Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
This is a classic new investor trap. Every new investor learns to budget for repairs and maintenance. Its a line item in every calculator or spreadsheet when you are running the numbers. I have always had a problem with that.
First of all, the 5% most investors are using is not enough, except maybe with new construction. Second, you'll never turn a profit this way. You get used to paying for repairs out of cash flow and pretty soon this becomes the norm: cash flow is just paying for everything.
If your cash flow is an average $200/mo and after 6 years you need a new roof, it wipes out all of the cash flow. And 3 years later you need a new HVAC, which wipes it out again. A kitchen remodel may cost you 10 or 15 years of cash flow. And if the building is 60 years old, you'll need to replace these galvanized pipes pretty soon. And the cracked-up driveway.
It gets worse. I spoke with an investor last year who owns 30 duplexes and has been operating them for over 40 years. He's old and wants to retire, but he can't because they are low value 100 year old buildings from the 1920s and even though he does most of the work himself, they are constant money drains.
@Marcus Auerbach - Agree with your sentiments. I think incorporating appropriate CapEx at the beginning of the analysis is a key step. Then, the property should cash flow "above and beyond" all the expenses, including CapEx/reserves. It protects you some, but I think most don't retain enough funding.
@Marcus Auerbach - Agree with your sentiments. I think incorporating appropriate CapEx at the beginning of the analysis is a key step. Then, the property should cash flow "above and beyond" all the expenses, including CapEx/reserves. It protects you some, but I think most don't retain enough funding.
You should include R&M, vacancies and credit losses (evictions) as provisions in your model. The CoC/profit would be measured after all of these. In real life, you put those provisions apart (may be in a money market) and add them to your initial reserve, so that when the time arrives to make that big expense you have the money ready.
Marcus, I see your point, especially with older properties where one major repair can wipe out years of cash flow.
But to me, if a property consistently needs more capital than it generates, the bigger question is whether it's actually a good investment in the first place.
@Marcus Auerbach we do pay repairs out of cash flow, but the trick for us is what happens before the first tenant moves in. When we buy, we renovate the whole house to a high finish level, not just the big items but the small things too. With that approach we budget about 7% for maintenance and it holds. If you buy an old house and rent it as is, I agree, the cash flow will end up paying for the roof.