It’s easy to focus on the purchase price when investing in a California rental property. That’s the price tag that most buyers use to begin negotiations, to plan their financing, and to calculate what kind of return they’ll earn on the investment.
But owning rental property in California requires more than a consideration of the purchase price.
There are a number of additional costs that come with owning an investment property. It can be a surprise to new investors or investors from other parts of the country who do not understand the nuances of California’s markets.
Real estate is a fantastic investment, especially in a market as diverse as California.
But the costs add up, and while some of those costs are expected, there are plenty of expenses that aren’t uncovered until later in the property owning process.
Let’s take a look at the true costs of owning investment property in California.
Uncover the Closing Costs Expense
Beyond the down payment and the financing that gets an investor to the purchase price, there are closing costs to account for. These are fees associated with finalizing the real estate transaction between buyer and seller. In California, these typically range from 2% to 5% of the purchase price. These costs may include:
Title insurance
Escrow fees
Appraisal fees
Recording fees
Transfer taxes (especially in counties like San Francisco and Los Angeles)
Attorney or legal fees (if applicable)
Here’s an estimated example: for a $700,000 investment property, a buyer could be looking at $14,000 to $35,000 in closing costs alone. These are often underappreciated when calculating the initial investment.
Planning for Property Taxes in California
California property taxes are governed by Proposition 13, which limits annual increases in assessed value to 2%, but sets the initial property tax based on the purchase price. The base tax rate is approximately 1% of the assessed value. Local assessments and special taxes can bring the effective rate up to 1.25%–1.5%. So, for that same $700,000 property, expect to pay around $8,750 to $10,500 per year in property taxes. If the property being purchased is in a newer development or a special district, expect to be at the high end.
Before buying a rental home, always research local supplemental tax bills that may go into effect after the close of the sale. When you’re not sure how to look for this or adjust your budgeting accordingly, contact us at Bell Properties. We’d be happy to help.
Insurance Costs: Fire, Earthquake, and Liability
Insurance has become a challenge for California property owners. Thanks to rising costs, higher claims, and major payouts being required for natural disasters such as wildfires, a lot of insurers have left the state entirely or stopped writing renewal policies.
Budgeting for insurance can be tricky, but it’s important to have a ballpark idea of what’s required to properly protect an investment property. Standard landlord insurance covers property damage and liability, but in California, especially in wildfire-prone or earthquake-prone zones, additional coverage is often required. We recommend that all rental property owners factor in the costs of:
Landlord insurance
Depending on where in California the property is located and how much coverage is needed, insurance premiums will be $1,000 or $2,000 a year in most places throughout California. This depends on property type, too.
Earthquake insurance
Earthquake insurance is optional. Despite the high risk of earthquakes in California, it’s not required for rental homes. We do recommend investors consider it, however, even though it will increase costs.
Fire insurance
Fire insurance is especially crucial in high-risk wildfire zones; and, most investors are finding that premiums are rising and availability is tightening. If you need help finding the coverage you need, contact Bell Properties. We can make some referrals.
Due to climate-related risks, insurers are increasingly selective. Some areas may even require coverage through the California FAIR Plan, which can be significantly more expensive.
Paying HOA Fees: The Cost of Community Living
More and more rental homes are showing up in HOA communities. These managed neighborhoods will have HOA dues, which are typically the property owner’s responsibility in California. These are fees that tend to cover:
Common area maintenance
Security
Reserve funds for major repairs
HOA dues in California vary widely. A condo payment could be $200 a month while a luxury community might have HOA fees that are closer to $1,000 a month. Investors need to know what they’ll be paying and what those fees cover. Be sure to uncover this cost.
Also, keep in mind that HOAs can issue special assessments, which are one-time fees for major repairs or upgrades.
Maintenance and Repairs: Budget for the Unexpected
The amount a property owner will have to budget for maintenance and repairs depends on the property’s age, condition, and whether or not upgrades and updates are needed. For most properties, we recommend that an owner budgets for things such as:
Plumbing and electrical issues
HVAC servicing and replacement
Roof repairs
Landscaping
Pest control
General wear and tear from tenants
Older properties and properties in coastal or high-humidity areas often come with higher maintenance needs. Conduct a thorough inspection prior to purchase and factor these costs into the investment analysis that’s done before closing.
Vacancy Costs and Turnover
Many investors are surprised at how much an unoccupied property will cost them. Vacancies are a reality in real estate, especially in cities with shifting job markets or seasonal demand. Whether it’s a one-month turnover between tenants or a longer period due to repairs or economic slowdown, it’s important to account for lost rental income.
Best practice: Assume 5%–10% annual vacancy when calculating your projected income.
If the monthly rent is $3,000 and one month per year is lost to vacancy, that’s a $3,000 loss. More, if the downtime is extended due to market conditions or needed repairs.
Even more expensive than vacancy are the costs associated with tenant turnover. When a tenant moves out and the owner has to prepare the property for a new resident, there are often maintenance costs that pop up. The property will have to be painted and cleaned. There will be a marketing cost. Screening.
This is a major cost to owning an investment property that often is not uncovered until an owner actually experiences it.
Legal and Compliance Costs
This is California, and that means it is very easy to make an unintentional legal mistake.
California has some of the most tenant-friendly and complex landlord-tenant laws in the U.S. Staying compliant is a best practice. It’s cheaper than having to pay a fee or a penalty. Some of the costs that could pop up unexpectedly for owners are:
Legal consultation and attorney fees
Lease drafting or review
Eviction proceedings
Registration fees for rent-controlled properties
Code compliance repairs
Investors also have to factor in rent control restrictions, just cause eviction rules, and habitability standards. There’s fair housing to worry about and the difference between a pet and a service animal. Don’t make mistakes unless you’re ready to pay for them.
Contact us at Bell Properties for support with legal compliance. We stay ahead of the laws.
Capital Expenditures and Planning for Big Projects
A new roof. An upgraded plumbing system. New paint inside and out.
Unlike routine maintenance, capital expenditures refers to major replacements or upgrades such as:
Roof replacement
HVAC system upgrades
Window or door replacements
Structural improvements
These costs can climb pretty high, depending on scope of work and the team that’s doing the work. Building a reserve can help investors approach these large expenses without any concerns.
Depreciation and Taxes
While depreciation is a powerful tax benefit; (investors can deduct the cost of the home structure or building over 27.5 years), that does not mean that the money is free. Once the property is sold, the IRS will often “recapture” depreciation at a 25% tax rate.
It’s also important to remember that California taxes capital gains at the state income tax rate, which can be as high as 13.3%, depending on income bracket.
Smart investors:
Consult a CPA before purchase
Use cost segregation studies where appropriate
Consider 1031 exchanges to defer taxes on profits
Property Management: Professional Help Costs Money
Property management and leasing fees should be considered as well.
Smart investors turn to professional managers to take care of the day to day logistics around the property. The management fee is typically 8% to 12%. Contact us at Bell Properties to talk about our management fees, which we believe are competitive and include excellent value.
In California, real estate investing remains a great way to earn money, but it requires more than just a down payment and a set of automated mortgage payments. By understanding and planning for these additional ownership costs, investors can make informed decisions that preserve profits and reduce risk.
Let’s talk about the deals you’re interested in making and the properties you want to buy. We can help you establish what those true costs may be. Contact us at Bell Properties.
