When most investors run their numbers, one thing I rarely see is enough budgeting put towards tenant turnover costs. These costs can be factored into vacancy rates, advertising costs or management fees, but usually they are on the low side in most pro forma budgets that I come across.
Be sure to consider all of the costs of tenant turnover because they do have a real impact on your bottom line.
Vacancy
Often people will use the CMHC vacancy rate for their area, or double it to be conservative. This is good because this number is based on fact.
When considering which vacancy rate to use in your analysis consider that 1 month of vacancy per year is equal to 8.3% vacancy. If the average tenure of your tenants is 2 years, and the average time between tenants is 1 month, your vacancy will be just over 4%.
Sometimes your tenants will stay longer, but sometimes they will move out sooner. Sometimes you will have no gap between tenancies, but other times you may have more than 1 month between leases. Just be sure the vacancy rate you use is realistic. In a good market, I like 4%.
Leasing Costs
Regardless of whether you find your own tenants or opt to use a property management company or tenant locator service to do the job for you, there are costs involved. Do you factor these costs into your analysis before buying a property?
If you elect to find your own tenants, you will usually incur some advertising costs to bring potential tenants through the door. Once you’ve got an application from the right tenant, there are due diligence costs for background and credit checks. Plus, what is the time you take to conduct showings, background and reference checks worth?
Outsourcing tenant location as many investors do will usually cost you 1 month worth of rent. For most Realtors, property managers or tenant locator services, this is the standard fee.
Rent Ready Cleanup
Even with good tenants, there are usually some extra costs once they move out to prepare the property for your next renter. Be sure to factor in some costs for cleaning the kitchens, bathrooms, and carpets between tenants. In many cases you’ll also want to freshen the look of your property by painting which can add substantial cost.
Seasonality
If your tenants are moving out in April or May, you are likely to command good rents when re-renting your property. However, if they are moving out in December or January when the market is typically in a lull, you may face reduced rents. A few bucks a month may not seem like much, but it is a real reduction in income that can quickly gobble up your formerly positive cash flow.
In the case of eviction, tenant turnover costs will be even greater, but I’ll save that for another post. My point here is to just make sure you realize all of the costs associated with tenant turnover and bake those into your analysis before buying a property. Your projected cash-on-cash return won’t be as pretty, but it’s always better to be realistic with yourself and to under-promise and over-deliver for your partners.
photo credit: Dan4th
