Los Angeles, CA · Member since 2017 · 29 posts · 7 votes
I am having a tough time understanding how $250-300 per unit is adequate for a CapEx Reserve. For example, if an HVAC blows out, that's a $3000+ expense and there goes 10 years of reserves. There are so many other items in an unit that the reserve should pertain to including appliances, roof, electrical, plumbing, etc.
So my question is, how do people justify $300 per unit annually for reserves and what do they expect to capture in that figure (versus just including it in repairs).
$250-$300 is not always adequate, and the lender will use third party reports to calculate this for you. You can see this jump up to $500 fairly easily for some buildings, or in some markets, or with some lenders.
In regards to your example, HVAC is likely the largest expense you'll see on a per unit basis. And the typical expectation is that you'll get more than 10 years of use out of it. We can get complete HVAC replacement for $2,500, with an expected life of 15 years. That's $167 per year. The roof of a 16 unit two story building will cost about $20,000 to replace. That's $1,250 per unit and lasts about 15 years, so $83 per year. Next largest is likely the water heater at $50 or less per year. Those three alone get me to $300 per year.
Lenders like HUD are a lot more conservative, and will likely require $500 per unit per year. But even if your lender doesn't require more than $250, I wouldn't underwrite less than $300, and even that is pretty skinny. We're able to underwrite $300, but we come in with cash reserves to replace the roofs (even if they're brand new), to replace a third of the HVACs (or more depending on current condition), to replace a third of the water heaters, and a third of the washer/dryers (if in unit). Hopefully I don't have to use these, but it's better to be safe. And even if you're not as conservative as that, you'll still need some type of cash reserves to hold you over until you can build up your reserves with the lender, which will take a few years.
$250-$300 is not always adequate, and the lender will use third party reports to calculate this for you. You can see this jump up to $500 fairly easily for some buildings, or in some markets, or with some lenders.
In regards to your example, HVAC is likely the largest expense you'll see on a per unit basis. And the typical expectation is that you'll get more than 10 years of use out of it. We can get complete HVAC replacement for $2,500, with an expected life of 15 years. That's $167 per year. The roof of a 16 unit two story building will cost about $20,000 to replace. That's $1,250 per unit and lasts about 15 years, so $83 per year. Next largest is likely the water heater at $50 or less per year. Those three alone get me to $300 per year.
Lenders like HUD are a lot more conservative, and will likely require $500 per unit per year. But even if your lender doesn't require more than $250, I wouldn't underwrite less than $300, and even that is pretty skinny. We're able to underwrite $300, but we come in with cash reserves to replace the roofs (even if they're brand new), to replace a third of the HVACs (or more depending on current condition), to replace a third of the water heaters, and a third of the washer/dryers (if in unit). Hopefully I don't have to use these, but it's better to be safe. And even if you're not as conservative as that, you'll still need some type of cash reserves to hold you over until you can build up your reserves with the lender, which will take a few years.
@Mike Ball one thing to consider is you should have a thorough inspection done before you purchase so you can account for any major repairs prior to closing and anticipate future needs.
On smaller properties $300-$500 is not much but over 100 units or more it’s $30k-$50k so your CAPx account can grow pretty quickly but as you point out unanticipated major repairs can wipe out cashflow pretty fast so you need to do thorough due diligence in advance of closing.
$300 annually? Where did you get that figure from? Generally 5-10% of rents per month is normal. I have fairly new hvac in a duplex and I set aside 5% of $2,250 rents per month. That’s $1,350 per year. Plus the reserves for maintenance and vacancy.
$300 annually? Where did you get that figure from? Generally 5-10% of rents per month is normal. I have fairly new hvac in a duplex and I set aside 5% of $2,250 rents per month. That’s $1,350 per year. Plus the reserves for maintenance and vacancy.
It's a standard figure from lenders, like Fannie/Freddie.
@Anthony Wick I set aside 7% for vacancy and bad debt as well. My question was more on the capEx reserve. Most institutional investors underwrite $250-300 for CapEx reserve from what I have seen.
@Sam Grooms Thanks so much for such a detailed response. Do you not consider things like electrical, plumbing, exterior of building, parking lot, etc? or is that thrown into the repairs figure.
@Greg Dickerson Good point, I will budget more than $500 since I am looking at smaller properties.
@Ben Leybovich I have increased it to $500 and the deal is a little tight, but still works.
@Anthony Wick I set aside 7% for vacancy and bad debt as well. My question was more on the capEx reserve. Most institutional investors underwrite $250-300 for CapEx reserve from what I have seen.
@Sam Grooms Thanks so much for such a detailed response. Do you not consider things like electrical, plumbing, exterior of building, parking lot, etc? or is that thrown into the repairs figure.
@Greg Dickerson Good point, I will budget more than $500 since I am looking at smaller properties.
@Ben Leybovich I have increased it to $500 and the deal is a little tight, but still works.
General interior and X terrier maintenance and repairs including the parking lot are linen item maintenance costs.
Major building improvements interior, exterior and parking lot would be considered capital expenditures.