I’ve seen many different spreadsheets and pro-formas over the years, calculating potential return on investment for a given rental real estate investment. It’s not uncommon to find wholesalers inflating returns by eliminating all sorts of typical expenses (ie. vacancy, property management, insurance, etc). While this may trip up a newbie investor, most folks know to build in the usual expense categories when developing a pro-forma. Even so, I find it interesting how infrequently I’ll see the following three categories in a typical ROI calculation:
What is turn-over expense? It’s money spent on a property when a tenant moves out to get the property ready for the next tenant. Inevitably, when a tenant moves out of a property there is some level of work needed to get the property in marketable condition. Most investors will touch up walls and paint (if not completely re-paint), clean and replace flooring as needed, take care of minor handyman items, etc. All of this can easily add up to over $1,000 (and sometimes much more) depending on the size of the property and the condition that it was left in.
While most investors have a line item for maintenance in the pro-forma, I find that it’s rarely enough to include turn-over expenses as well. Maintenance is really an ongoing budget item as repairs will inevitably be needed over the life of the property. Turn-over expense is really associated with the moving in and moving out of tenants.
Another budget item that may or may not belong on a specifc property proforma, but should be calculated nonetheless is bookkeeping and tax preparation. For the small investor who doesn’t mind tracking expenses and doing his own taxes, this may not be an issue. However, for the investor with multiple properties and an operation more like a business with properties in multiple LLC’s, it’s likely that there are costs associated with bookkeeping and tax prep. It’s important to include these figures when evaluating new properties for acquisition.
CAPEX stands for Capital Expenditures and pertains to big ticket expenditures that increase the useful life of the property. I think the most obvious CAPEX type expenditures on residential properties are items like the roof, HVAC, water heater, etc. I consider this slightly different than maintenance because they are higher cost items.
It’s very common for investors to buy a property with an old roof or an old HVAC and not budget for future replacement. For example, if you determine that you only have 5 years left on an old roof and you determine that a new roof will cost around $5,000 to replace … don’t you think you should budget $1,000 per year for the next 5 years to cover this expense? It seems obvious, but I almost never see investors doing this.
Understanding the true cost of an investment is one of the most critical elements to succesful investing. It’s important that investors use accurate numbers and budget for all appropriate expenses associated with a potential acquisition.
What about you … how many of you specifically budget for these items?