I currently own 2 positive cash flowing duplexes and intend to grow my portfolio over the next 20 years or so. While analyzing a property for purchase, I allocate %5 of gross rents for capital expenditures. On my most recent acquisition this is about $68 a month. Do you recommend that money staying in the general business checking account or do you bump that money each month to a CapEx savings account to build up a fund for future capital expenditures?
I don't recommend doing this at all. Why? What is your goal? To use this money to do what? Replace a roof, furnace, hot water heater, etc...? LOL.
This a one of the many problems in using "%'s" instead of "$'" here. 5% savings makes it seem as if you are accomplishing something...and you're not. It's an illusion, and a dangerous one. Instead of looking at the numbers with "%" after, let's look at the numbers with "$" in front...the ones that actually matter.
Problem: You said you are saving a whopping $68/month. That means you are setting aside an enormous $816/year, assuming no vacancies, or any other surprises. How much would a new roof cost you now? Maybe $4500 on the cheap side? Now, doing simple math (you know, that math many said they would never use when they were in school, so why are we learning it? I guess many never did...learn it that is), I calculate that if all goes well, it will take approx. 5.5 years to have enough cash stock piled away to pay for that roof.
But wait, before those 5 years are reached, we had a vacancy (what are the odds?), which meant lost income, carrying costs (taxes, insurance, etc...), and the cost of repairs not covered by the SD (paint, etc...). How about over the course of those 5 years this adds another $2500 in costs...or subtracts it from the $4500 that you are saving for CAPEX.
That's $7k you need, and those 5 years turns to...it doesn't matter, because this method doesn't work. It's an illusion.
Solution: Instead of doing it this way, you're much better off setting up one company you designate as your management company (not property management, business management), and they have a growing LOC that is used for all of the properties you own/manage. As each property needs funds for "sh.. happens", the LOC is used, and the property repays it after the fact using the CF from that property.
As long as you can maintain a possitive cash flow for the property with the problem, you're still ahead. This is how you manage the situation, instead of the situation managing you...and you turn the costs into expenses.
@Joe Villeneuve That's an awesome idea.Thanks for sharing!
@Joe Villeneuve , I understand what your saying here and think you have an interesting plan with the LOC. I would like to throw out there that this was 5% was only accounting for CapEx. I would only be using these funds as a means to pay for roofs, water heaters, furnaces, ect. I have included additional contingencies for repairs and vacancy. I based the 5% on many factors including the small size of the building, the roof being new two years ago and the overall durability of the structure. I could see this number being 10% percent on a larger or more complex property. I don't think 5% is a catch all number for all properties.. My intention is not to be argumentative as I did as for your advice and opinion however, I would feel better about accounting for these imminent replacements on a calculated savings basis rather than financing them as they arise.
I'll dive deeper in thought on your LOC/ Business Management company establishment to see if I can find any pro's or con's for my units as well. Thanks!
One aspect I do appreciate about the LOC plan is that it would provide a level of consistency in cash movement. Rather than a 5k roof coming out all at once it would be dispersed over several years. The monthly payment to the LOC very well may work out to be near the 5% number that I had accounted for in my analysis. A second advantage I could see is the LOC would eliminate idle cash sitting around earning nothing when it could be better invested. I do fear this CapEx account could grow to an unnecessary balance in time.
@Aaron Currier - was wondering why you'd bother having a separate account for CapEx? I mean, what does that get you as a landlord/business owner, other than more churn?
If it is to compartmentalize costs, would you also have an account to pay your PM, another account for maintenance, another account for vacancy? Seems like it could become a logistical nightmare fast.
If your goal is to see the performance of each property and see, in the long-term, what is costing you more in terms of CapEx, etc. why not just use QuickBooks or some similar accounting tool to track categories?
Also, I'd advise against a sole CapEx account because CapEx are bursty, non-linear events. That is to say, you could maybe pay $10K next year before having been able to save up for it, but would not need to invest any more money into your CapEx account for another 10 years. On average, you would be OK at $68/mo, but you're still vulnerable to having to do CapEx work before you've saved up enough.
This is just what I do:
For the SFHs I have, I just have a separate Ally Savings account for it (hey 1.25% why not). I also seed these accounts from the beginning with a few thousand dollars, depending on what you might think is an appropriate amount for emergency funds. From the BP calculator calculations, I just siphon the monthly projected cashflow to my personal bank account as income, and keep everything else in the Ally accounts. If an emergency happens, I'll always be able to know that bank account will be able to take care of issues related to that specific house, and if, say, some bank accounts are doing way better than other bank accounts over the long-term, then I'll know which SFHs to toss in the long-term. But keeping the vast majority of the rental income in one account is very nice because the warchest just keeps growing.
Finally, once an account has exceeded what I would think is reasonable for a turnover/CapEx situation, I'll withdraw my initial seed and pay myself back. For example, if I thought $20K is definitely enough for any repairs coming my way for a particular property and I initially injected $10K in there, I'd withdraw my initial $10K when the account reaches $30K.
And if I wanted to track what category of expenses is costing me the most money, I could just do a QBO or some other accounting software.
But having multiple sub-accounts for the same property is going to make accounting actually fairly difficult, and will make moving money around just a logistical nightmare. Would recommend against.
@Angelo Wong, My only reasoning was expense tracking and security. I don't currently use an accounting software but this may be a good solution as well. I mostly am interested in trying to keep a sum of money separate from the general operating account. Maybe I'll look into shuttling cash flow to an account specific to each property up to a sufficient reserve amount (maybe 10-20k) then stopping. Then if I hit that properties account for a new roof I'll begin to rebuild the account until its at it intended balance again. This whole question started because I feared drawing too much from these properties to put towards the next deal. The way things are going, I can see my checking account growing to a 20k balance within two or three years, I'd like to make sure I can pull money from it for the next down payment without drawing too much, causing a shortfall for a major repair or something of that nature. It sounds like you are recommending a "reserves" account rather than a set CapEx fund.
I think everyone is over thinking this. Budget for capex when you buy to make sure the numbers work then forget about that number forever. Next put a chunk of cash away to cover any expected capex costs. If you draw down you account below a certian level then put all cashflow back in to your capex savings until you have a comfortable amount in there again.
@Aaron Currier I have two properties that I purchased in the last 2 years. last year I set up separate savings accounts for cap ex, maintenance/repairs and real estate savings. I started the cap ex account with a couple thousand dollars and will continue to put $300 per month total for my two properties. I put about $75 per month into my maintenance account and put all other money in my real estate savings account which I will use to reinvest in my next property, as well as covering vacancies, income tax, etc. I like separating the money out because it makes it easy to ensure I am not overreaching and using all my savings for another deal only to have a large cap ex expense that I don't have the money for. I just added the additional savings accounts to my regular bank account, it took about 15 minutes and there are no fees associated with the extra accounts. There are plenty of ways to keep track of your money but this is an easy way that I like.
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