) / 6% = $2,000 increase in market value
#10: Cut water costs
The average water bill in the U.S. is over $70 per month, according to Move.org. As we’ve seen from the above example, cutting water costs by just a few dollars per month can lead to triple-digit returns.
Even if your tenants pay the water bill, a rental property that’s water-efficient can help to keep vacancy rates low by giving your tenants more value for their rental dollar:
- Faucet aerators in the kitchen and bathroom break up water flow into multiple streams, reducing the need for high-pressure water flow
- Adjust toilets to use only the necessary water levels
- Put landscape drip systems on a seasonal time to make the most from minimal water use
Every $1 you save by cutting down on rental property expenses can literally be turned into $10, $15, or more. That additional cash flow is critical, especially in today’s challenging economy.
Before making any changes, be sure to research the landlord-tenant laws in your local area, and also learn what the norm is in your market. Then, make sure you have a detailed system in place to track income and expenses to help identify cost reductions that can drop straight to the bottom line.