Help with understanding Cap Ex, Repair Costs, and Vacancy Rate
I am in the analysis paralysis stage of learning before starting to invest in real estate. As I am running these numbers I feel like its a complete guessing game for the Cap Ex, Repair Cost, and Vacancy rate percentages. I have been running all of these at 10% each to ensure I don't get burned. However, this seems overly conservative and makes a huge difference in the over all ROI numbers. It seems really tough to find any deals that make sense running the number at 10% across the board for these. Does anyone have any set methods or systems in place for calculating these percentages? Any help would be much appreciated.
@Sean MIddleton Hi Sean, I feel your pain when estimating CAP Ex, Vacancy Rate and Maintenance Costs. These variable expenses are so hard to correctly budget for as they will vary from month to month and year to year. I personally use 5% for all three of them when analyzing deals, but there are a lot of variable's from property to property and even city to city that you will want to look at as well. I look forward to seeing what everyone else has to say as I could probably improve in this area as well! Good luck with your investing!
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For my calculations I'm using 4% for Cap-ex, and maintenance. Vacancy is equal to one months rent which so 8%. Property taxes can be found online and insurance is quoted over the phone. I'm self managing so I factor in zero for that.
A good PM company can be a life saver for investors, but if you're starting out they don't make sense. Just pay yourself the 8-12% they typically charge and learn the ropes for a couple years.
@Sean MIddleton your CapEx and maintenance will be easier to gauge when you receive an inspection report if you go under contract on a property. If you're analyzing a property and the roof, HVAC, furnace, and water heater are all past their life expectancies, then plan to account for these items in your analysis and increase your CapEx. I would say 10% is conservative but then again these are variable expenses. My general rule is to set aside 4-5k for each property. Depending on your market, calculating vacancy should be fairly straightforward, not to mention rental demand is at an all-time high. To accurately gauge vacancy, have your real estate agent or PM run lease comparables to determine the average days on market in your specific area. Hope this makes sense and helps!
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@Sean MIddleton it depends. If you find a property that needs everything fixed when you buy - you'll do the rehab and then your capex will be low for a while. If you buy a property that needs a new roof, new furnace, new windows... those are your capex. And some markets have mostly older houses, some have mostly newer.
The fact is that it's just a best guess that you'll never know how accurate you were until you sell the property in the future. You could own a building several years without making any capital improvements, or you could need to on day 1. Also using a percentage of revenue is inherently flawed, I assure you that whoever you have doing your maintenance or improvements will not base their pricing on what you receive in rent.
That said I understand that some we need to have some convenient way of budgeting for these expenses. I typically use a certain $ per unit per month for capex, remember this is to cover the cost of major improvements, so you can estimate the costs to replace major systems and divide that by expected life span as a methodical approach to come up with something. Think furnace, water heaters, kitchen cabinets, roof, siding, driveways, etc. etc... For budgeting, the current age of the systems does not technically matter since they'll eventually need replacement even though that may be years down the road. But say a $10k heating system that should last 25 years (300 months), that alone is $33.33 per month ($10,000/300), even if it was just replaced yesterday since it will need to be replaced again in 300 months. Improvements tend to come in waves, though as you add units you'll find that those waves somewhat smooth out.
For maintenance I start with 8.3% of rent (I know, flawed) and then make some adjustments based on the size of the units (which, conveniently, somewhat correlates to rent assuming all else being similar) and overall condition of the units. For what it's worth, over the years this has tended to be on the conservative side, and I hire out my maintenance via my PM. Hopefully I didn't just jinx myself
Vacancy really depends on your market.
@Sean MIddleton My bare minimum is $230 per month for vacancy, repairs and capex. You should do an analysis. Vacancy, you can call a property manager and ask what it runs in the area. I always pad a little incase of evictions. Most lenders assume 5% vacancy. That is you base. 5/100=1/20. So 1 turnover every 20 months. In a 10 year span you will have 120/20 or 6 turnovers. Assume you have to evict once every 10 years and it takes you 3 months to get them out. 6 turnover + 3 months no rent= 9/120 months= 7.5%. I use 8% myself.
