What CapEx numbers to factor in rental deal?

Question

Hi All,

I am trying to work the numbers on a deal that I am interested in and am curious as to what Capital Expenses I should average into my long-term costs? For example: if the roof is already in good shape, should I still set aside money in a reserve fund for future replacement of a roof? Say a new roof is $5k and lasts for 20yrs...should I set aside in my "reserve funds" about $250 per year or $20.85 /month?

1) Should I also try to do the same thing (set aside reserve funds) for about everything: water heater, windows, furnace, etc? Or does this seem overkill assuming the items are in good shape already? If I add up all possible expenses for a reserve fund, it seems that my cashflow will be very low.

2) I understand it is important to account for vacancy, maintenance, etc. but when it comes to setting aside money for major future repairs, I am not sure how much money I should be setting aside. I don't want to set aside too little, but I also don't want to estimate too high expenses for every little thing and never keep any cashflow on the deal.

3) Also, should I be setting aside a management allowance, even if I plan on managing the property myself? If I set aside a 10% management allowance, this also kills cashflow. This is a duplex and I would doubt most people who purchase a duplex would hire a management company anyways?

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Below is a summary of my deal and expenses:

Duplex - Gross Monthly Rents $1,300.00

Monthly P&I Only $485.00
Monthly PMI Insurance (If Applicable) $107.00

Total Debt Service & PMI $592.00

Cashflow Using 50% Rule
Monthly Operating Expenses (50% Rule) $650.00
Monthly Cashflow (NOI - P&I and PMI) $58.00
Annual Cashflow $696.00

Cashflow Using Actual Numbers
Monthly Operating Expenses $559.85
Monthly NOI (Gross Rents - OpEx) $740.15
Annual NOI $8,881.80
Monthly Cashflow (NOI - P&I and PMI) $148.15
Annual Cashflow $1,777.80

Monthly Operating Expenses
Monthly Insurance
Homeowner/Hazard Insurance $69.00

Monthly Property Taxes $155.00

Monthly HOA Fees (If Applicable) $-

Monthly Management
Management Allowance 10% of Gross Rents $-

Monthly Utilities (If Owner Paid)
Electric $-
Water $-
Sewer $-
Gas $-
Garbage Pickup $-
Water & Sewer & Trash $143.00

Other Costs (Averaged Monthly)
Vacancy (7% of Gross Rents) $91.00
Advertising $-
Snow Removal $-
Landscaping $15.00
Maintenance $25.00
Office Supplies $-
Accounting $9.00
Legal Fees & Court Costs $10.00

Capital Expenses (Averaged Monthy)
Roofing ($5k / 20yrs) $20.85
Furnace & A/C ($4k @ 15yrs) $22.00
Water Heater(s) $-
Windows $-
Siding $-

Total Operating Expenses $559.85

Total Expenses Overall Including PITI & PMI = $1,151.85
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Please answer my first 3 questions at top first and possibly analyze my numbers if you wish. Thanks!

Harry M. · Answer

Hey Craig - we aim to always keep at least that much in reserves, so if it were to fall below we'd replenish it as quickly as we could.

We don't really differentiate the money we have saved for reserves from the money that we are putting aside for the next property, as long as it doesn't fall below the reserve amount. Suppose that for property X, 6 months of PITI is $6000, and we have that. And suppose that we are currently part of the way towards saving the down payment for our next property, lets say we have $15,000 saved for that. So, $21,000 total. Then a major CAPEX occurs for property X, say it costs $5000. We'd be left with $16,000. So, technically, after that we wouldn't have to replenish our reserves since we still have $16,000, well above the reserve floor - it would just take longer before we were ready to buy the next property.

