Calculating Expenses for Small Multifamily (Repairs/CapEx)

19 Replies

Hey everyone,

I am searching for a small multifamily property (most likely a duplex) in South Jersey.  I am going to look at three properties tomorrow with my agent.  I am crunching the numbers and determining at what price these deals make sense.  While these particular deals do not make sense unless there is a 20-30% discount, I am wondering if you all estimate different expenses for small multifamily properties any different than SFRs.  I understand that this depends on the location and condition of the properties, but I am looking for general advice and insight as to the numbers you all use.

I have seen BP users use anywhere from 5-10% for vacancy, repairs, and capex.  I am using 8% for each to be conservative. What do you all use for small multis?  Because gross income is higher for small multis, that 24% really adds up.  I was thinking that for small multis, some of the major expenses are under one roof and spread out across units (roof, HVAC, water heaters, etc.) compared to SFRs.  So, is it necessary to budget as high as 24% for vacancy, repairs, and capex when each unit does not have its own roof, HVAC, etc.?

Thanks for your input.

Hey Ian, it is always best to use those reserves to protect yourself from any future problems. Each category is a form of insurance to cover random malfunctions or property hiccups. I do 5% repairs, 5% vacancy, 10% Management, and 5% capex. This is to help beginners save a good amount of reserves and start off investing conservatively.

@Ian Livaich To add to @Ryan Short ' comment though...this is also going to heavily depend on where you are investing. If you are in a while collar area where people take care of things and don't move every year and evictions are low...his numbers are probably great. Investing in properties like I do which were built between 1880 and 1940 and I have tenets with hourly income, more blue collar work, section 8 rents, they tend to have some more issues paying bills and can be more transient. Therefore I anticipate my expenses will be higher due to the age of my properties and the types of tenets I know I'm dealing with. I'm at 8-9% for each repairs, vacancy and capex, and then my property management is 9%. 

It also depends on where in the country you are. If your rents are only $700 a month...you might need a higher percentage of 10% for each category. If your rents are SF/NYC/LA kind of rents (2-4k) than 4-5% might be more than enough. 

@Ian Livaich You  are over complicating and over calculating. If it is a good deal, buy it. If it is not a good deal, make it a good deal by putting terms into your offer. In this market, you are not likely to get the best price.

CAP-Ex is not an expense. It is a savings plan to cover repairs. If you plan for 5% for cap ex, the money is in your account, so it still counts as income. I suggest that people put all of the rental income into a separate account and only spend money from that account on their property expenses. If you have no roof to fix, the money just piles up in the account. It's called savings. Just a suggestion.

@Ryan Short Thanks, Ryan.  You hit the nail on the head.  I am trying to be conservative and if the deal makes sense after conservatively estimating income and expenses, it help reduces some of the risk of investing.

@James Masotti Appreciate your insight as always, James.  You raise great points about the expenses being dependent on the property and the location.  While the properties I am targeting are old as well (1920's-1940's), I definitely want to be conservative with repairs and capex, but I also recognize that I will likely be dealing with young professionals and families in my target areas in Camden County.  Also, I am looking for deals that need some work, so after rehabbing the property, I think 7-8% each for repairs and capex is more than fair.  

@Anthony Dooley Thanks for the extra motivation!  I am walking through a property on Wednesday with a contractor and hoping to move forward with it depending on the rehab cost.

Sounds exciting. Looking forward to hear how it pans out. :)

I'm not looking in New Jersey, but i am looking in Massachusetts/New Hampshire. I was trying to crunch numbers to determine my cash flow, but my situation would be owner occupied. Does the expenses/savings plan change when you are also living there or do you just hope the cost of the rent covers half the mortgage and you are able to save some for repairs, cap ex, vacancy, etc..?

@Ian Livaich I had trouble believing that 8 or 10% of my gross rents would be needed to cover such expenses but let me tell you first hand that it is very necessary. I am at 6% right now and I am not covering nearly enough...a simple service call these days can run you $200 per visit and then that can grow higher if the problem is worse than expected and requires additional labor and/or parts.

I would need ~3400 in gross rents to cover this at 6% and that's the bare minimum. If you want a property to work and operate itself then these expenses need to be accounted for. Once I move out of my house hack and increase rents I am aiming at 8-10%.

Best of luck!

I like to play it safe and go with 10%. You never know what could happen and it is always best to cover yourself and protect your investments imo.

