The rule of real estate investment is that any profit is a good profit. But of course, you want to earn enough profit on your real estate investment so you can live a good life on that profit! Clearly, $1 is better than $0, but is it worth owning a rental property for $1 of profit? Let’s do some math on this, as well as address a related question I get asked quite often, which is, “How much can I rent my house for?” But first, I’ll dive right into the profitability factor…
How much profit should you make on a rental property? When you are evaluating cash flow on a property, you must assure that your rental income will cover all expenses such as taxes, insurance, property management, and any debt you take out on the property. After you subtract those expenses, what is left over for you is your profit. Generally, a profit of at least $100 from each rental property is considered a worthwhile return on investment.
But of course, in business, more profit is generally better!
If you are thinking about purchasing a rental property, and want to calculate potential profit, here are a few steps you can take to get a handle on it.
How Much Rent Does The Property Make?
If the property has an existing tenant, you already know how much that property will make in rental income. If it does not, however, how can you estimate this?
A little homework will go a long way. You can use websites such as Rentometer.com, which gives you average rents by neighborhood. This is good for ballpark estimates, but you should go one step further and ask a local realtor who specializes in rentals.
You may get a range for your potential rental, such as between $800 and $1000 per month. Use the lower number for your calculation to be conservative. That way, if you make more, it’ll be a pleasant surprise! For those of you who are new investors, I’ll cover rental income in more detail later in this article.
How Do I Know What Expenses Will Be?
You should estimate that 40% of your rental income will go towards expenses. This is assuming that your property does not need rehab repairs. If that’s the case, that’s beyond the scope of this post. 40% of expenses include property taxes, insurance, property management, and possible vacancies. It’s a conservative number, but again, we are being conservative on purpose here.
So is the other 60% Profit?
Not necessarily. If you are planning to get a loan on the property, the remaining 60% can be used to pay for the monthly mortgage payment. This means you should not secure a loan with monthly payments higher than 60% of the estimated monthly rent.
So NOW is the remainder profit?
Yes! Whatever is left over after your 40% expenses and your mortgage payment is your profit. But it’s also the profit that the government will tax you on, so make sure you do not spend it all because the taxman wants his share of that leftover pie! The taxes you pay on this income are NOT the same as the taxes you pay on the property. These are two different things, so make sure you plan to pay BOTH. There are ways to lower your taxes as a real estate investor but those things are beyond the scope of this post. However, you can head over to my article that goes into detail on the topic – Rental Income Tax Guide for Real Estate Investors.
Let’s Do A Sample Problem
We’ll play this out so that it’s clear, using conservative numbers. Let’s say you find a rental property that you can buy and the tenant in that property pays $1,000 per month. This means that the amount of money that property will make is $12,000 per year. You set aside 40% for taxes, insurance, management, and vacancy.
That’s $4,800. The remaining $7,200 plays out to $600 per month. If that’s your profit, great! But let’s pretend there is also a mortgage payment of $300 per month on the property. In which case, your profit is now $300 per month. This is pretty great for one property! One property does not a millionaire make but it’s a great start towards financial freedom!
So How Do I Know If It’s Worth It?
This is a difficult question. It depends on what your cash flow situation is. Will you need that $300 to supplement your lifestyle? Or perhaps you have a high-paying day job and you want real estate to be a tax shelter. Real estate offers all manner of solutions to all manner of goals. But let’s assume you want to use that profit to live your real life right now since that’s usually the reason one starts investing in real estate. In which case, the more profit the better, right? Duh!
So, is it worth it then if your estimated profit per month is only about $100 per month? Generally, yes! Is it worth it if your estimated profit per month is less than that? I am going to say proceed with caution. If your estimated profit per month is $50, that profit can easily be eaten up by the following unforeseen circumstances:
- A city tax assessment whereby the city asks you to pay for some kind of municipal repairs such as a new sidewalk or sewage line. These things do happen and can be expensive, and what can you do about them? Nothing. All you can do is pay the bill. These obviously eat into your profit and they are annoying.
