You may be wondering why you need sound rental property accounting practice. Investing in real estate requires a lot of prudent planning. And rental income should be thoroughly calculated for two reasons-
- Time Value of Money
When you invest in rental properties, your major expense will be the rent you have to pay to the bank from which you’ve taken a loan. The rents you charge should be more than the interest payment at any given time. This is your ROI. Because the value of money decreases over time, you need to calculate your rents carefully.
- Unpredictability of Existing Expenses
You know that you will have to incur certain expenses such as taxes, insurance, maintenance, and repairs. However, you can’t predict the actual expenses year on year. You also can’t ensure 100% occupancy. Factors like Public perception about the location, societal policies, and economic status can't be expressed in terms of monetary value. These must still be expressed in your rental property accounting
Rental Cashflow
Your profit on investment, called ROI, is your revenue minus expenses. Your rental accounting should at least get you to breakeven. Apart from the interest costs, there are several others that could impact your revenue.
Factors in Cashflow Determination
- Financing Costs
Banks will not bear the entire cost of your investment. You need to finance a part of the total out of your own capital funds. Long terms loan have lower EMIs but higher interest payment. If your rental property accounting doesn't consider your repayment ability, you'd end up losing more than what you make
- Taxes and Insurance
The rent you charge should account for the taxes that you’ll have to pay. The volatility of the economy affects the tax rates. In the long run, if your rents aren’t calculated properly, you stand to suffer losses. This will affect your cashflow adversely and increase the payback period. Some properties need insurance while others don’t. And if your property needs insurance, you will that annual expense as an overhead.
- Vacancy Factors
You can’t always expect 100% occupancy. Occupancy depends on a lot of factors. The neighborhood, potential growth, public perception, proximity to various facilities like schools, hospitals, supermarkets, places of entertainment, etc. are some of the things that impact occupancy. If you think your property meets more than a few of those requirements, you can expect anywhere between 85-90% occupancy.
- Miscellaneous Costs
Your advertisement can’t just be ‘For Rent’. It has to attract people to your rental property. You will also incur costs in the form of capital repairs and maintenance expenses. It is hard to predict the exact amount because it depends on the tenants. A rough estimate can be made, depending on the kind of tenants the neighborhood attracts.
Calculating the Cash Flows
Annual rental income is relatively easy to predict. In comparison, the expenses are harder to predict. And therefore, you can always leave a reasonable percentage for exigencies. You must also have a reasonable idea of how long you want to hold on to the property.
When you decide to sell it, depreciation will be a huge dent. Social conditions in the neighborhood might change. Since you can’t account for everything, the least you can do is anticipate every possible monetary cost. Your cashflow should be the excess of revenue over expected and contingent expenses.
To Conclude
Rental Property Accounting for budgeting profit is a tedious process in the beginning, it is usually a one-time process. For every year after that, you only need to account for inflation. Rents charged appropriately can add to your revenue with minimal governance. And this can be a great post-retirement source of income as well.
