Deferred Maintenance – A Silent Cash Flow Killer
Deferred Maintenance – the practice of postponing maintenance activities such as repairs on both real property and personal property in order to save costs, meet budget funding levels, or realign available budget monies.
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That is the definition of deferred maintenance according to Wikipedia. My definition, as it relates to income producing investment properties, would be a little less subtle and much more emphatic. If you defer maintenance to save dollars, you might as well place that money in a box next to your fireplace to use as future kindling. Your cash flow is going up in smoke!
Deferred maintenance can be an absolute killer for an investor looking to build a reliable passive income. What makes deferred maintenance particularly worrisome is when an investor purchases a property without knowing there is deferred maintenance and that puts future cash flow at considerable risk. Two recent incidents brought this topic to the fore front and served as inspiration for this article. One had nothing to do with real estate…but raised the term deferred maintenance in a whole new light for me. The second was very related to real estate and spoke volumes of why there may be an epidemic of misinformation and likely lost cash flows to come.
Time for a check-up
I readily admit that what others view as intelligence on my part is often my having the fore-thought to surround myself with really good, smart people who give good advice. So when I recently put off a visit for a check up with my doctor, it was my wife who, in here infinite wisdom, pointed out the error in my thinking. Yes, she is smarter than me! She used an analogy that, as a real estate investor, I would understand. I had used the excuse of having visited a minor med recently for a strep test. While there, they did all the usual tests and the doctor and I had a good discussion about my over all fitness and after about a 15-minute visit, it ended with him declaring me fit as a fiddle – and the strep test was negative.
She immediately countered with a scenario from earlier in the year that involved one of our properties. She reminded me that I made four roof repairs to fix small leaks on one of our properties. With the first leak, the roof should have been replaced, but I chose the low-cost repair. By the time I had paid for four repairs, I could have replaced the roof and not had to worry about it for another 20 years. With the 5th small leak, I did replace that roof and it cost me twice as much as it would have had I simply replaced it at the first sign of trouble. She then asked me why I have all of the systems in my properties checked each year. She wanted to know why I replace furnaces and AC units that look suspect instead of repairing and maintaining to get every last breath out of them. She was right. She reminded me that deferring maintenance on properties only led to higher costs in the future. Why in the world would I defer maintenance on my body if I wouldn’t on my properties. What would that cost be?
Getting Investment Property “Rent Ready”
We recently hosted a group of investors in our offices who were touring the country visiting good markets for purchasing cash flow properties. This was a new phenomenon for us as we had never hosted foreign investors before and I have to admit, the stories we heard made us cringe. By far the worst thing we heard from these investors was the explanation they received of the “American” way to invest. They had been told that in America, we do not spend $1 dollar on maintenance or repair that we cannot recoup on rent. It’s called getting the property “rent ready”.
So when the investors asked about the cracked electrical covers, they were told new plate covers would not lead to any additional rent. When they asked about the missing handrails on the steps outside, they were told hand rails wouldn’t allow them to raise the rent. When they asked about the dust and duct tape on the rusty furnace, they were assured that it had been serviced and it had plenty of years left. No need to replace now, it will only lead to less cash flow!
I was appalled that anyone still thought this way and I zero in on the term “rent ready”. I absolutely agree that there are different levels of renovation for a property that you want to retail to a new buyer and one that you want to hold for cash flow. Overspending on the wrong items can set your return back, but should not eat into your monthly cash flow. I am not referring to cosmetic cures to attract a buyer. I am talking about big-ticket items such as roofs, furnaces, water heaters, electric panels and plumbing. When I used Google to search the term “rent ready” and read the returns on the first page, I found multiple lists and none of them listed any of these areas. They all say to clean the yard and that having your property smell nice is a good thing. None of them say replacing an original roof on a 30-year-old property is a good idea or that replacing a rusty furnace held together by duct tape is a good idea, whether it lights or not!
These are the types of items that are easy to ignore and convince ourselves that a $200 repair bill is better than a $1,500 replacement. But after paying 5 or 6 repair bills, which can make a full month’s cash flow disappear each time you get one, you are faced with the decision to replace. That is when the real cost of deferring maintenance comes into play. If you calculate the costs to maintain with the cost to replace, in many instances it could cost twice as much and often an entire year’s return can be lost.
Secure Your Cash Flow
If you are investing in real estate, it does not matter how you acquire it, make sure you have a plan in place to address the big-ticket items on a property. If you are purchasing a property that someone else has renovated, pay attention to what has been repaired, what has been replaced and what has not been addressed. If you cannot get that information, no matter how good the deal looks, you don’t have the info. you need to make a good decision. If you are purchasing a property and looking for ways to make the deal stronger, cutting back on needed repairs and deferring maintenance is a sure-fire way to make that deal weaker not stronger. These items will eventually need to be addressed and it costs a lot less to address them on the front end than it is on the back.
For those of you wondering, I was definitely swayed by her argument and have an appointment scheduled for a full check up after the first of the year. I’m not willing to keep patching with minor med. visits!
Photo: Tony Alter