- Something expensive breaks in the house such as a water heater or roof.
- The city raises your taxes. You can contest your property tax but if you lose and are stuck with a high tax bill, this obviously will eat into your profit too.
- Your insurance premiums go up. This could also happen. Sure, you can shop around for a better price, and you should, but increased insurance costs cut into your profits. Insuring your rental is important, though, and it can protect your profits. To see what I mean, dive into my post on understanding landlord insurance coverage.
If any of the above were to happen, it shouldn’t cripple your investment, but if your profit margin is pretty low, it might. That’s why we suggest only doing investments that will cash flow at least $100.With that said, I suggest using gross rent multiplier metrics to determine the potential profitability of a rental property. Head over to my latest post on GRMs where you’ll find the formula that’s used in the calculation.
What About Taxes?
Great question! You must remember that you will be taxed on that profit, whether it’s $1, $300, or $600 per month. The taxes you set aside in your 40% was for property taxes. You as the owner will be taxed on the profit YOU make at the end of the year at your current tax rate.
Experienced investors know how to mitigate these taxes, but if you are reading a post like this, you are not an experienced investor. You are most likely just getting started, so take it one step at a time. Don’t get overwhelmed. But remember that real estate is an amazing tax shelter if you know how to play the game. Make a mental note to learn that next!
Alternatively, your business entity will be taxed at the end of the year at the business tax rate on the profits of the property if you are buying in an entity such as an LLC, which, of course, you absolutely should be! Either you are taxed or the business is taxed, but someone is going to pay tax on that rental income. The government will be sure of it. So that $300 profit is no longer $300. It’s $300 PRE-TAX dollars. Keep that in mind too.
Now that we’ve thoroughly discussed the profitability factor, let’s dive deeper into rental income, which is the source of that profit.
How Much Can I Rent My House For?
Ok, now for the related topic I mentioned earlier in the article – How much rent can I get for my house? This is an essential question that shouldn’t be underestimated because figuring out how much rent you can charge for your investment property will allow you to better pinpoint how much profit you’ll actually make. Why is this the case? Well, of course, the more rent you reel in, the more profit you’ll have after the mortgage and other bills are paid each month.
The bottom line is that your goal as an investor should be to generate a high return on investment (ROI). So, finding out what you can charge and making sure you charge the max rent is imperative. This is one reason why I admire new investors who come to me asking how much they should charge their tenant, instead of just guessing. You see, if the property owner is asking for too much in rent, the rental may sit vacant for months. Ask for too little, potential renters may think there is something wrong with the property.
As you can see, it’s a fine balance. But with certain tools, it’s not hard to determine what the best rate is when you want to know how much I can rent my house out for. I’m unable to provide you with a specific rental rate that you should charge because there really is no one-size-fits-all “fair market rent,” and that’s why these tools are crucial. In reality, the rate would depend on a variety of factors that apply to each specific property – location, number of bedrooms, one-story or two, and so on.
To give you a head start on the topic, here are a few resources I put together that pertain to rental rates:
- Three Ways to Determine How Much You Should Charge for Rent
- The Driving Factors Behind the Ability to Charge Higher Rental Rates
Best Strategies for Determining Fair Market Rent: Rent Comps & Property Managers
There are a few tools and resources that are commonly used for determining what monthly rate to charge for your rental home, and I mentioned that a realtor is one, as well as websites such as Rentometer. Sites such as these are where you’ll find some great “how much can I rent my house out for calculator” tools. If you are interested in a rent calculator such as this, visit Rentometer, as well as Zillow. Their calculators can provide investors with the rough estimate needed to get the ball rolling when it comes to narrowing down a final rate.
Zillow calls their calculator The Rent Zestimate, and it’s pretty helpful. I’ve used it many times, and whenever I need to quickly find out on Zillow how much can I rent my house for, I’m provided with an answer within minutes. Both Zillow and Rentometer provide useful rent estimates through what is called rent comparables (rent comps), where similar properties are compared against the rental you’re looking into.