Originally posted by @Anthony Dooley :

@Ian Livaich You  are over complicating and over calculating. If it is a good deal, buy it. If it is not a good deal, make it a good deal by putting terms into your offer. In this market, you are not likely to get the best price.

CAP-Ex is not an expense. It is a savings plan to cover repairs. If you plan for 5% for cap ex, the money is in your account, so it still counts as income. I suggest that people put all of the rental income into a separate account and only spend money from that account on their property expenses. If you have no roof to fix, the money just piles up in the account. It's called savings. Just a suggestion.

WHAT?

CapEx *is* an expense you need to account for!!!

Let's say you have have $15K of rent every year, and standard expenses (tax, repairs, utilities, etc.) of $5K every year, and budget $5K for CapEx each year (which, we will assume, is accurate). Sure, if there are no CapEx expenses in Year 1, you make $10K of income. But if you have a $10K expense in Year 2, then you have $0 of income. Average those two out, and it's -- wait for it -- $5K of income on average for those two years.

So CapEx is definitely an expense. It's just different in that you could go years without such an expense, or have a whole bunch in one year. The idea of budgeting a certain amount for CapEx isn't just a savings plan, but also to account for the CapEx expenses. Otherwise you are under the impression you are making more money than you actually are.

Or am I missing something?

@Scott P. you are missing something Sir. You are taxed on your income. Just because you call $5000 of that "cap ex" doesn't matter. You made money. If you spend $1000 repairs, you can deduct that expense on your taxes, but you don't get the entire $1000. You only get the taxes that you would have paid on the $1000. So in a 25% tax bracket, you will get $250 back. You will still pay taxes on the other $750 because it is income. Cap Ex is not an expense until you spend the money. Until then it is in your bank account and it is taxable.

Originally posted by @Anthony Dooley :

@Scott P. you are missing something Sir. You are taxed on your income. Just because you call $5000 of that "cap ex" doesn't matter. You made money. If you spend $1000 repairs, you can deduct that expense on your taxes, but you don't get the entire $1000. You only get the taxes that you would have paid on the $1000. So in a 25% tax bracket, you will get $250 back. You will still pay taxes on the other $750 because it is income. Cap Ex is not an expense until you spend the money. Until then it is in your bank account and it is taxable.

I guess it depends on what you are looking at. If you are trying to figure out how much taxes you pay each year (for example, if deferring taxes from one year to another can benefit you significantly, due to AMT or something), you need to treat CapEx differently.

But if you are putting together a proforma for yourself to see if a building is worth buying, you need to include CapEx. Because whether you pay $5,000 exactly each year or $10,000 every other year, you're spending an average of $5,000 a year, and that is money that you aren't going to make.

@Ian Livaich I went in blind to capex and vacancy when I purchased a 4 and 5 unit. I found bigger pockets later.

Had I calculated for capex, it would have been far below what we put in (very run down) and there is no vacancy in my very hot market besides that attributed to renovation.

We spent a year looking at duplex’s in good/decent markets. It was impossible to find one that cash flowed, all had us bleeding just on fixed expenses. There are too many live in buyers who are not looking at it the same way as another investor. Too many cash only bidders and speculators.

Best of luck- duplexes are very tough in a good market.

@Scott P. don't take my word for it. Do some research from other sources and you will find that BP is the only place that talks about cap ex. Income minus expenses equals net operating income. Net operating income minus debt service equals cash flow (net profit). Notice that debt service is different than an expense. That is because you don't have to use debt to buy property.  I am not saying that you shouldn't plan for expenses. What I am saying is that until the expense is paid for, you have the money. Some just call it "reserves". Cap Ex is a planned way to pay expenses in the future. Don't use BP as your only source of information.

Originally posted by @Anthony Dooley :

@Scott P. don't take my word for it. Do some research from other sources and you will find that BP is the only place that talks about cap ex. Income minus expenses equals net operating income. Net operating income minus debt service equals cash flow (net profit). Notice that debt service is different than an expense. That is because you don't have to use debt to buy property.  I am not saying that you shouldn't plan for expenses. What I am saying is that until the expense is paid for, you have the money. Some just call it "reserves". Cap Ex is a planned way to pay expenses in the future. Don't use BP as your only source of information.

Let's go with a silly example.

