What are the actual operating expenses of a rental house? This question sounds simple, but it's been debated for years. I have been investing in real estate for more than 15 years. I currently have more than 70 houses and pay the expenses on each one of these houses. In this article, I'll show you the actual expenses and back them up with academic research.
The actual expenses of a rental house are about 40% of the rental income. In some years, it will be a lot lower for an individual house, and in others, it will be higher. However, you can be sure that when properly managed, the expenses will average about 40% of the rent annually over a long period.
If you scour the internet for this data, you will find people claim it's a lot lower. So-called real estate investing gurus will calculate the yearly rent, subtract taxes and insurance, and allow a pittance for repairs and maintenance. They will show you the massive cash flow you will get and give you all the details when you buy their course.
What Makes Up Rental House Expenses?
- Fixed Cost: Fixed costs are set for a certain period. Examples are property taxes, homeowners insurance, and HOA fees.
- Routine maintenance: This is the customary work you must do to a house as it's lived in—things like replacing faucets, patching small holes in the drywall, and repairing a cracked window.
- Unit Turn Around: The more extensive projects that must be tackled when a tenant leaves. This will include things like painting and replacing the carpet.
- Long-Term Repairs: These items are infrequent repairs that are usually very expensive. Replacing a roof, the HVAC system, and even the plumbing from the house to the road falls into this category.
What do the Experts Say?
An academic study, Rental Yields and HPA: The Returns to Single Family Rentals, by Andrew Demers and Andrea Esifeldt, analyzed data from single-family rentals over 28 years. This study divided the houses by their metropolitan statistical area (MSA) to analyze the return on such investments. This was the first study of its kind over such a long period.
Although the study focused on appreciation and rental yields, it needed to calculate the operating expense for each property analyzed. It found that rental profits average 60% of gross rents (page 3), with the remaining 40% going to expenses. During a separate analysis, their paper concluded that expenses average 41% of gross yields. The 40% and 41% discrepancy is simply a rounding disparity between the different calculations.
What do I Say?
After reading this study, I checked my books to see how close I matched the study. I removed mortgage interest from my reports and calculated my expense ratio over five years. My expenses averaged 41.3% of the rent collected, pretty close to the 40% predicted in the academic study.
When the last calendar year ended, I performed the same calculation on a single year of data. My reports show an expense ratio of 39.6% from the year ending December 2020. This is also in line with academic study.
The peer-reviewed academic study, using almost three decades of data, concluded that the expense for a single-family rental should average around 40% of the rent collected. An examination of my data was in line with the findings from the research paper. Therefore, I feel confident that a rental house's expenses average about 40% of the rent. This study is further discussed in the article operating expense of single-family rentals - a primer.