CapEx on Rentals - Eating Up All Cashflow?

Question

I've got a handful of singe family rental properties that I mostly completely renovated when I bought them, but I am starting to look at what I should be setting aside for capital expenditures and am pretty blown away at the costs.

If I intend to hold a property forever, I am calculating somewhere in the neighborhood of $200-250 per month for capex, which seems to be in line with others' assumptions on BP. Most of my houses rent for around $1000 per month and if I assume 10% of rent for maintenance, 8% for vacancy, 15% for taxes (taxes are relatively high in TX), 10% for management, and 5% for insurance, that is around the 50% rule. But then capex is ANOTHER 20-25% on top of that.

So total expenses long term would be in the neighborhood of 70-75% of rents! If you have a mortgage on the property, you'd basically be at zero cashflow, and even if you bought for all cash you'd be looking at a pretty terrible cash on cash return.

What am I missing? If appreciation kept up with inflation, that would mostly make up for the capex expenditures, but I don't really want to count on appreciation to bail me out.

Gonz Trevino · Answer

It can be tough and that's why it is good that you're being strict with numbers. Sometimes you just have to use the BRRR strategy to get something significantly under market value and increase your cash on cash return. That stands for Buy - Rehab - Rent - Refinance. If you have enough cash you can also in theory skip the refinance part. But if you find a house worth 150k and you can buy it for 90k and put 25k in it, well it's giving you a nice 35k spread and increases your Cash on Cash return. It's definitely a patience game. :)

Dan Coleman · Answer

To me maintenance and vacancy is a built in capex and I never add capex into my projections. My thought process is I rarely use the 5% allotment for repairs or the 5% alloted for vacancy of the GRM I allocate over my entire portfolio. Vacancy for me in my market is low basically zero with a 60 day notice. So I have basically 10% that rarely gets used and I don't' feel the need to save additionally on top of that. With that being said I'm a full time investor can avoid a management fee and have the control to keep my costs down.

Obviously over saving is prudent and best especially for beginners. But at some point 20,000 is more than enough to cover any major item in a portofilio of SFR. After having so much money as a standing reserve I feel you don't need to be pumping that money into it each month especially if you rehabbed the properties.

JD Martin · Answer

You can use the numbers however you like, and if you have a bunch of wrecks, you might need to factor those kinds of capital expenditures.

My experience with capital expenditures. With the exception of a couple of years when I took a job out of state, I have lived in the same primary home for 22 years. I bought the house relatively new, just a couple of years old. During that time, here are the capital expenditures I have experienced that were required (i.e. not because my wife wanted some newer fancy stuff):

• Roof replacement - $5,000, though part of this was covered by insurance (tree went through roof)
• Bathtub replacement due to poor installation - $1,000
• Kitchen counters replaced (still serviceable but scratched laminate) - $1500
• Replacement french door, rotted frame - $500
• Replacement wood floors for worn carpet, which was replaced once before - $5000
• There were a couple of odd assorted things -a broken window, etc.

That list comes out to $13,000. Even if I round up to $20k, I would have less than $1k in capital expenditures per year. My house would conservatively rent for $1500 in my market, which would work out to about a 5% capex.

At any rate, yes some things can kill you on smaller houses that rent for less. But if you do your purchases right, many of those biggest expenses should have been accounted for within your opening costs. Example: earlier this year I bought a 1000 SFH. I could see it needed a roof but had brand new HVAC. I based my offer on the upcoming expenses and did the roof straight out when I bought it (I remodeled the rest of the house while it was vacant). This unit now has a brand new roof, HVAC, water heater, flooring, appliances, main electrical service, kitchen cabinets, bathroom. My all in is just under $50k and the unit rents for $650. Short of destruction by the tenant, there's not a whole lot to go wrong in this unit for quite a while. Because it's a full remodel, I would feel comfortable at a 5-10% capex for the forseeable future, meaning the next 5-10 years.

I don't know what you're paying for these places, but if you have to set aside $4200 per year for replacement & maintenance on places that can only pull $12k gross, you may not have the right market for rentals, or you may be paying too much for these properties.

Scott Pigman · Answer

IMHO, 10% for management might be a *little* high, maybe. It's market rate in Maryland where I own a rental. Last I asked in Austin I was told something like 8 or 8.5% was market here. I don't know about rental.ai but they must make money somewhere unless they're some sort of charitable outfit. However since I can't seem to get any information about them without first giving them my email address I'm not going to be able to figure out what their angle is.

My guess (and it's just a guess) is that there's some overlap between your 10% for maintenance and your cap ex estimate.

