Hey there, money nerds!
How’s your 2020 tax return going? Who else out there besides me gets turned on by a long 1040 Form, multiple 1099-MISC’s, sexy AGI, and itemizing deductions for their MFJ status? (and who has no clue what the heck I’m even talking about? → don’t worry, that’s what H&R Block is for!)
Anyway, I just received my annual Profit and Loss Statement for my rental duplex for 2020, and I thought some of y’all might be interested in checking it out.
It’s basically a summary of all income and expenses that my property management company reported in 2020. They send me one of these for every property, every year, which I use for tax filing.
Also, it’s really handy for calculating the annual ROI for this investment, which I’ll do within this post.
Example of a Profit and Loss Statement for a Rental Property
Here’s what my P&L for 2020 looked like:
INCOME: In 2020, we had 100% Occupancy and 100% rent collection. Woohoo! Every investor’s dream! Especially given the pandemic challenges last year.
There are two units in this duplex. One pays $1,000 per month and the other pays $975 per month, so $23,700 total for the year.
EXPENSES: These expenses listed are just the items that my property manager handles. So insurance, property taxes, and mortgage payments we’ll look at separately in the overall ROI in a bit.
- Property management: I pay my property management company 7% of all collected rent.
- Commissions are paid for renewing tenant leases. Last year there was only 1 renewal, and it’s calculated as ¼ of 1 month’s rent (Unit #2 renewed at $975/m. The other unit was on a 2-year lease.)
- General repairs: From my monthly detail reports, I can see this is mostly toilets, sinks, dishwashers and stove repairs here and there, etc.
- A/C & Plumbing: I’m not sure why plumbing is broken out separately, but I like how the HVAC has its own line item. From memory, this was preventative maintenance and cleaning. New A/C units cost about $5-6k when they blow up, so keeping them clean and up to date is important!
- Landscaping seems big, but it works out to about $15 per week. The lawn peeps come every 1-2 weeks depending on the season and do the front and back lawns.
All in all, total income minus expenses was $18,832 last year.
Now let’s add in the other 3 big things that I pay separately for this property. This helps calculate my actual profit in 2020…
PITI: Mortgage Payments, Insurance, and Property Taxes for a Rental Property
Investors sometimes call this “PITI,” which stands for principal, interest, tax and insurance. Here’s the PITI expenses we paid in 2020:
Mortgage Payments: $7,938.60 in total
- $2,830.97 was principal
- $5,107.63 was interest
Property Tax: $5,185.42
Insurance: $1,042
It’s important to note that mortgage principal isn’t technically an “expense” because this money is actually applied to paying down the loan balance. So the $2,830.97 in principal payments was paid to myself, and therefore we can remove it from our overall expense tally.
Total PITI (without principal paydown): $11,335.05
OK, now let’s add this all up and see what the real profit was for 2020…
This duplex made me and my wife $7,497.05 last year.
This was made up of $4,666.08 in positive cashflow and $2,830.97 in loan balance paydown. Not bad!
What About Property Value Appreciation?
Another thing we could calculate into our annual profit is appreciation. The value of the house could have risen in 2020, making us even more money.
But I have no idea if it’s really increased in value. There hasn’t been much buying/selling in my area this past year, particularly for duplexes and fourplexes, so we can only make a rough guess about changes in value.
I could pay for an appraisal or competitive market analysis, but unless I’m looking at selling, I don’t really need to know how much the place is worth currently.
So at this point, I’m gonna just use our actual *realized* profits of $7,497.05 to calculate the ROI for the past year.
Total Return on Investment for 2020
To work out the ROI, I’ll take the total 2020 year gains ($7,497) and divide it by the value of the investment at the start of 2020 ($102,973).**
($7,497 / $102,973) = 0.0728. So basically, that’s about a 7.3% ROI.
Not great, but definitely not bad. We didn’t include any appreciation or tax advantages, which would boost this number.
**For those of you wondering how I arrived at the investment value at the beginning of 2020… I used a $220k valuation, minus the outstanding mortgage on Jan 1 of last year, plus the balance of my emergency reserve account at the time. Happy to debate with you over a better way to do this – or if you have other ways you work out ROI within a single year, hit me up in the comments!
Other Good and Bad Notes for This Rental Property in 2020
Just for annual review purposes, I like to jot down a few goods and bads for the year. It’s mostly for my own records so I can remember back later in life. For other co-owned properties that I manage, these notes I usually send to my partner investors to keep them in the loop.
Good stuff from 2020:
- 100% occupancy
- 100% rent collected, no late payments
- No major repairs or emergencies
- Tenants happy and likely to renew
Bad stuff from 2020:
- property taxes took a ~9% price hike
- We didn’t increase rents at all
Is 7.3% a Good Return?
Well, in 2020, the total stock market index increased by 21%!! 😳 My piddly little 7.3% doesn’t look so great standing next to a kickass stock market year.
That being said, this rental property serves a specific purpose within our long-term retirement plans. It’s a really flexible asset that will give my wife and I various income options later in life. It’s not always about chasing the highest return in a single year.
For a stable property that doesn’t take much of my mental energy to manage, I’m fairly happy with a ~7% return year over year. (Appreciation may add another 2-3% or so on average per year, which is great too). This isn’t a slam dunk investment, but it’s definitely not a loser.
How are your rentals doing? I know a lot of landlords are hurting right now – especially those who own vacation rentals. Do you other investors do annual reviews like this?
Cheers, and have a great week!
– Joel
PS: Seriously if you haven’t figured out your tax stuff yet and are looking for help filing online, HR Block has a FREE basic filing service, as well as they’re offering 20% off these packages for easy self filing!
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Happy Monday Joel!
I think the 7.3% return is a great number – especially considering that your duplex is a way of diversifying your assets over the long run… I’m heavily considering rental real estate for my future as well, because I know that although the stock markets could have a great year (like with last year’s returns), there will also be years where the stock market will have negative returns… and that’s where one will be thankful for having such a stable income source in rental real estate.
You guys made a great investment… and honestly paying 7% to your rental management company isn’t that bad of a deal – in the area where I live, most rental management companies charge around 10%. (And there is no way that I will be managing the property alone :).
Cheers!
Fiona
Hey Fiona! Yeah, we got a sweetheart deal on property management, and we have multiple properties with the same company which helps.
Joel,
Congrats on getting 100% rental collection in 2020. That’s a big success given the COVID situation. I know this isn’t part of today’s post’s purpose, but you mention this unit is part of your long term investment strategy. I’m assuming possibly for early retirement income. I’m curious, if you could explain your long term strategy for this property? Given the numbers provided, you are getting a n approximate 7% ROI utilizing leverage in what amounts to a really good year from a low vacancy and low maintenance standpoint. In a few years, this property will at best output approximately 3% once paid off (even less after appreciating additional years). It doesn’t sound like a great long term investment, so I’m curious if you have an exit strategy for this building or if you have a different plan? If so, I’d really like to hear your ideas for the long term.
Hey ThomH! I’m glad you brought this up… You’re right, as the property increases in value and mortgage gets paid down over time, my ROI gets lower and lower. Even if I continue to raise rents to cover increasing expenses, I’m still only looking at a ~5% cash return for this asset once paid off (3-4% if we have vacancies/emergencies).
The reason I want it still part of my long term retirement portfolio is for diversification and cashflow income. (and maybe potential future leverage).
For diversification – let’s say I retire with a $2.5M portfolio and this property represents $250k of that (if fully paid off)… That’s only 10% of my total NW, so i’d be happy achieving 3-5% cash return knowing it’s paid off and relatively stable. I realize there are higher returns elsewhere (or if I refinance) but my guess is i’d prefer a lower return for lower risk. It’s only a small-ish % of my portfolio.
As for cashflow – this just gives us a different stream of income. Might only be ~$1-2k per month, but it’s relatively steady and provides us income outside of portfolio withdrawals.
As for flexibility and leverage – I have no idea how I’m going to feel about leverage in retirement. But I like having the *option* to refinance. Cash-out refinancing could give us a large chunk of cash for a future year/years where we don’t want to withdraw from the stock market. Pulling 100k of equity out – tax free – sounds like a great plan in an extreme down market. Again, I don’t know if I’ll actually ever do this, but options are nice.
That’s how I feel today – but as I continue to grow and learn, maybe I’ll be feeling different later in life!?
Joel, I just reread my post and wanted to clarify, when I said “it doesn’t sound like a great long term investment”, that sounded kind of rough. I recognize you may get a great ROI from selling with appreciation and tax benefits from holding for an extended period. So maybe a better way to have asked my question was “It may not continue to provide such a great long term ROI (@ 2%-3%) once paid down, so what is your longer term strategy?” (My apologies, if the first attempt sounded harsh. It was not my intention. I’m really just curious about your longer term strategy.) Thanks in advance!
Haha no worries! You didn’t sound rough at all. Part of sharing numbers online is having people question them! It’s all good and appreciate your notes!
Lol! Thanks Joel. Appreciate the feedback. I ask as we are in the early retirement situation with roughly 50+ units. I’m always curious what others exit strategies are for their rentals. My properties are aging, so I’m considering 1031 exchanges, and building newer (low maintenance) units and “resetting the clock” so to speak. Sounds like you’ve thought it through, but take it from an older owner, maintenance and vacancy expenses grows with time. That ROI slows to a crawl once paid off as a result. It is still good diversification, as you say. I’m leaning toward likely to exchanging into (building) some newer buildings and hopefully continue to achieve higher ROI’s as my buildings age out. Thanks again. Good discussion.
