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Don’t Forget To Budget For These 3 Overlooked Expenses

by Ken Corsini on May 2, 2014 · 7 comments

  
Expenses

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:

Turnover

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.

Related: The Two Most Painful Words a Landlord May Ever Hear…

Bookkeeping/Tax Prep

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.

Related: Paperless Accounting: How to Streamline Your Real Estate Bookkeeping

CAPEX

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?

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{ 7 comments… read them below or add one }

Jordan Thibodeau May 2, 2014 at 9:33 pm

Yes those hidden costs can be real killers. Once you account for those, the high cash flowing properties don’t look so good.

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AJ May 2, 2014 at 10:27 pm

This post needs more comments/attention.

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Lisa Phillips May 3, 2014 at 9:17 pm

CAPEX! Definitely! These are my “surprises” I try to do all of these repairs up front to not worry on the backend. Otherwise, year 5, you got about half your cash flow taken away for that year.

Thanks, this is a great way of thinking ot hings, for instance, of saving a certain amount each year to replace these big ticket items! Great article :-)

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Billy May 4, 2014 at 1:00 pm

don’t forget Tree Trimming if you have big old trees

Reply

Angel Prentiss May 5, 2014 at 12:52 am

My custom built rental calculator factors the following

1. LEASE-UP COSTS ($500 for 1 mgr, 50% for another mgr, 100% for 2 other mgrs or I hire a prop mgr to do lease up for me during turnover)
2. MAKEOVER COSTS (tenant pays for some things like professional carpet cleaning but we still have to fix this, tweak that)
** Monthly reserves for these are calculated by using vacancy rate**

3. ACCOUNTING/TAX PREP– our CPA allocates our tax return cost across the portfolio as an expense and some onto our personal tax return

4. LEGAL – getting advice from our attorney on landlord tenant issues. I just dropped $200 last couple of weeks on one property (a tenant headache) and needed attorney guidance to identify a solution and navigate legal process. Necessary for new investors. Doesn’t have to be big especially if you have a portfolio to accumulate across the board. We do $10-15/property. Even little amounts reserved is an expense and including it gives you a moreaccurate picture of cashflow.

5. PERIODIC MAINTENANCE: say annual yard clean up/shrub trimming, terminate treatment. I also inspect inside and outside of our local properties 2x/year with my hourly contractor– we do preventative maintenance.

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Jason May 5, 2014 at 1:06 pm

Ken,

Great topic. People always look at my numbers like I am crazy, but i tend to be tight.
12% for maintenance. This includes long term projects. We try and repair major systems up front or budget for them. This also accounts turn repairs. I am starting to tweak those numbers based on the level of repairs and age of the property. Right now that is my back of the napkin number.
12% Property manager. 8% ongoing plus 4% renewal/lease up.
8% vacancy. This accounts for the vacancy plus utilities/upkeep.
~ 32% without taxes, mortgage and insurance.

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Shaun May 11, 2014 at 12:41 am

Not putting away reserves for CapEx items is easily the biggest, and dumbest, thing I see people do. “Well the roof is only a few years old” or “They just put in a new Hot Water Heater” or “This house was just rehabbed so there really won’t be any repairs.”
Unless you are only going to be in for a few years and want to roll the dice this is a bad idea.
(In that last case you see people not even budget for repairs and maintenance!)
I usually run my numbers putting away 10% for repairs and maintenance and another 10% for CapEx and reserves. I assume turnovers in the 2nd if it is more than a “bad month” on maintenance.

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