The break even point for an income property is a ratio that shows the annual income level required to cover operating expenses and debt service.  To calculate the break even point, the total of annual operating expenses plus annual debt service is divided by the annual effective gross income and the result is expressed as a percentage.  A break even point of 100 indicates that a property is making zero profit.  All of the property's income is required to pay debt service and operating expenses.  When purchasing an income property, the typical range for the break even point is 60 to 95.  The lower the break-even point, the more profitable the property.  To put it another way, to be profitable, an income property’s annual effective gross income must be greater than the cost of it’s annual debt service plus annual operating expenses.  

NOTE:  Break even analysis doesn’t take into consideration the cost of personal property such as lawn mowers, snow removal equipment, stoves, refrigerators, etc. which may be required to rent and manage an income property and capital improvements such as the need for a new roof, new carpeting, a new heating or cooling system, etc.  When purchasing an income property, take a good look at the condition of the personal property being transferred at the time of sale that might require replacement and the need for potential capital improvements such as a new roof.  The cost of a new roof can be greater than the property's annual operating expenses.  Be aware that break even analysis is affected by how much money you put down on a property.  The more you put down, the lower the break even point.  Break even analysis for an income property is also affected by the property's annual vacancy rate.  The higher the vacancy rate, the greater the break even point.  A good property manager can reduce a property’s break even point and maximize profits by minimizing vacancies and by keeping rents at market value. 

The break even point is calculated like this. 

Operating Expenses include the following items: heat and electricity paid by the owner, property taxes, property management fees, insurance, leasing commissions, wages, pest control, advertising, accounting fees, legal fees, trash removal, etc. 

Annual debt service is equal to the monthly mortgage payment or payments required to purchase an income property times 12.  If you have an interest only loan, the annual debt service will include just interest.  If you have a fully amortized loan, the annual debt service will include both interest and principal.

The effective gross income for a property is equal to the annual maximum gross rents possible plus other income such as laundry receipts, vending receipts, parking fees, etc. minus the annual vacancy amount.  It is best to use the actual or effective gross income rather than the potential gross income when calculating the break even point.

Example:  The annual debt service for an income property is 50,000.  The annual operating expenses are 35,000 and the effective gross income is 100,000.  Calculate the break even point.

This means that it requires 85% of the property's effective gross income to cover operating expenses and debt service.

The On Target Real Estate Investment Software calculates an income property's break even point and many other important real estate investment ratios.  The knowledgeable real estate investor should have a good understanding of the break even analysis and how it is used.  Let the On Target software do the calculations for you reducing the possibility of error. 

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