Matt R. · Answer

@Andrew Herrigundefined

This is the challenge. Find something that can overcome the known expenses. But single family homes were not designed to be investment vehicles as much as they were designed to be lived in.  If there is zero appreciation it is probably hard just to keep up with inflation. Some guys can make it up with volume...like hundreds or only buy super deals from the start. Otherwise it is probably a 50/50 outcome for many when all pennies are accounted for. Now if the hood appreciates timing can also be huge and easily overcome even the worst  case scenario expenses. Good luck!

Gabe G. · Answer

Well, at the end of the day all the numbers, outside of mortgage payment(if applicable) and taxes and insurance are estimates at best. You try to buy a decent rent able property for a reasonable price where your estimates make sense.  I have only been at this for 3 years. But one thing I have found, is you need to be able to cut costs without sacrificing quality, which you can do on some things. For example in my area a full service plumber would charge 900 dollars for a hot water heater install. However, I have found I can buy one at lowes for 300, and a handyman can do the install for 150. Basically cutting my costs in half. Those things add up, when you are talking about multiple units over several years.

The 50 percent is a good estimate.

I break mine down like this, since I am self managing currently.

15-18 percent for taxes and insurance

5 percent for vacancy(currently)

10 percent for maintenance(repairs)

10 percent for capex(new roof etc, doesn't happen every year)

Self managing I am looking at 40-43 percent operating expenses.

When I am buying I assume 50 percent, and make sure that the cash flow at 50 is acceptable.

Also keep in mind the 50 percent rule is over a portfolio of properties over a long period of time, if you only have one property, you can have years, where operating expenses are 100 percent or more of rents, and other years, where they may only be 30 percent. But over time, over a portfolio of properties, 50 percent, seems to be a reasonable estimate, including property management.

JD Martin · Answer

OK, so that's a good example. If you don't expect any major capital expenses in the next 10 years, why would you budget $30 grand for capital expenditures during that time? You can, if you like, but that would of course make your numbers look pretty weak.

Normal wear and tear from tenants will happen, but you can minimize the effects by tenant-proofing your house on the front end. Good quality flooring will last far longer than 10 years. I have beautiful wood floors in one of my rentals that are original to the house, which was built in 1928. I have no idea how many times they have been refinished, but before my last tenant moved in I had the downstairs redone for about $1.75/sf, which was full sanding and three good coats of poly. The floors probably hadn't been done downstairs for 20/30 years, I would guess. Well-done tile jobs in bathrooms will last 50 years, especially if you keep up with basic maintenance - keeping grout up, caulking, etc.

Some of your capital expenditures should be offset by appreciation, and some of them should be offset by tax savings. The houses I have that required heavier remodels had anywhere from 30-50 years of neglect behind them before I took over, and still didn't need more than $20 grand in rehab.

Andrew Herrig · Answer

Here is an example of a property I recently BRRR'ed:

3/1/1 brick ranch, built in the 1950s

Purchase: $37kRehab: $43kRent: $1200/mo

I replaced almost everything in that house (roof, HVAC, water heater, windows, electrical panel, gutted the kitchen and bath, fixed foundation). I don't expect any major capex in the next 10 years or so - although I got a call from the tenant about a gas leak over Christmas and ended up having to replace the entire gas line for ~$2500, so count that as capex I suppose. My main concern with any house built in that time period is the plumbing, so I'm sure I'll be spending another $5k or so on that over the next 10 years.

One of the biggest contributors to capex is just normal wear and tear due to tenants (I assumed painting the whole house every 7 years and replacing flooring every 10 years). And looking out past 10-20 years, and then replacing some of the major systems like roof and HVAC, and the eventual need to remodel the kitchen and baths.

Andrew Herrig · Answer

Thank you all for the replies!

@Scott Pigman I agree, there is probably some overlap between capex and maintenance. I could see maintenance being closer to 5%.

@John Thedford My current maintenance expenses have been all over the map. My longest held rental has only been for 3 years, so I don't think I've settled into what I would consider "normal" yet. The pattern that seems to be emerging is that I do a pretty extensive rehab after purchase, and then inevitably end up spending another few thousand the first year on something that was missed (usually plumbing related).

@Robert M. I like the idea of looking at capex as a fixed cost. Makes sense that the higher rents you can get for the same size house, the lower capex will be as a percentage.

@Jd Martin Most of the houses I'm buying were built in the 1950s, so they have their fair share of deferred maintenance. I think the majority of capital expenditures would come after Year 20, assuming the property was new. I do full renovation on all my properties upon purchase, so I agree capex will be low the first several years, but looking at the big picture and assuming I will hold forever, there are some large expenses that come up over time you would never see if you held a house for <20 years.

Kenneth LaVoie · Answer

***I would add that I don't do a single maintenance or repair item myself, not so much as changing a light bulb, though we do take care of management ourselves.

CapEx on Rentals - Eating Up All Cashflow?

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