Capex reserve for cheaper props

[Edmund Li]

I am a newbie investor looking to get my hands dirty with my first purchase. I have been in search for my first rental property for a while, and I haven't pulled my trigger because I couldn't get the math right.

I've found some very cheap property with seemingly positive cash flow after P&I, insurance, management fee, property tax etc. However, the CapEx is the part I have been having trouble.

It seems that from various sources, the suggestion of capex reserve is about $180-$230 for a single family home. This makes sense since the prices for the large items don't seem to vary by a lot given the home price. So buying properties that are too cheap with lower rent seems always to be a bad deal. 

i.e. a $60k property with $800 gross rent, the $200 capex pretty much always put the cash flow to negative. While a $150k property with $1300 rent seems to be ok since the $200 capex would take up less portion from the gross rental income. Note: I am comparing properties about the same size.

So my question is, is the $200ish cap reserve pretty close to what I need even for cheaper properties? If so, does that mean cheap properties with lower rental income (even if it meets 1% rule) is pretty much always a bad deal?

[Aaron K.]

A roof will cost the same, a furnace will cost the same, most things will cost the same, but many people just use a percentage of rents to make sure they don't run low on funds.  If a big ticket item comes up you may have a loss for the year, think of capex more as self insurance it isn't spent every month like your mortgage payment.

[Dennis M.]

@Edmund Li I’d rather just have an open unsecured line of credit that if and when it comes up I just draw out of it to fix or upgrade and then paybIt back . Much easier and better than stockpiling reserves

[Edmund Li]

Thanks very much for the reply. What you guys said makes total sense. But when a big ticket item comes due, I have to spend the money to replace/fix it. It doesn't happen every month, but it does eat into the cash flow. Doesn't it not make sense in the long run?

Consider this. A $60k property, I am happily collecting $700/mo. Let's say I net $200+ cash flow before capex reserve. Nothing happen for 3 years, then the roof com due for $5k. My total accumulated cash flow is $7200. So I have $1200 left. Then if in another year the HVAC comes due, I will be in negative territory.

Given this math, how do you guys manage to make a profit on cheaper properties? I might be very off, but I am trying to make sense of the analysis.

[Jim K.]

Edmund, you are not off at all, at least from my perspective. The way to make money for me is to reduce those expenditures where I can. I have a duplex with 25 windows, for instance. Instead of paying a window replacement company $400 per window and then $400 for labor for each window, I would change out the windows myself, at a cost of $150-$200 per window. Once I had done that a couple times, I would certainly be in a position where I could easily ascertain if a handyman changing out windows could do a good job at it for $30/hr, at an average of 1 window per hour, for a maximum of $230 per window.

Instead of calling my plumber in when the cast iron stack cracks and starts leaking, for a $600 repair and the $200 to have the wall patched, I could do it myself for maybe $100 in materials.

I'm sure you can see how the math changes when you're willing to trade your time for money+experience, and then later as an experienced handyman you can hire and effectively supervise/teach unskilled labor to help with these jobs. Passive investing it ain't, and it's also not scalable past a certain point. But by the time you get close to that point, you're already working on transitioning out of the asset class. But while you can do it, SFR and small multifamily are a great way for a handyman to get started in the real estate game without outsized cash reserves.

What do you need to do to maximize the advantages of being a self-managed handyman investor? First of all, you don't buy properties for 60K that will rent for $700/month. You have to live in an area you can do better than that, and you have to go after properties that the hands-off investor probably can't make money on. That means C/D class, old properties with lots of deferred maintenance issues that cost you a lot less cash out of pocket/financing costs to fix than someone paying contractors through the nose, rock-solid tenant screening, and wise property management.

Again, this is not passive investment in the slightest. I'm in my early 40s. I figure I have ten more years before I'm done, and start selling to the next hungry pup to put my money elsewhere.

Nor does everyone have the skills or even the physicality to do this. I see these posts here by young ladies thinking about investing in D-class small multifamily deep in the ghetto and shake my head sadly. As my friend Dennis M. says, you have to be more savage than your tenants to make it in the ghetto, and yeah, I've done ugly things and my tenants can see them in my face. My other friend Derrick E. can tell you stories that will turn your hair white.

People WILL look down on you, especially in the beginning, and it's a very tough slog to get started. Thankfully, once you get past a certain point, you come here to BP, read stories about totally inexperienced landlords losing the s**t because of trivial issues, or saying wholly ignorant things about low-income people, or just ridiculous things about contractors ripping them off for minor repairs, and you laugh, not unkindly. You understand that yes, a lot of people are trying to get into this with clean hands and fantastic notions of how money is made and lost in real estate, and thankfully, that's not you anymore.

[Dennis M.]

