How to Calculate Rental Income – Huge Mistake Most
So how do you really calculate your rental property income? Friends, Kris Krohn here limitless TV and that is what we’re going to be talking about today. Rental property income how do you calculate this? And I got to tell you that there is a right way and there is a less right way. Ultimately, I want you to know that in the accounting world, if there’s one thing I’ve learned it’s that even though the IRS has stacks of rules on how to do accounting they’re in some ways are these acceptable ways but there’s a lot of gray area. And so today, I want to share with you what the number one mistake is that people will make but first we got to hit the math right? Like, how do you, what do you really take into account when you really want to know what is my rental property income? And so when we’re talking about a property there’s a couple of different things that you need to be aware of. We’re gonna set this up as if it is a rental. Right? We’re not talking lease options or things like that I’ll tell you a little bit what that could look like. If you’re doing a rental, you usually are collecting first month’s rent. You’re collecting a deposit and sometimes part of that deposit is non-refundable as a cleaning fee for when you leave to get in there. So let’s just say that it’s $1,000 a month to be able to rent this house. That’s what my rent is. And let’s just say that my deposit is also $1,000. So I’m gonna put my first month spring down of a thousand. I’m gonna put my deposit of a thousand. And let’s just say that $300 of it is non-refundable. Here’s what that means, no matter what that 300 is mine. But a year later if they move out and they keep the house in good clean condition the other $700 would go back to them. Note that the standard as though is that a property management company or use the landlord are gonna go in and you’re gonna see wear and tear and you’re gonna say, you know I want to paint this room. You know, I want to have the carpets cleaned. I want to do something beyond this and so it’s very normal often for people not to get their deposits back. Clean freaks? that exist, are going to demand their deposit back if they’ve done a great job taking care of the place and so that’s a factor that you need to have. So when you’re calculating your, what is my real rental property income? The next piece of information we need to know is, what is the mortgage? And let’s just say for the case of this example that the mortgage is $700 a month. Well I know that I’m renting for a thousand, I know that my mortgage is 700, what’s the difference? That’s three hundred dollars. So my cash flow is three hundred dollars. Now let’s do some basic math here. Let’s just say that I rent this for an entire year and I’m collecting, they’re paying on time and I’m getting three hundred dollars, twelve months. Well what is that? that’s $3,600. That’s what my rental income looks like not my gross that’s my take home cash flow. That’s my profit. Now by the way that’s not what your profits gonna look like on paper cuz you gotta write offs, you’re gonna write off interest. In fact, this number often turns to zero to the government but you actually put $3,600 in your pocket. This is why people with, with leftover money looking for tax shelters they’re buying real estate because it just it works out in your favor the constitution was written to favorite real estate investors. Now this $3,600 I’m gonna add to it. Remember my non-refundable cleaning fee? Although I probably wouldn’t necessarily look at that as income because that money is really either going back in their hands or it’s being set aside to what? Clean the property. So, no. I’m not really gonna look at that part but then we also have to look at the fact that you might also then have a couple of expenses. For example, are you hiring a property manager? Your property manager charging ten percent of gross rent that they collect? Well what’s ten percent of a thousand dollars? That’s a hundred dollars. That’s a hundred a month. So you’ve had twelve hundred dollars in expenses for property management which really just took your thirty six hundred down to twenty four hundred. And then if you don’t have people that are reupping their lease for a second or third or fourth year, then if every year there was change over you’re often going to experience in most markets one month of vacancy right? An 8% vacancy. So I’m gonna lose them, I’m gonna lose a month which might be a $700 payment that I’ve got to pay once. And this $2,400 now becomes what? It now becomes $1,700. Now $1,700 and we’re not taking into account the equity. We’re not taking into account the tax benefits and the tax advantages and some of that. We’re just at this point looking at calculating our rental income and what really the true income is. Now we gotta ask our self, is this investment a good investment or not? This is a little bonus you didn’t ask for this I’m just gonna put it in there whether you want it or not. Um if I bought this house if this house has a value of $100,000 and let’s say I purchased it for $75,000, then the first thing that I know is I’ve got $25,000 of equity. And when I bought it I put 20% down. So what’s 20% down on $75,000? It’s 15 grand. That the closing cost got wrapped in let’s say that I had you know $5,000 a fix-up and repair on it cuz I got a discount. I put up $20,000 to be able to buy this house and it produced $1700. Well 1,700 is 9 or 8 percent of 20,000. Which means that my cash on cash return was doing eight or nine percent on my money. Now I just want to ask you a question, some of you were wondering like, well how did you do that? You can do the math you can divide them into each other and figure out what what was my effective return. Let’s just call it 8%. Does your 401k producing 8%? Is the stock market producing 8%? Is the stock market giving you $25,000 of equity? Is my bank account giving me 8%? No it’s giving you a half percent is giving me 1%. So in this deal, we’re talking about someone increasing their net worth $25,000 and based on what’s left over here, guess what? They’re making 8 9 percent of their money. In real estate, at the end of the day taking all your expenses into account, if you can step into equity and if you can be making 8 to 10% minimally on your money then you are easily and grossly outperforming the financial markets. And you know what this is why most American millionaires made their first million in real estate. So this is the first bit of information that I want to share with you about how you about how you calculate this. In the next segment, what I want to do is I want to talk about the one danger that if you do the math wrong it’s gonna crush you. So stay tuned. Now here’s the number one danger zone that you need to be aware of there’s a difference between net and gross. A lot of people on paper will say, this looks like a good deal look at the numbers. And the question is, are you looking at the gross? For just a second imagine that you’re making $1,000 of rent every month for 12 months. 12,000 dollars of income! No you need to subtract out the expenses like it just showed you. And then are you remembering to subtract property management fees? Are you actually setting money aside for a sleep well at night account for vacancies or unexpected repairs? You know what we’re doing now is we’re moving within the realm of reals and reality as opposed to on paper everything looks good. You know there’s a lot of investors that will get in on a deal thinking that hey this is amazing this looks good on paper it’s perfect. Look at the ROI and then in hindsight, six months passes two years passes you are like, all this deal kind of stinks and the reality is deals are gonna go that way so if you want to make sure you’re living within reality make sure you’re always looking at net numbers instead of gross numbers. Ask on every investment. Are there any other possible expenses? any whatsoever? any at all? And what it’s going to reveal for you is ultimately subtracting out everything to get you to reality of what you can really make on the deal. Thanks for joining me today. Click the bottom link below if you want to learn more our next three day real estate training event where we can take all this information and systematize it so that you can start your world of real estate investing right now.