Depreciation is Real - Don't get Caught Like I Did!

General Landlording & Rental Properties
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Depreciation is Real - Don't get Caught Like I Did!

Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes

Took a call yesterday from a local investor. She is looking to "unload" some units. The problem - she wants above market prices...:)

And here's how this happens:

She owns a PIG. Translation - a building similar to the ones you CA guys buy turn-key in Ohio. You know - 70 years old functionally obsolescent crap with lipstick on it - you know the ones?!

BTW - looking at my T12, 3 out of the 4 houses I still own in my portfolio in Ohio lost money in 2014. Can you guess why - CapEx, otherwise known as replacement of depreciated components. Just sayin...

Well, she tells me that she'd just spent $35,000 remodeling the down-stairs unit (it's a duplex) and she wants that money back...

I spent 30 minutes on the phone (cause I am a nice guy) explaining to her that replacing electrical, plumbing, windows, fixtures, and all the rest of it was something that she HAD TO DO in order to make the place stay alive, but none of those things improve the rent or add to the value. At the end of the day, what she still has is a pig; just has some lipstick on it.

Depreciation is not just a tax break. Real physical items depreciate over time and eventually exhaust their useful life, at which point you MUST spend the money. But, you won't get it back.

Don't get caught by the real depreciation y'all. You can thank me later...or now :)

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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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@Ben Leybovich

 Your statement can be made of any town any city in America... it does not matter if you buy a 1920's built home here in Portlandia, the issues are the same... the difference is location and do you have an exit if you need to exit.. cap ex does not increase rent as you mentioned..   It is why values are where they are at by region... And why you have the great appreciation Vs cash flow debates..  And why its critical if one is buying cash flow properties to know what they are buying and the condition of the major components in the homes.  Some of the most bullet proof homes I have ever financed were the little brick bungaloo s in Detroit.. those houses were built to last.. once you had new water sewer elec windows roof.. you have a home that could last for a few decades.. And now what I really like is what some of the guys in Chicago do with those same type of brick buildings that were built by craftsmen of yesteryear.. the guys I have been funding take them all the way down to the studs  so its a awesome brick shell and everything is new inside  everything. So its basically new construction.. But of course the values are far greater and the price of entry higher but for rental stock its pretty nice stuff...

35k to remodel or upgrade one unit of a duplex is pretty high unless it was a studs out remodel.. then  she has another 30 years to recapture those out of pocket costs.

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  • Dale Stevens
    Investor · Downers Grove, IL · Member since 2015 · 353 posts · 213 votes
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    I don't buy something unless the POSITIVE Cashflow after PITI, Management, etc is at least $300/door/month.

    With that being said, I do keep 25% each month in reserves/maintenance so it adds up nicely.

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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    @Dale Stevens

      300.00 X .25 =  So an additional 75.00 a month goes into your long term Cap ex fund. and this is on top of your normal vacancy repair operating costs of ?

    Do you use a %  like 40% of gross rents should cover those expenses  ... We found 50% of rent to be pretty good number and with long term reserves 60% was a safer number if you did better great but that usally kept you out of trouble for serious cash call.

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  • Verna M.
    Tujunga, CA · Member since 2015 · 88 posts · 48 votes
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    I think it can be summed up as greedy people looking for a way to get rich quick.  Real Estate is an asset class just like any other.  The numbers have to work. If you're not living in it, it's not a house, home or anything else.  It's an investment and it's either working or its not.  

    I used to work with people who were like this with stocks.  They'd buy something that could have been a  great investment but never taking the time to learn the metrics and figure out a strategy.  So they'd impulse buy at an inflated price after a particularly good earnings report and have no exit plan. Then, they'd jump ship at the first sign of bad news losing a ton of money. With real estate you have the added part of capex which can compound a bad investment into a downward spiral of horribleness. 

    And yes, in 15 years everything will cost double to replace!

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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    @Verna M.

      buying high and selling low is a time honored tradition ! :)  just think of all those that bought into the market at 15k rode it down to 6k panicked and went to cash.

    Or how the RE market crashed in the same time period and investors and banks did the same thing... rode it down and sold at the bottom... sometimes though factors out of the investors control asseverated the crash.. IE banks calling loans on folks that were current but no other banks would right new loans..  

    I still like the CA.. Model or WEst coast or higher end model if you can break even that's great let your tenant pay your house off.. because in 20 or 30 years in prime areas of RE your asset will have appreciated and might have appreciated to incredible heights..

    the point @Ben Leybovich

     is trying to make is he is not bullish for any kind of recovery in his little town or area. And of course population shifts will continue to happen everywhere. But Ben's little town is just one Auto plant coming in and building a new factory away from a rebound :) example whats potentially happeging in Toledo with FIAT Chrysler and the state selling bonds to facilitate it.

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  • Max T.
    Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
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    What are people's thoughts on financing the big ticket items when they need replacing? I'm thinking about furnaces/central AC, roofs, sewer lines (the things that cost more than 5,000).
    1Reply
  • Verna M.
    Tujunga, CA · Member since 2015 · 88 posts · 48 votes
    11y
    Originally posted by @Jay Hinrichs:

    @Verna M.

      buying high and selling low is a time honored tradition ! :)  just think of all those that bought into the market at 15k rode it down to 6k panicked and went to cash.

    I am trying to learn from the mistakes of my parents. :-/ And his point is to do your homework. Don't buy somewhere you don't know the economy!

    I had a HELOC shut down. I had equity and was making payments. I had a LOC for 75k with about 10k out (on a car of all dumb things!) I wanted to borrow more to buy the house next door to me that was in foreclosure and no one would write me a loan. I still cry about it.

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  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    11y
    Originally posted by @Max T.:

    What are people's thoughts on financing the big ticket items when they need replacing?

    I'm thinking about furnaces/central AC, roofs, sewer lines (the things that cost more than 5,000).

    When I have to do a roof, I arrange it with the contractor such that I buy the materials and pay for them over 6-12 months at 0% interest on a store CC then the contractor gets paid after the job is done.  So you can partially finance big items like that.  But I wouldn't do it if I had to pay interest.

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  • Jeff S.
    Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
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    And how do you get a loan for big ticket items @Max T.? If you have equity and CL's that is one thing but ideally you pay for them from rents. Realize that starting out there hasn't been time to build reserves so like they say "a man (or woman) has to do what they have to do." Spreading out the payments to preserve cash always a good idea unless pretty liquid either through cash or credit.

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  • Max T.
    Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
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    Originally posted by @Jeff S.:

    And how do you get a loan for big ticket items @Max T.? If you have equity and CL's that is one thing but ideally you pay for them from rents. Realize that starting out there hasn't been time to build reserves so like they say "a man (or woman) has to do what they have to do." Spreading out the payments to preserve cash always a good idea unless pretty liquid either through cash or credit.

     I know of a friend who had his furnace replaced and had a central AC condenser put in with the new one. Total cost was around 6k, but he financed it at 1% interest (0% for the first year). Seems like a good deal.

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  • Jeff S.
    Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
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    Yes, that is a good deal as long as nobody steals it @Max T.

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  • Marcus Auerbach
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
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    @Max T. 6k? expensive furnace that is...

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  • Max T.
    Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
    11y
    Originally posted by @Marcus Auerbach:

    @Max T. 6k? expensive furnace that is...

     High efficiency, gas, with AC condenser and outdoor unit... Plus the labor. That isn't so bad in this market.

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