I'll start out by saying I'm not trying to debate the merits of the "50% guideline." For various reasons, that guideline will not work for me. I don't know what is included/excluded in that value, and every time it is used, it is immediately followed by "but you should calculate the actual expenses for the individual property." Having searched the site, I have not been able to find any information on how to actually do that.
I want to do some buy and hold properties, but need to estimate the cash requirements to know if they are a good idea.
Some expenses seem easy to estimate (insurance, prop tax, vacancy, management, etc). But the "maintenancy" stuff seems pretty nebulous... So I made up a method that makes sense to me, but I need some help and feedback for if it is realistic at all.
I was thinking the "maintenancy" expenses could be broken into 3 pieces:
A. CAPEX -- stuff breaks and has to be replaced
B. Regular Maintenance -- preventative maintenance, consumables, etc.
C. Turnover Maintenance -- "make-ready" costs for a new tenant
The idea is to estimate the capital expenditures based on their expected cost and how often the purchase happens. eg if you buy a roof every 20 years, on average your annual expense is 1/20th of the future roof cost.
So I put together a list of some stuff that I thought might need to be replaced in a SFR along with how often it would need to be replaced:
Roof: 20 yrs
Water Heater: 10 yrs
A/C: 15 yrs
Heater: 15 yrs
Blower: 20 yrs
Ductwork: 45 yrs
Siding (if applicable): 30 yrs
Oven/range: 10 yrs
Dishwasher: 5 yrs
Countertops: 20 yrs
Wood flooring: 30 yrs
So if I know how many of each of these there are in a property, and estimate the remaining life on each of them, I can get a good feel for what the annual average cash requirements will be to replace stuff.
So I guess my questions are:
1. Does this approach make sense?
2. If so, do the lifespans I listed make sense? What else should be added to the list?
3. How can I estimate "regular maintenance" for the small stuff?
4. How can I estimate "turnover maintenance"/ make-ready cost?
Thanks in advance for any feedback, and sorry for the long post!
P.S. I am trying to invest for cash flow. I know that depending on what accounting you use, CAPEX stuff might not technically be "expenses" but I'm just trying to figure out cash obligations.
For a single family home I'm calculating 35% for vacancy, capex, maintenance, and property management. Roughly 10% vacancy, 10%, capex, 10% PM, 5% maint.
You should know up front what heavy capex or maintenance is needed sooner than later and you may address some with rehab before placing a tenant.
Your lease will impact these numbers as well, is your tenant responsible for basic things like toilets they clogged, light bulbs, etc.
Lastly, I try to look at it macro rather than micro. I may have a tenant stay 3 years, then turn over twice by year 4.
@Greg Baker Thanks for the feedback, and that's a good suggestion about looking at turnover in the long term.
The part I'm struggling with is thinking about expenses as a % of rent vs in terms of $. If I'm looking at 2 properties in different areas that are the same size and expect the same $ of maintenance, but the properties have different rents, it seems like that would throw off the % numbers.
I think your on the right track. I think listing out items and estimating repair/replacement cost is the only way to get a accurate estimate. I agree with you on the $ amount vs the % or rent. I would much rather figure off a dollar value for maintenance and CapEx. I also agree with @Greg Baker , take a snapshot of 1yr to 5yr capex and adjust your offer. If you know the roof and hvac both have 1-2yrs those expenses will come out of your pocket/reserves. I know a lot of buy/hold people analyze like they are holding forever, but goals change all the time so you might hold for a shorter time and not gain back all that cash from 20 yrs of rent.
The appraisal will also show the expected "CAPEX" for the items in the home. In my case, the appraisal is usually around $50 a month.
@Frank B. That is actually what we started doing, because I thought (like you) that doing it as a % of the rent is absurd. We have rentals in CA that rent for more than twice the amount that our rentals in AZ rent for, but things don't cost twice as much to fix/replace here as they do in AZ.
I also agree with @Neal Bratton that your planned holding period will affect your estimates. We only plan to hold our CA units for about another 5-ish years, so we're not setting money aside for some of the bigger ticket items (like roof), because they won't go bad before we sell. We have no plans right now to sell our AZ rentals, so we do set money aside for that stuff.
I literally sat down one day and did what you did, just wrote down all the stuff we spend money on, estimated the cost, estimated the frequency, and then figured out how much to set aside each month. For our CA units, it came out to about $25/unit/month (again, not planning for big ticket costs since we're going to sell it), but for our AZ units, it was something like $85/unit/month. That's for everything - capex, maintenance, repairs (not PM, though). I'm considering breaking it out into separate amounts for capex, and maintenance/repairs. I'm also considering figuring it out as a % of the rent and updating it accordingly every so often, because setting it at a fixed dollar amount doesn't account for inflation. In other words, I can't leave it at $85/unit/month for a decade because that won't be enough in 15 years due to inflation. So I'm thinking I'll convert it to a % of rents and adjusting it, say, once a year.
But I absolutely think these numbers need to be figured out on a per property basis. It is very dependent on things like the type and quality of roofing, type of hvac system (boiler? gas furnace? central a/c? no a/c?), amenities (does it have a dishwasher I'll have to replace? fireplace I'll have to sweep? garage door I'll have to service?), etc.
Yes that approach makes sense. The fact you figured this out on your own shows you have a good head for business and numbers.
This is how you build a reserve chart. Now you add in the cost to replace those items, then break it down by cost per year. Assuming you are buying an existing building, not new construction, the years should should be the remaining life of the item.
I don't do this for every property. I did it once to get an idea of what the number would be. That works here as all my rentals are Baltimore city row homes of similar size and construction. I now simply figure about $1500 for both repairs and cap ex.
If you are doing a larger commercial property it is worth the time to do a specific detailed analysis for that property.
I think you years number looks OK on everything but that is not my expertise. Nothing seems grossly out of line. You might add some other items, windows, extractor doors, new kitchen, new bath etc. It might be overkill to figure it in, but a kitchen that is 30 years old is going to look pretty dated and need to be upgraded to get top dollar rent.
This is what I like to see. People doing real work to figure out expenses. Way to go @Frank B.
I deal with apartments mostly so my model is different. Apartments have a lot more expenses built in. For capital improvements I start with 250 per unit, per year. If there are items that need to be addressed now, I figure in the hard costs.
Most things that break are considered maintenance. I capitalize appliances, paint, flooring, roofs and other major repairs. Simple things like faucet repairs, routine plumbing, electrical outlets, and other things of that nature are maintenance.
You can separate out the turnover costs if it will give you data that is important to you but it is not necessary.
You can add 3% per year or so to your model to account for inflation if you are forecasting.
Create Lasting Wealth Through Real Estate
Join the millions of people achieving financial freedom through the power of real estate investing