Phantom Repairs when doing Rental Deal Analysis
I'm curious to hear how other people account for phantom repairs when looking at a deal to purchasing a rental property. By this I mean the depreciated value of having an older roof, furnace, etc. in a house you are looking to purchase. I call it a phantom repair because these items are still perfectly functional at the moment so there's no current repair to be done, but you'll probably have to replace them sooner than if they were newer.
For example, say you are looking at two SFH that are identical in every way. The only difference is that one has a brand new furnace and the other has a furnace that is 15 years old but works just fine.
Generally when doing deal analysis it seems people will account for estimated rehab to make a unit rentable, and they will estimate an amount for monthly or yearly maintenance and capital expenditures either as a percentage of rent or some estimated dollar amount. Using this method both houses would look the same on paper even though the one with the new furnace is obviously better.
Here’s my thoughts on ways to account for these.
1. Ignore it. It seems many people do. I suppose this kind of makes sense if you’re planning to own the property for a long time because even though you’d have to replace the items sooner, after replacing them you then wouldn't have to replace them for a longer period of time. So it would at least mostly wash out in the long run.
2. Count it as part of the rehab cost to get the unit rentable. If the furnace is 15 years old and you expect a furnace to last 20 years, then include the cost of 75% of a furnace in your rehab costs even though you won’t actually be spending it now.
3. Use a discounted cash flow model. This would take the future timing of the expense into account. Or on a similar note, do the same method as number 2 but discount the 75% cost by 5 years. I don’t think most people get this sophisticated in their deal analysis though.
4. Increase the estimated capital expense/maintenance expenses. Of course then the question is, by how much? Some arbitrary amount? To pay for the cost of a new furnace in 5 years? By that logic if it was older than its life expectancy you have to raise it enough to pay for a whole furnace every month or year which obviously doesn’t make sense.
So, do you account for this when you’re looking at a deal, and if so, how?