Zillow utilizes millions of data points, and takes into consideration local market trends to provide rental property owners with a good starting point for setting a monthly rent. As for Rentometer, they pull from over 10 million rental records per year to give rent estimates that investors can rely on.
I’ve used metrics such as rent comps for many of my properties, even when I was just trying to figure out how much can I rent a room in my house for. If you are not familiar with rent comps, you’ll want to see my article on maximizing rental income that covers in detail what rent comps are and how to use them to calculate your monthly rental rate.
Professional Property Managers are Experienced in Setting Rental Rates
If you ask an experienced property manager, “how much can I rent my house out for?”, they should know right off the bat because that’s what they do for a living. It’s part of their job to be familiar with going rental rates in their area. Also, the more rent you charge, the more profit the PM makes, so you can bet they will ensure you are charging the max rent for your property.
I trust a property manager’s rate suggestion over an online calculator. I feel this way because they work directly in the neighborhood and are up to date with the specific housing market, any recent changes that can affect the rate, and so on. If you’d like to look into the role a PM plays, then bookmark my post on the topic for some weekend reading – The Ultimate Guide to Residential Property Management.
For How Much Can I Rent My House: Real-Life Examples
Of course, every state and city will have different fair market rental rates, and rent comps can help pinpoint the rent for your property’s location, but just to give you a quick idea, here are a few examples:
A new construction three-bedroom rental home in, let’s say, Lubbock, TX, might rent for $1,750 per month. However, in contrast, a one-bedroom apartment in a suburban area of Los Angeles County in California has a much higher rent than a three-bedroom house in TX, and might rent for around $2,500 to $3,500 per month.
The higher rent you might receive in CA may sound attractive, but it’s really smoke and mirrors. You would actually make less profit in CA, and I would never recommend buying there. Why? Because CA has sky-high property prices that push mortgage rates through the roof, not to mention the fact that property taxes are impossible there, and it’s not a landlord-friendly state, which could end up costing you thousands in legal fees and missed rent if an issue were to arise with the tenant. Whereas Texas has more affordable housing prices, it’s a landlord-friendly state, and in cities such as Lubbock, TX, there are no state taxes, which increases your profit margin.
I use the city of Lubbock as an example because it has all the metrics I look for in a location worth investing in, including being recession-resistant. Check out my article that talks about it – Lubbock Recognized as Recession-Proof City and Maintained a Strong Texas Rental Market Throughout Pandemic.
Your Profit Will Vary Based on Rental Rates and Property Count
So, what’s the bottom line on all this…let’s say you took all the right steps, asked a property manager how much can I rent out my house for, or used rent comparison tools or other metrics to come up with a fair market price, determine your rate, and then pulled the trigger – now you own an investment property and you are making a profit of, let’s say, $300 per month, or $3,600 per year.
That’s great but that’s not enough to live off of, at least not in most United States suburbs and urban centers. But if you can do this once, you can do it again! One win begets the next and eventually, you will acquire enough of these that add up to something you can live off of! Maybe $300 doesn’t seem very exciting but it’s a lot more exciting than $0, where you will remain if you don’t get started.
You can only build your investments, brick-by-brick, dollar-by-dollar, profitable investment-by-profitable investment. So do your homework, run your numbers, and do that deal and collect that profit! You can do it!
For those of you who are inspired, but are new to the game, and not sure how to make this all happen, I suggest scheduling a free 30-minute call with my team at Morris Invest. They can answer all your questions, create a custom investment plan based on your unique situation, and help you place a new construction cash flowing rental property in your portfolio. In the meantime, if you’d like to do some research on your own, head over to our Morris Invest & SDIRA Program Overview page where you’ll find essential details on investing in rental real estate.
If a high profit is your goal, then you should know that new construction properties will bring in more profit than older rehabbed properties. With that said, watch the following video I put together that explains why this is the case:
