Analyzing Apartments, am I missing something?

Question

I'm sure someone can help me with this. I've read many books on commercial and multi-family properties. I understand using the 1% rule of thumb to see if a property is worth looking into deeper as well as the 50% rule of thumb to see if the property cash flows after mortgage is paid.

I know NOI = Income - Expenses but how do I deduct or calculate for replacement costs from the NOI?

At what price are annual replacement costs should be calculated per unit?

Gilbert Dominguez · Answer

@Ayodeji,

If you purchase a building with immediate maintenance or repair issues or items you would include that in your purchase price or acquisition price. There after you set up an account of between 5% to 10% for ongoing maintenance. When you say annual replacements you should not understand it to mean that you will be replacing anything on an annual basis. For example you would not replace a water heater once every year or an A/C unit once every year or replace the roof once per year. You just set up a budge to deal with those eventualities as they come up.

Roy N. · Answer

Firstly, if you are looking at true multifamily residential and other commercial real estate you should become comfortable with discounted cash flow analysis.  Pick up a copy of "What Every Real Estate Investor Needs to Know about Cash Flow" by @Frank Gallinelli and work your way through it  {then put it on your shelf as a reference}.

As you indicated Net Operating Income (NOI) is Effective Gross Revenue - Operating Expenses.   Your Effective Gross Revenue is your scheduled rent and, if you wish, ancillary income streams, minus your economic vacancy.

Once you have NOI, your debt service is deducted from this amount as are any other reserves (capital reserve for future CAPEx; environmental reserve for reclamation on an industrial property, etc).  Your income taxes are also paid from this amount.

The amount of NOI you allocate to your capital reserve will depend upon the age and condition of your asset.  If you have a new building, major CAPEx are 12 - 20 years down the road, so you can build your reserve at a more modest level.   If you have an older building you will be facing more CAPEx expenditures to renew, modernize, and defer obsolescence.   When analyzing a property - before you have operated for a period and developed a better understanding of your upcoming CAPEx - we typically allocate 10% - 15% of NOI to our capital reserve.

Kevin Siedlecki · Answer

Hey- this blog post from last week should help answer your questions!

http://www.biggerpockets.com/blogs/6815/blog_posts...

Austin Youmans · Answer

by replacement costs I am assuming you mean maintenance. most people put aside 5-10% of the monthly rent. It depend on the class of property and how old the property is.

Ayodeji Kuponiyi · Answer

@Gilbert Dominguez ok that makes sense. So for maintenance/repairs I just put 5%-10% of rental income aside each month?

Ayodeji Kuponiyi · Answer

@Austin Youmans thanks for the response. That's what I do as well but after reading Matthew Martinez's book "Investing in Apartment Buildings" I learn about new terms.

@Kevin Siedlecki Thanks for sharing!

@Roy N. Thanks that was very helpful!

@Joe Fairless thanks I'll use that $250 moving forward thanks. So once I get my NOI, I deduct $250 * # of units to get my annual NOI? Also I enjoy listening to your podcast. Great stuff. Very helpful and inspiring. Hopefully one day I'll be a guest.

Jeremiah O'Neill · Answer

On the SFH rental I just purchased, I created a list of all the capital expenditures and their life expectancy.  For example, I assumed my roof replacement is $8,000 with a life expectancy of 24 years, so $333/year.  In the end, my CapEx number worked out to be about 6.5% of my annual rents, only time will tell how accurate this number is.  In addition to CapEx, I carry an additional maintenance allowance for repairs throughout the year, leaky pipes, patching a hole in siding, etc.

Joe Fairless · Answer

@Ayodeji Kuponiyifor replacement reserves I use $250 per unit per year but that can go up depending on the class and property attributes.

Analyzing Apartments, am I missing something?

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