You do a repair budget just like the vacancy. Cost to do a turnover( new paint + deep cleaning). Assume every 3 years. Cost $1500. Now assume you have 1 repair(clogged toillet, leaky faucet, burner not working, etc) per year. Assume $150 per repair. In 3 years you will spend $1500+$450=$1950/36 months=$54 per month. Bare minimum for me is $50 per unit.
Now onto capex budget. Go to your favorite flooring store and ask what the commercial warranty is. Most will be 10 years so that is your life span. My area it is $6 sf to repalce. Assume 1500 sf of flooring. $9000/120 months=$75 per month for 1 item. Still have roof, appliances, hvac, hot water heater, etc to add. Bare minimum for me is $100 per month. Their is a comprehensive capex budget in the files section of BP. Called cap ex by @ Sam Tato.
@Tim Herman this is probably the most concise explanation I’ve seen of how to factor in cap ex cost when analyzing a deal. Thank you!
@Zack Berridge Soft costs are never linear, but it's nice to know what amount you need to save to cover your costs. Most people see the videos and take the numbers as gospel when in reality they can be widely off.
@Tim Herman I agree. As a new investor it helps to have a general idea in order to see actual numbers for analysis. And in reality it can take one major cap ex to drain months/years of cash flow, so ideally I’d prefer to fix anything with that could potentially become problematic within next few years with the financing used when purchasing.
Thank you for all these great responses. I have learned alot from them and it really helps to be able to reflect back here when Im running numbers to be able to take in all this good advise when determining these values.
@Tim Herman I'm new to the game and currently helping a family member rent their property. Your thorough and thoughtful response is much appreciated. I love the BP community, so much experience and guidance in these forums!
@Gerard Fox Beginning investors make the mistake of using all their funds and have no reserves. If you have no reserves and have a major problem that makes the rental uninhabitable, you will have no income to fix the problem. I had a sewer line collapse from the bathroom to the main line but had the reserves to fix. I am not a big enough investor to cash flow major capex without reserves. My philosophy is pick your most expensive capex item and multiply that by 1 1/2 times. Let's assume that it is 5k for a roof. So I need 7.5k for reserves. So you have a property that cash flows $250 more than your reserve fund. Assume you use $250 for your soft costs. Take your $500 and in 15 months you will have a fully funded reserve. After that you can use the $500 for your next dp or spend. When ever you use any of the reserve, you immediately stop taking any of the money and replenish it until it is fully funded.
@Tim Herman The hits don't stop! Great advise. I appreciate the response. My relative has a budget to paint and put down new flooring before moving renters in. The next big expense will be the roof. I'll advise them to build a reserve in the first year before pulling spending money.
@Tim Herman "So you have a property that cash flows $250 more than your reserve fund." - Ahh the good ole days. This is the golden ticket that's so hard to find right now. We have been looking on/off market for over a year and nothing comes close to that with a SFH or duplex. Nothing is impossible but the prices are to high to buy rentals right now.
@Jaron Walling I am semi retired and haven't bought anything in 2 years. The last one I bought did have that margin. Like you say a lot harder in to find cash flowing properties.
This is management accounting. There isnt a one way to calculate this but rather just using numbers to assist you in making a decision. For my area, vacancy is 0. Capital expenditures and repairs in my opinion are the same thing. My strategy is to take income minus monthly operating expenses minus financing interest expense and the rest is my cap/repair yearly maximum. The main fear is having a Canada revenue agency loss, this can trigger a "Why is your property losing money" survey. This may mean that I am cash flow negative for first few years. But Since my updates/repairs are front loaded, it helps to maximize rent and eventually repairs/upgrades will slow down, and income will increase. Just my thoughts.