So recently we looked at a property that was priced right and in a great location. Aesthetically the property was fantastic.
The problem was that the AC unit, roof, water heater and some plumbing needed to be replaced or updated. Also the carpet eventually was going to need to be torn out.
My question is, at what point is to much repair expenses enough? How do you factor in the repair expenses into how profitable a property can be?
@Geraldo Coldros , first you need to delineate repairs from CapEx. Basically, repairs are things that break (like door knobs or light switches), CapEx are things that wear out (like roofs and water heaters). Typically, CapEx items are more expensive and only occur occasionally.
To determine Capital Expenditures (CapEx) you need to determine the remaining useful life of the various parts of the building. If something needs immediate replacement, that should be taken into account when determining your offer.
The other items must be planned for, which is why a percentage of rent is put aside each month forCapEx. As a rule of thumb, I use 7.5% of GSR (15% total for CapEx and repairs). You can certainly drill down much more by estimating the remaining useful life of the properties components, the replacement cost, and then budgeting each month.
For example, if your roof has 5 years left of useful life and will cost $5k to replace, you need to put aside $84/month, just for the roof.
Now do that for the furnace, water heater, carpet, windows, plumbing fixtures, etc.
@Geraldo Coldros , all of those items decay and will need to be replaced eventually.
This particular scenario has you replacing a lot upfront. A water heater lasts 5-7 years, HVAC 7-12 years (more w/ preventive maintenance), roof 25 years for shingle, and carpet has a 5 year life.
You can always try to amortize those expenses. It's also a nice selling point when you've taken the financial burden to replace everything.
This is where IRR comes into play much better than ROI. Determine how long you want to hold the asset for, total expenses and total profits. If IRR is lower than you'd prefer, pass on the deal.