One good tip is to find a local handyman and have him do simple repairs . Make sure he underatands your standards and he realizes not to over improve the property . This has saved me lots of money and general contractors are usually hard to get to do anything and very pricey . I would almost say find a good reasonable handyman before you find the property . I’d do it all myself but I’m more valuable at my job than swinging a hammer , he’s a writeoff on my taxes and to be honest I don’t want to be around my tenants or that area very long lol Jim K has given you great advise . I’d take it and think how you can apply it your business 

[Jay Hinrichs]

Originally posted by @Jim K.:

Edmund, you are not off at all, at least from my perspective. The way to make money for me is to reduce those expenditures where I can. I have a duplex with 25 windows, for instance. Instead of paying a window replacement company $400 per window and then $400 for labor for each window, I would change out the windows myself, at a cost of $150-$200 per window. Once I had done that a couple times, I would certainly be in a position where I could easily ascertain if a handyman changing out windows could do a good job at it for $30/hr, at an average of 1 window per hour, for a maximum of $230 per window.

Instead of calling my plumber in when the cast iron stack cracks and starts leaking, for a $600 repair and the $200 to have the wall patched, I could do it myself for maybe $100 in materials.

I'm sure you can see how the math changes when you're willing to trade your time for money+experience, and then later as an experienced handyman you can hire and effectively supervise/teach unskilled labor to help with these jobs. Passive investing it ain't, and it's also not scalable past a certain point. But by the time you get close to that point, you're already working on transitioning out of the asset class. But while you can do it, SFR and small multifamily are a great way for a handyman to get started in the real estate game without outsized cash reserves.

What do you need to do to maximize the advantages of being a self-managed handyman investor? First of all, you don't buy properties for 60K that will rent for $700/month. You have to live in an area you can do better than that, and you have to go after properties that the hands-off investor probably can't make money on. That means C/D class, old properties with lots of deferred maintenance issues that cost you a lot less cash out of pocket/financing costs to fix than someone paying contractors through the nose, rock-solid tenant screening, and wise property management.

Again, this is not passive investment in the slightest. I'm in my early 40s. I figure I have ten more years before I'm done, and start selling to the next hungry pup to put my money elsewhere.

Nor does everyone have the skills or even the physicality to do this. I see these posts here by young ladies thinking about investing in D-class small multifamily deep in the ghetto and shake my head sadly. As my friend Dennis M. says, you have to be more savage than your tenants to make it in the ghetto, and yeah, I've done ugly things and my tenants can see them in my face. My other friend Derrick E. can tell you stories that will turn your hair white.

People WILL look down on you, especially in the beginning, and it's a very tough slog to get started. Thankfully, once you get past a certain point, you come here to BP, read stories about totally inexperienced landlords losing the s**t because of trivial issues, or saying wholly ignorant things about low-income people, or just ridiculous things about contractors ripping them off for minor repairs, and you laugh, not unkindly. You understand that yes, a lot of people are trying to get into this with clean hands and fantastic notions of how money is made and lost in real estate, and thankfully, that's not you anymore.

excellent post.... those that I see make it in low end cheap rentals are usually mom and pop operations.. Mom does the books and leasing Pop does the handyman work.. nothing is subbed out except heavy duty items..  those that don't live there and have to rely on 3rd party management and maintenance are just setting up your next buys at some point in time.. we call that burnt out landlord syndrome.. And when they figure out hey that did not work they just dump them to the locals.

[Caleb Heimsoth]

@Edmund Li Percentage of rent is generally a bad way to estimate capex. Take all the major items in a house (roof, furnace, AC, water heater etc) Find the cost to replace and install. Divide that cost by years left of useful life and then divide that yearly cost per month. Alternatively, depending on area you can just do fixed amount of reserves. For example the houses I buy in Memphis are all relatively in the same area and same size. If I have a 5k reserve for each one, that would cover everything but the roof and considering several of them have brand new roofs anyways, that’s okay.

[James W.]

I used to use a percentage of rents but have since moved to an estimate for the property based on the estimate cost of items in my area. My estimate comes to $220/mo for a SFR which does not sound too attractive but gives me a sense of what I should consider reasonable.

I still look at is as a percentage of rents and change the Cap Ex figure a bit too to see if I can possibly make something work, but I do want to get an idea on the return on various levels of cap ex too as I could potentially sell a property before realizing some of those items as well.  

[Dennis M.]

In My area it seems like every c class or d class multifamily has an old slate roof . Some good some patched up . Every landlord seems to have a new furnace and water tanks installed though. If I see it needs a new roof I won’t even consider it unless it’s absolutely smoking of a deal because a roof on a 3 or 4 unit 3,000sq ft house can be 8-10 grand right off the top . If I see knob and tube I better get a huge dIscount ..To Be able to walk in , do a 15 minute inspection and knowing major repairs and their costs will go along to your investing career . If you gotta pay a licensed general contractor to come out and do every little thing you will go belly up in short order .