Love it Thom, thank you for your wisdom! I’m nowhere near 50 units, and I’ve already started to back-peddle and want to sell some off. Thankfully, we don’t have very much appreciation so there’s really not much gains tax to pay if we sell soon-ish. If we wait, our problem will worsen over time. But for this duplex, it’s the only keeper I’ve identified so far.
Good luck exchanging and consolidating! Getting really off topic here… but have you ever thought of 1031 exchanging into a Syndication? (feel free to email me if you want to carry on with this offline!)
Hi Joel,
Great post on the rental property. My wife and I have a single family property and like you we are looking at this property from a long-term view. We are yet to increase the rent in 3 years which is dumb, I know, considering rent has gone up 10% since we started leasing. However, we like our tenant and she takes good care of the property. Using your computation method, our ROI was 7.6% for 2020 but we do not use a property manager. However, we use one of those Home Maintenance Insurance. People typically have bad experiences with this home maintenance insurance but we have nothing but good things to say with the company we use. You mentioned having other properties. Do you get similar returns from your other properties? Seriously thinking of getting another property soon.
Hey Julius! Awesome to hear about stable tenant! Rent increases are eventually necessary (your expenses increase so gotta keep up the pace) but everyone has different times and ways of going about increasing rents. I tried Home Warranties for a little while, but they weren’t quite worth it each year. Glad it’a working out for you!
As for my other properties, some have similar returns and some unfortunately went through a rough year. Regardless, I’m planning on selling the others slowly because they don’t fit the long term plan. This particular duplex is cherry picked from the pack for long term hold, as I believe it has the most prosperous outlook for steady growth.
Good luck finding your next place!
Impressed and jealous you had 100% occupancy last year! One of my units was vacant for 2 months before the pandemic hit, luckily they seem to be awesome tenants so I’m happy they are there. Unfortunately though I found out the tenants on the opposite side won’t be renewing their lease this summer. hoping with enough times notice and the economy opening back up, the unit won’t sit empty for long!
Thanks for sharing formulas to help with ROIs, super helpful!
Cheers Amanda and good luck with the new tenant. Really nice to have a lot of notice so you can plan any upgrades/rent increases too!
Thanks for the breakdown. I am considering picking up a rental property or two in the future and it’s nice to see some real numbers in action.
Awesome! If I could share the 2 biggest things I learned regarding rental property numbers, it’s this:
1) Calculate the ROI based on the equity at the beginning each year, not just the initial downpayment amount from when you bought it. A lot of people fool themselves by inflating their YoY numbers, overestimate values, and focus on how much they originally put in. Being realistic will serve you better. :)
2) The decreasing ROI thing ThomH said above… As your property value increases in value, ROI *decreases*. Kind of like a bond. Actually I wrote an article a few years ago about that here: https://5amjoel.com/return-on-equity/
Excited to hear you’re getting into rentals and if there’s anything I can help with, let me know. -Joel
Can you lower your taxable income by depreciating the rental property? I have no idea how that works but it’s touted so much by real estate folks as a huge benefit to keep in mind and go into the real estate investing game.
Even though you returned 7.3%, a positive return is always a good one!
I guess the depreciation could only be used to offset the income generated by that rental property, which make it zero in profit on book?
Hey Andy! I believe it depends on your total income, and whether you’re a “real estate professional” or not on your tax filing. Here’s a cool article, check out the Potential Tax Limitations section. Anyway, if you make a +5000 profit and claim -7000 in depreciation, you may be able to use the additional -2000 to offset other regular income, etc.
BTW I am not a tax professional and I use a tax guy to figure out all this stuff for me!
Hey David, yep, you can absolutely claim depreciation. My tax guy does this for me each year. You take the cost of the property (minus land value) and divide it by 27.5 and this is the amount you can claim. For me, I think it’s about $6500 or so we claim each year – and some other stuff so we show not much paper profit at all.
However, it’s important to learn about depreciation recapture. When you eventually sell the property (more than it’s “depreciated value”, which is usually is) you have to pay tax on all the $. you depreciated over the years. This is why I typically don’t include it as a “profit” each year knowing that it gets all screwed up and I get heavily taxed on the sale.
Joel, I’m unsure of where you’re located, but you may want to consider appealing your property tax assessment — in some areas (like Chicago) appealing your property tax assessment is highly recommended in order to reduce your property’s assessed value and thus the tax you owe. Doesn’t work everywhere, but if it can work for you, it’s a great way to keep the property taxes from spiking too much.
Thanks! Yes actually 2020 was the first year I appealed the tax assessment. Believe it or not, this is the reduced rate! ouch.
I’ve got a feeling it will go up again this year again too. :( and I’ll appeal again at that time.
