How do you tell real profit from money that's just waiting to become a repair?

Question

Every month I look at what's left after mortgage, insurance, and taxes and part of me wants to call it profit. But some of that number isn't really mine, it's just sitting there until the roof or the water heater needs it.

The tricky part is nothing forces you to separate the two. The cash sits in one account either way, and it's easy to spend against a number that looks bigger than it actually is until something breaks and you realize half of what you thought was profit was already spoken for.

How do you all draw that line? Percentage set aside automatically, separate account per property, or do you just keep a mental buffer and hope you guessed right?

Bill B. · Answer

It’s never a percentage, if you mean a percentage of rent. Your repair costs don’t go up when you raise rent or go down when you offer discounted rent.

If you don’t have a tile roof like much of the west coast. And you don’t get a “free” roof from hail damage like much of the Midwest.  You can divide a roof replacement estimate by remaining life to solve your biggest issue.  Do the same with your AC if you’re in a market with central air.  That’s 90% of it.

Figure 1/2 an appliance every year (5-6 laundry/kitchen appliances lasting 10 years). And 1/6th -1/10th of a water heater if you care to.  The unknowns will be any carpet, plumbing fixtures, garage door related expenses and so on.

Personally I disregard anything under $2,500 as “just an expense” in the planning stages.  Realistically that means an ac unit every 20-30 years if you plan to hold that long, and a roof if you still have asphalt shingles.

Lastly. Try to get to 5+ properties. The most dangerous time for a real estate investor is less than 3 properties in regards to vacancies and expensive repairs.  Ever since I got to 10+ properties I haven’t had a repair that wasn’t covered by the current month’s rent. Not water heaters or appliances obviously, but not even minor water damage from a couple plumbing problems.

Personally I never started spending the money. Once I finished by buying phase I started using the money towards paying down/off the mortgages to increase income and cashflow.  So it was never sitting around in an account.  I used credit cards for reserves when I was still growing.  Good luck in your journey.