Your breakeven point is a vital piece of information that is useful for you as a landlord and also for a mortgage lender. Working out your break-in point or ratio gives you a good idea of how viable a property is as a rental investment, which can help you to find a good property and help your lender to make a decision.
Using the breakeven ratio formula
A breakeven ratio formula is very simple as it has just three variables:
- The property’s debt service, or how much you pay on the mortgage each year
- The property’s operating expenses, such as insurance, taxes, maintenance, safety certificates, repairs and so on, and
- The gross operating income of the property, which is what the property will earn in rent minus any voids or refunds
Once you have all the variables, you simply add your annual debt service to your operating expenses and divide this amount by the gross operating income.
An example
Your rental property has an annual debt service of £12,000 and operating expenses of £5,000, so it costs you £17,000 each year to run the property.
Your annual gross income from renting out the property is £24,000.
This means that your breakeven ratio is 17,000/24,000, or 0.71%.
So, your magical breakeven ratio is 71% – you need your rental property to be occupied for a minimum of 71% of the year in order to earn enough rent to cover the running expenses.
Why you need to know your breakeven ratio
You already know it’s important for you and your lender. Your breakeven ratio gives everyone a good idea about how much cash potential the property has. A high ratio – 90% or so – means that even a small void could send you into a loss, whereas the 71% ratio above is a pretty good proposition. You could have two or three void months a year and still pay your expenses and even make a profit. Most lenders and investors are looking for a breakeven ration of 85% or below – preferably below.
Reducing your breakeven ratio
If you’re hovering around the 85% mark, then you’ll probably want to improve your breakeven ratio, especially if you’re looking for a lender or to increase your profitability and resilience.
The easiest ways to reduce your ratio are to increase your revenue and to reduce your operating expenses.
Boost your revenue
You can’t just increase the rent because you feel like it, but you can offer more services which your tenants will probably be happy to pay for. You could add a small surcharge for pets, for example, or include extra satellite TV channels.
Alternatively, you could make sure that there are no void periods at all. Start up a waiting list of potential tenants, even when the place isn’t empty, so that when one set of tenants does give notice, you have someone waiting in the wings.
Lower your operating costs
Shop around to find cheaper plumbers, window cleaners, and other maintenance service providers. Don’t wait around to fix small problems, as they often grow into bigger and costlier issues and your tenants might get annoyed with waiting.
Reduce your fixed costs
You could do this by remortgaging to a lower interest rate, but if your breakeven ratio is high, you might have to wait until you’ve paid more of the mortgage down to help you to qualify for better rates.
