If you rehab a property completely will expenses be less?

Question

I have a question? I understand the 50% rule for the most part but am unclear about what expenses it includes. If you purchase a property and rehab it completely is it safe to assume your expenses will be slightly less because you've added a new roof, heating system, updated electrical, ect? I know tenants can break windows, put holes in walls, ruin appliances but I can't imagine them destroying major things like roofs and heating systems.

Thanks ,
Heather

Account Closed · Answer

The actual expenses you pay out each month or year will be less during the first few years after a heavy rehab. However, for the purpose of running a business, IT DOES NOT MATTER.

Why?

Because you need to be setting aside reserves for the NEXT expense you have to pay. The investors who front the money for expenses do it because they didn't build any reserves to cover expenses you know or should know are coming.

Everything in a building has a definitive useful life. The roof, the appliances, carpet even the paint on the walls.

Smart investors use this fact to set aside monies to pay for repairs and replacements. That is part of what the 50% rule of thumb gives you, the ability to budget for future expenses and set the money aside so that it is there when you need it.

Heather Pelletier · Answer

Thanks Taz and Mike,

I appreciate your input.  I have every intention of putting every dollar I make into a reserve fund.  I have learned from my mistakes and now I am trying to learn from all of you.

" I had a friend about 2 or 3 years ago that had a tenant steal the furnace and sell it for scrap. I know another landlord that had a tenant plug all the drains in the house and turn the water on when she left. I know a professional property manager who had a tenant steal all the kitchen cabinets, sink, and the countertop when the tenant left."    Yikes, that's scary stuff Mike.  Thank goodness it's far and few between.

Heather :)

Heather Pelletier · Answer

The "50% rule" lumps both of these, as well as vacancies, into the "50%".

So does this mean the expenses will be slightly less?  Maybe I'll just explain the deal I'm analyzing.

REO asking price 57K
ARV-124K
FMR-1000-12000
Estimated repairs to be able to rent immediately-15K
The house will eventually need a new roof and exterior paint-  15K

We're thinking a fair offer would be 43K but aren't sure becaue we know it will eventually need a roof.  What are your thoughts?

Michael Rossi · Answer

Then you need a more vivid imagination!  I had a friend about 2 or 3 years ago that had a tenant steal the furnace and sell it for scrap.  I know another landlord that had a tenant plug all the drains in the house and turn the water on when she left.  I know a professional property manager who had a tenant steal all the kitchen cabinets, sink, and the countertop when the tenant left.

Part of that is due to inadequate screening by these landlords and some of it may have been unpreventable.

I've been lucky and haven't had anything that bad happen yet, but it's coming.  It's a statistical certainty!

This king of damage/theft doesn't happen often, but it does happen!  If you have enough rentals for enough time (or if you only have one rental and you're very unlucky), it WILL happen to you.

Mike

Jon Holdman · Answer

J Scott is correct that the IRS treats expenses and capital items differently.  The "50% rule" lumps both of these, as well as vacancies, into the "50%".

Maintenance is a significant piece of the equation, but its only a piece.  Many of the "expenses" are independent of age or condition of the property.

Richard Warren · Answer

If a house was rehabbed properly and the basic systems were upgraded or replaced you should see a reduction in major repair expense.  Understand that many, if not most, smaller repair items are caused by tenants.  The expense reduction that you may see will be in the early years.  It is better to assume that the expenses will be there and bank any savings in a repair fund.  I have a separate reserve account for these items.  If you replace a roof or furnace it should be many years before you need to do it again, but there will be plenty of other items.

:cool:

Heather Pelletier · Answer

Thanks for the clarification guys, I appreciate it!!

Heather :)

J Scott · Answer

There is a difference between "expenses" and "capital improvements".  Things like new roof, new HVAC, etc, are capital improvements, and must be budgeted for during the lifetime of ownership of the property.
            
            Generally, expenses refer to everything else -- vacancy, PITI, maintenance, property management, etc...
            
            Your expenses may be lower if you tackle the capital improvements earlier, but probably not significantly.  For the most part, capital improvements are "all or nothing" -- you either need them (your roof is leaking) or you don't.

Certainly there are some maintenance expenses that you can make up front (plumbing repairs, better insulated windows, etc), and those may save you some money on maintenance expense, but again, it's whether you spend it now or later...

If you rehab a property completely will expenses be less?

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