How do you account for larger repair costs when analyzing deals?

Question

Hi! I'm a buy-and-hold investor currently trying to expand into multifamily and focus more on cash flow. One of my hesitations is that multifamily homes are typically older and come with a lot more maintenance. I've seen people purchase units that will net them under $500/mo after all expenses and I'm genuinely curious how you account for potential repairs down the road related to HVAC, roofing, etc.? I think the obvious answer is to ensure these have been updated recently, but nonetheless, what if something goes wrong? I'm struggling to wrap my head around purchasing a property that cash flows $500/mo and then in a year potentially needing to spend $5K to fix something major. Didn't that just eat into most of my profit? I'm coming at this from the angle of wanting to use REI to replace my 9-5 income to have the option to quit as I start expanding my family so I want to make sure I'm accurate in the numbers of what it would take to actually get there.
I would love if someone could explain this to me! Thanks!

Ryan Kelly · Answer

@Remisola Omodara cash flow is generally the LAST thing you benefit from and I wouldn’t be in a hurry to take the profits too early. I’ve had some rentals nearly a decade and still don’t take a dollar of cash flow. You can benefit from depreciation, appreciation, and loan pay down while you wait. To cover the bigger expenses, you want to have reserves and allow the cash flow to build them up over your first years with a property. Big expenses are simply going to happen with any property, so if you are assuming you get to take all the cash flow, you won’t be prepared for cap ex and remodeling budgets.

Matthew Paul · Answer

I was getting taxed from the day the doctor slapped my butt until the day I die .

Joe Scaparra · Answer

Remisola, That is an excellent question.  Cash flow is king as far as I am concerned.  It is getting more difficult to find enough cash flow in the Austin MSA to make a good investment.  However, depending on the circumstances it can be possible.

I am more a duplex investor as the POSITIVE cash flow is easier to obtain than say a SFH.  Depending how much you have to put down a deposit to get into a property, will affect the cash flow coming in.

There are a couple different angles to look at cash flow.  It is easier to make things work if you are considering your first purchase as compared to renting.   If you are renting say an apartment for 1800 a month, would it be better to own a duplex with a mortgage of $3000 a month.  If the mortgage included taxes and insurance then yes the duplex could be a better option.  Rent one side out for 1500 and you now have 1500 to pay on your side.  Rent out a room on your side for 800 all bills pay and now you cost is 700.  Saving 1100 from renting.  1100 X 12 months equal 13,200 per year because you decided not to rent.  Yes you have the vacancy and maintenance to deal with but with $13,200 extra you have some cushion before you go negative for the year.  Additionally, you have principal buy down on the mortgage and possible appreciation of the property to also offset the cost of vacancy and maintenance.

Now backing up, if you are looking for property as a pure investor meaning you are not going to house hack the property then it is extremely difficult to buy in the Austin market and cash flow positive.  I would look more to College Station/Bryan TX where you can find cash flow as a pure investor.   Investors are looking to STR or MTR to increase cash flow and that could work but the risk associated with those strategies also is increased.

If you want to discuss this in more depth you can DM me and we can either talk on the phone or meet for coffee.  I mentor several people on real estate investing because I enjoy giving back.   Cheers.

Matthew Paul · Answer

Something is ALWAYS going to go wrong with a house , especially a rental .

You have to have reserves built up before that cash flow is something you put in your pocket .

You may have a few years that a property goes negative . A couple expensive repairs , tenant vacancy , etc .   Its a long term investment , you have ups and downs

Bonnie Low · Answer

It is tricky to underwrite older homes and get cash flow, particularly at today's interest rates. When you're buying, you want to assess the age of all the major items and mechanicals. If a property needs a new roof, negotiate for either a seller credit or price reduction. You can do that in the current environment where you don't have to compete with multiple above asking offers. When you do your underwriting, use a tool that allows you to factor in how much you need to set aside each month for capex and maintenance and make sure you budget accordingly. I usually budget 10% for capex and 5% for maintenance. These should be coming out of your gross (IMO) so someone expecting $X net should have already accounted for this. Put that money aside so it's there when you need it. Or, you could just buy newer properties or do extensive rehabs. This is what we usually do. We buy severely distressed properties and rehab them. By the time we're ready to put it on the market, it's almost an entirely new build so cap ex and maintenance are minimal.

Jay Thomas · Answer

Investors often wonder about the potential risks of multifamily properties, a valid concern before diving into investments. When evaluating a multifamily property, accounting for repair costs is crucial. Allocate 1-2% of the property's value for annual repairs and 5-10% for a capital expenditures (capex) reserve fund covering major, less frequent repairs. In case of unforeseen issues impacting cash flow, options include using the capex reserve fund, borrowing, raising rents, or selling the property. The decision depends on individual circumstances. While multifamily investments carry repair risks, they can be lucrative, especially for cash flow-focused investors. To minimize unexpected repairs, consider buying newer properties, conducting comprehensive inspections, hiring a qualified property manager, and maintaining a capex reserve fund. The Houston multifamily market is robust, offering potential returns, but be aware of the weather-related repair challenges.

Peter Sosnow · Answer

@Remisola Omodara

Agree with the other responses.  Cash flow is choppy.  Maintenance, deferred maintenance and capex improvements and more all impact cash flow. Been investing in small multis for 5 yrs in CT, 3 FT and I have needed large reserves and a diversity of income streams (stocks, spouse w-2) to help with fund our lifestyle.

Remisola Omodara · Answer

Thanks for that response, Matthew! Are you getting taxed during that time of building up reserves or you'd have a bunch of write offs?

How do you account for larger repair costs when analyzing deals?

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