I buy an apartment building for $1M, that makes $100K in rent every month, and standard expenses are $100K. I know the building will be worth $1.2M in 10 years, so I buy it, planning to make $200K in 10 years (not knowing that there are better investments out there than this simple example). I ignore the $50K/year CapEx because I read online that it wasn't an expense. After 10 years, I've now had $1M cash come in (rent), and $1.5M cash going out ($1M expenses plus $500K in CapEx costs).

In this (obviously silly) example, after 10 years I get the $1.2M I expected. But throughout that time, I had to shell out $500K of expenses. So what I thought was going to make money lost money.

Now if you include CapEx expenses in your line for repairs in a proforma, all is fine. But those numbers HAVE to appear in your proforma, or else those CapEx costs come out of your pocket and lower the return on your investment.

Originally posted by @Anthony Dooley :

@Scott P. don't take my word for it. Do some research from other sources and you will find that BP is the only place that talks about cap ex. Income minus expenses equals net operating income. Net operating income minus debt service equals cash flow (net profit). Notice that debt service is different than an expense. That is because you don't have to use debt to buy property.  I am not saying that you shouldn't plan for expenses. What I am saying is that until the expense is paid for, you have the money. Some just call it "reserves". Cap Ex is a planned way to pay expenses in the future. Don't use BP as your only source of information.

To be clear, I definitely agree with you on a few things.

First, estimating your CapEx costs and putting aside that much money every month/year as a savings tool is great (and would help a lot of landlords who don't plan for such costs, and then cannot come up with the money to pay for them, causing even greater expenses, such as fixing the damage from a leaky roof that didn't get replaced).

Second, I agree that your taxes are based on actual expenses, not estimated CapEx. Meaning that if you budget $5,000 a year for CapEx, but have $0 expenses in Year 1 and $11,000 in Year 2, you would show $0 of CapEx expenses on your tax return in Year 1, and $11,000 in Year 2.

The only thing I disagree with is not factoring in CapEx costs as expenses when trying to determine how profitable an investment will be. That, if it is what you are suggesting, just boggles my mind. If the numbers show that I'm going to make $10K/year on my investment, but then I realize I didn't include the cost for new roofs ($10K every 20 years), I'm going to be making $9.5K/year. Whether you call it CapEx, repairs, maintenance, or something else, it's still an expense that affects how much you make on average.

The calculations I use are 5% CapEx, 5% repairs, and 8% vacancy. 8% vacancy=1 month of vacancy per year. A total of 18%.

But I do minor adjustments for different situations. For example, if I just totally rehabbed a house, I have lower percentages for the CapEx/repairs. If the unit is a lower end property, I'll bump up the repair percentage.

However, I primarily only use those numbers to "analyze" a deal. In actuality, I keep a healthy amount available on my HELOC for those eventualities. If I dip into the HELOC for a major repair, then I'll pay it back down until I'm back at the level I want to be at. For more minor repairs and vacancies, I'm usually able to just cash flow those.

I've heard of other investors doing something similar, though usually with a reserve fund in a more typical checking or savings account for their bank product of choice.

More advice. I'd highly recommend starting off with some kind of reserve fund and then growing it to where you are comfortable with your percentages from the rent. If the property you purchase has an upcoming CapEx item, ie will need a new roof in about 5 years, then keep that in mind and save more, accordingly.

@Scott P. I am not suggesting that you don't factor in estimated expenses when determining profitability. Of course you do. As I said before Income minus expenses equals profit. However, your example above is stupid. If you make $10K per year on a property and you need to replace the roof after 20 years, you made $200K and then you wrote a check for the roof in year 20. The first 19 years, you made $10K in your example. A roof 20 years from now does not affect my annual income today. Assuming that you still own the house in 20 years and assuming that you didn't buy any more property over that time. If you buy a house per year for 20 years, then it doesn't matter that you had to replace a roof. Your monthly cash flow can cover any repair of a single house if you scale the business. Again, everyone should have reserves or an "emergency fund" to cover big ticket repairs, but the idea of saving $28.93 per month to replace a $300 dishwasher in 8 years is ridiculous. And, the dishwasher 8 years from now is not an expense today. 

Originally posted by @Anthony Dooley :

@Scott P. I am not suggesting that you don't factor in estimated expenses when determining profitability. Of course you do.

OK, I think we are in agreement. I read your "CAP-Ex is not an expense. It is a savings plan to cover repairs" and assumed (mistakenly, it seems) that you meant that you do not think that CapEx costs should be considered expenses in a proforma.

@Scott P. No biggie. We are not always going to agree, but with combining ideas maybe we can all make a few bucks. 

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