My wife and I are new to real estate investment and hopefully will be buying our first property soon. When researching deal analysis I have found a large debate on calculating expenses and saving money. Some say the best is to save a certain % per month for expenses (vacancies, capex, etc.), while others argue that saving 5% on $1000 income/month would be a slow fruitless savings. These people will keep large amounts of cash in savings for these expenditures and collect cashflow.
So I suppose this is a two part discussion. How do you go about saving money, especially when starting out, and if you agree with the latter, how do you factor that savings into deal analysis?
Thank you all for the opinions and perspectives!
Eric & Emily
Hi @Eric Davenport We started 3 years ago. My husband and I are not able to save up for CapEx out of monthly cash flow. We usually plan a budget within the deal for each of our properties based on its condition. We add this budget to the down payment and total price when we analyse the deal and look at ROI and cash flow.
We try to fine tune our ballpark amount during inspection and tally up bigger items (roof, plumbing, painting through out, etc.). Our biggest mistake with the first couple of properties was that we didn't plan any money to re-fresh the unit and do some repairs. Something always comes up, even if the house looks nice.
If we spend more than planned initially, then we keep track of all capex and reimburse ourselves during re-finance. Until then, we cover the costs out of our credit line and/or other income.
@Anna Belov , what do you mean that you can’t save for cap-ex out of cash flow? Are you saying that it’d take too long to hit a sizeable sum of money?
I always figure 10% capex and 5% vacancy into my deals when I run the initial numbers and then I leave that money in my rental operating account. On a $1000 rental that adds up to $1800 per year which usually more than covers any repairs I might have done and leaves the rest saved for future repairs and big ticket items. I’m about to set up a savings account for my rentals and transfer the money every month so I know how much I have set aside for capex and vacancy. As the money adds up you may be tempted to use it for something else, I used a large chunk of mine to renovate a new property last year, so I think it’s best to separate that money from the general bank account for your rentals.
@Eric Davenport Congratulations on taking the first step!
IMO, what path you choose to take depends on your risk tolerance, personal balance sheet and/or market conditions. If you have a high risk tolerance, have adequate liquidity and have bought in a hot market, you can get away (not recommended) with doing light capex through revolving lines of credit.
A more conservative (and arduous) approach involves letting a stabilized property finance all associated costs from it. Hence, the revenue generated from a property should be able to cover most (if not all) expenses. For ones like major CapEx, property's cash flow should be able to pay it off over a period of time.
@Matt J. This is a very smart technique and how I analyze my deals when running numbers. My only fear is that when starting out something big will cause us to go in the negatives on our investment before we have that reserve saved up. Have you had a situation early on where something like this happened? Like @Anna Belov said you could always reimburse yourself.
Anna, when you say that you add this budget to your down payment, do you put this cash into a savings account for when these repairs or rehabs need to happen?
@Omar Khan You're right, it does really depend on these things. We are pretty risk adverse and do not have a large HELOC or LOC we could pull from for repairs so we will probably go the more conservative route and put a % in savings.
@Eric Davenport I haven't had a major maintenance issue in the early going but that is primarily because I BRRR so my units are typically like new. You could budget for a home warranty at purchase to give you a year to build up a cushion in your reserves. I just sold a triplex for someone and they provided a basic home warranty to the buyer for $865, the more inclusive versions were in the $1100 range I believe.