Hi Joel, thanks for this post!
I have few further questions on the ROI calculation if you don’t mind, as I’ve also been trying to figure out the fairest way to calculate ROI on my own rental property.
1. When accounting for your investment value, do you count closing costs as well, or only the principal investment? It sounds like you didn’t, do you mind sharing why?
2. I know you said that we should focus on calculating ROI against the total amount invested and not just the initial capital expenditure, but this leads to the phenomenon that ThomH noticed – your ROI will decrease over time, unless you can increase the rent massively. Doesn’t this kind of underestimate true ROI, especially since you dont consider any appreciation of the property value?
Not trying to be harsh or anything, but I’ve been struggling to find the right answer to these questions myself, in order to arrive at the “fairest” possible ROI computation. I think that’s important to decide between holding vs selling and pursuing other investment options.
Would love to hear your thoughts!
Hello LadyFIRE! Love the questions! I’ll do my best to answer…
1) I bought this property in 2015, and for the first year of ownership I absolutely included my closing costs in my ROI cost basis. It was (cashflow + princ paydown + appreciation) divided by (downpayment + closing costs + emergency funds). The reason I don’t include closing costs in my 2020 ROI is because I’m only trying to calc the ROI for this year only. If I was trying to calculate my total ROI over the entire investment I would include all out of pocket costs for the life of the investment and all profit for the entire holding time. Make sense?
2) You ROE will decrease over time because your leverage is getting smaller and smaller. You can’t stop this unless you refinance over and over. I should note… I didn’t include appreciation in my figures **this year** because I can’t confirm the property went up in value this past year. But in other years I absolutely do include appreciation because that is true profit and growth (and a very large part of it). If the property raises in value from 220k –> 230k this year, I will include an additional 10k in the profit and it’ll blow out my ROI for 2021. So it’s not that I never include growth, it’s just that I didn’t this past year.
I realize calculating annual ROI each year is kind of short sighted of me, because the true return is the average over many many holding years. But I think it’s fun to review every year and make sure that things are still growing in the right direction.
Thanks for the replies Joel.
1. Do I understand it correctly that you’re only looking at the equity in the duplex + emergency fund as “investment value” because that portion is what you could otherwise invest somewhere else, while closing costs etc are already gone and could not be invested elsewhere? That makes sense to me. Thanks for clarifying! I think that’s a good way to look at it on a yearly basis.
2. Thanks. I’m torn about including growth because it’s really just an estimate and could make the investment look “too good” on paper. But assuming no value appreciation whatsoever also doesn’t feel fair, that would be like counting only stock dividends but not considering value appreciation. I’ll keep thinking about this… Perhaps accounting for half the suggested appreciation is conservative but fairer… Not sure!
Hey Lady!
Yes, exactly. I use the amount I could otherwise invest elsewhere. (well, no gains tax or selling fees included). It’s the amount i also include in my NW reports for this asset.
If there’s growth, include it! But, like you said, just make sure it’s fairly appraised and conservative. Making it look “too good” on paper might give yourself (and others) a brighter outlook on rentals than what’s really going on.
Cheers! Have a great week!
AFA ROI decreasing as the property becomes more valuable, yes that’s true, but consider this:
I bought a a 3BR duplex in 1980? (jeesh I’m old) for 70K. It’s been paid off for 25 years and I now get about 18K a year in income, netting 13K after expenses/taxes. Current value is probably around 240K. A back-of-the-envelope IRR in Excel shows an approx. ROI of just under 8%…
Yeah, maybe I should have sold it, but I’m happy with my decision. My only involvement is to look for an email around the 8th of the month saying $1400 has been deposited to my account as I have a Mgmt company taking care of it. I’m happy, and that’s all that matters…
Anyway, just my story and good luck with whatever you do,
Love this perspective! If you’re happy with the return (I’m certainly happy with mine) then that’s what matters most. Congrats on 41 years of ownership! It’s stories like yours that got me into real estate to begin with.
Cheers for writing Cornelius! (I know that’s not your real name, but thought i’d just take a wild guess)
Wow, great to hear Joel! Having 100% occupancy and 100% rent collected in a pandemic is great. And good to know you’re still positive cash flow!
I do agree about the property taxes going up. I think it’s just one of those things that comes with investing in real estate. I still have your idea in mind about doing a write up on protesting taxes as I’ve done it several times. I may put together an episode about my experience doing it on the podcast.
Good tip about maintaining the AC. I had one blow up a few years ago. It’s definitely a high cost item! Glad I got a new one and just replaced it.
Regarding annual reviews, I keep a spreadsheet and look at it during tax time. Something I’ve been doing over the years.
Appreciate the update on your rental duplex. Looks good to me! :)
That means a lot coming from an experienced investor like you! Cheers! I’m definitely interested in any tax negotiating tips you have to share :)