The most important thing to us is just to make sure that if large unexpected expenses occur, there is money available to deal with it. Note - the reserves aren't specifically for CAPEX, they're for everything, for example an extended vacancy. If there was an expected large CAPEX coming up - for example, if there were only a few years of life left on the roof - we would save for it separately, so that when we spent the money our reserves didn't get too low. We'd temporarily raise our overall floor amount of cash that we maintain for the couple of years or so prior to when we expect the roof to need replacing. Being ready ahead of time is good. For example, if the roof started developing leaks a year or so before we planned to replace it, we could make a more long-term decision between spending money to patch it up versus replacing it a year early.

We also maintain a separate floor amount for our personal finances. So if push came to shove, for example a couple of large expenses one right after the other in the early months of owning a property before there was much saved for the next property to serve as an additional cushion, we could tap that. The underlying thing for us is making sure that we are on solid financial footing so we are ready for the curve balls that life/real estate can throw at you.

Hope this helps a bit. -Harry

Joel Owens · Answer

Plan for management. Your life situation might dictate you to not manage in the future or you might find you just do not like being a manager and want that separation.

Joel Owens · Answer

Craig when you run the numbers you plan the "time horizon". This is the time you plan on holding before moving up to another larger property or multiple properties with built up equity.

If your property needs no immediate repairs then you go 50% of costs with no landlord paid utilities, if you pay utilities you go 60% costs.

So if you plan on holding 10 years for example and the roof has five years left you plan a capital expense in year five for projected labor and materials.

If you decide to not fix the roof and sell in year 7 or 8 for example then simply the buyer will reduce the offer price to compensate for the deferred maintenance. Sellers always try to suck the cash out and then make a buyer pay for their delayed repairs. It doesn't work that way. Either the seller maintains the property correctly with no deficiencies and commands a higher price or they do not fix things and get a much lower price on resale. One way or another they will pay for it.

Reserves is subjective and up to the individual. If you are flush with cash then you can afford big capex items when they occur and invest the cash flow elsewhere instead of parking it. If you have limited reserves then putting away most might make sense so you do not get in trouble when a big repair occurs.

Craig S. · Answer

Thanks for the reply @Harry M.

When assuming setting aside 6 months PITI in your example, when you do incur a CapEx and take money out of the reserve you have set up....do you replenish the 6 month reserve after you pay an expense? Do I always keep 6 months of PITI as a reserve?

Harry M. · Answer

Hi Craig,
Just to second what Joel Owens said regarding management - not only might your circumstances change, but if you sell later down the road, your potential buyers may be factoring in management cost in deciding how much they can offer. I don't have facts and figures, but it's not that unusual for a duplex owner to use management. I'd run the numbers twice, once without management expenses, to see what you can expect to earn self-managing, and once with to make sure that the property will do ok if management does become an issue.

Regarding itemizing the expected expenses in a lot of detail, @Jon Holdman gave some great advice about this in some previous threads about the topic. To paraphrase, he cautions that it can lead to a tendency to noodle each item to get the deal to work. Not saying at all that this is what you are doing, but I can certainly see the danger (I've caught myself doing it). The good thing about the 50% rule is that it accounts for the fact that you don't know what every single expense is going to be.

Speaking of 50% rule, I believe that it assumes that the tenant pays utilities. If you do have to pay water/sewer/trash, you need to add some to the percentage.

Regarding setting aside money for capex - our policy is to save up about 6 months PITI as reserves before buying the property, then after that save 100% of the cash flow towards the next property. In other words, we basically just maintain a floor amount in our bank account that we never go below, and before considering ourselves ready for another property, the floor goes up another 6 months worth of PITI for that property. This is kind of simplistic and we'll need to do something a bit more accurate before we move up to larger properties (small apartment complexes and bigger), but for the stage we're at now, it makes sense to us.

Best of luck with your plans. -Harry

Craig S. · Answer

How do my numbers above look? Does it look like I am estimating expenses properly, or do they look high or low?

Craig S. · Answer

Ok thanks for the info Joel!

Should I still account for management allowance, even if I plan on managing the units myself? Should I account for management when determining if it is a good deal or not?

What CapEx numbers to factor in rental deal?

What CapEx numbers to factor in rental deal?

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