[James Wachob]

@Edmund Li are you taking leverage to purchase the property? I have found that it is a great idea to take care of the big-ticket items, upfront.  i.e. Roof, Mechanicals, and Flooring (60% of my full renovation budget)

That way you can mortgage these items rather than pay cash in the near future.  

If you are paying cash and the roof does not need to be replaced for a few years... then wait. 

[Jay Hinrichs]

Originally posted by @Dennis M.:

In My area it seems like every c class or d class multifamily has an old slate roof . Some good some patched up . Every landlord seems to have a new furnace and water tanks installed though. If I see it needs a new roof I won’t even consider it unless it’s absolutely smoking of a deal because a roof on a 3 or 4 unit 3,000sq ft house can be 8-10 grand right off the top . If I see knob and tube I better get a huge dIscount ..To Be able to walk in , do a 15 minute inspection and knowing major repairs and their costs will go along to your investing career . If you gotta pay a licensed general contractor to come out and do every little thing you will go belly up in short order .

 slate roofs are rare here and would cost an arm and a legg  only the multi million dollar homes have those .. :) like I say real estate is regional.. but we would pay 60 to 100k for a slate roof alone.. 

[Dennis M.]

@Jay Hinrichs The old slate sure a long time . most of the multIs Here were buIlt from roughly 1880- 1930 . Everyone seems to just tear the slate off of them and go with a metal panel roof anymore . I imagine slate replacement would be cost prohibitive especially on a 25k duplex or triplex

[Edmund Li]

Wow thank you so much for all the great responses, guys! I am very glad I posted this thread here before getting all excited and place an offer. 

@Jim K. gave great advice. However, I am going to invest remotely. As much as I'd like to, getting my hands dirty is just not an option (I am located in an area that don't have any property available to generate a reasonable yield, or even if there is, I can't afford). As to @Dennis M.about finding a local handyman, how would you access their work if you can't meet them? I will need to rely on management companies to take care of the day to day management because it doesn't make economic sense for me to fly over unless I have multiple properties in the same area (and that's probably a long way to go since I am still looking for my first purchase).

@Caleb Heimsoth , I also looked at properties at Memphis. My question to you, how do you manage to invest remotely? And prices there are so cheap that I doubt it even covers building a new one from scratch. My research shows that it costs about $100/sqft to build a home in Memphis, and various properties I looked at are lower than $50k for over 1000 sqft. So my number goes, if I buy it without fixing anything. And when it breaks down, I build a new one from scratch, it will cost me $100k, and my rent will be maybe $100 more which is about $800, how can anyone even make money off that? And what you said is interesting in a sense that, if I foresee not having to replace the roof in the next 10 years and selling within the next 10 years, I can just not reserve for it. And when it comes to sell, I just count on the appreciation to offset the roof deprecation, is that right?

@James Wachob , I am taking a mortgage to leverage as I want to purchase multiple to spread out my eggs. To what you said, I feel that unless I get a steep enough discount, it wouldn't make sense to shorten the lifespan of usable items right? If the roof can still last 3 more years, why shorten it to bring up the cost?

[Caleb Heimsoth]

Originally posted by @Edmund Li:

Wow thank you so much for all the great responses, guys! I am very glad I posted this thread here before getting all excited and place an offer. 

@Jim K. gave great advice. However, I am going to invest remotely. As much as I'd like to, getting my hands dirty is just not an option (I am located in an area that don't have any property available to generate a reasonable yield, or even if there is, I can't afford). As to @Dennis M.about finding a local handyman, how would you access their work if you can't meet them? I will need to rely on management companies to take care of the day to day management because it doesn't make economic sense for me to fly over unless I have multiple properties in the same area (and that's probably a long way to go since I am still looking for my first purchase).

@Caleb Heimsoth , I also looked at properties at Memphis. My question to you, how do you manage to invest remotely? And prices there are so cheap that I doubt it even covers building a new one from scratch. My research shows that it costs about $100/sqft to build a home in Memphis, and various properties I looked at are lower than $50k for over 1000 sqft. So my number goes, if I buy it without fixing anything. And when it breaks down, I build a new one from scratch, it will cost me $100k, and my rent will be maybe $100 more which is about $800, how can anyone even make money off that? And what you said is interesting in a sense that, if I foresee not having to replace the roof in the next 10 years and selling within the next 10 years, I can just not reserve for it. And when it comes to sell, I just count on the appreciation to offset the roof deprecation, is that right?

@James Wachob , I am taking a mortgage to leverage as I want to purchase multiple to spread out my eggs. To what you said, I feel that unless I get a steep enough discount, it wouldn't make sense to shorten the lifespan of usable items right? If the roof can still last 3 more years, why shorten it to bring up the cost?

When you have an appraisal the appraiser looks at what tr would cost to rebuild.  Mine have typically cost the same as approximately market value but that’s just me.  Not sure how accurate those are either

[Jeffrey Almonte]

Hi @Edmund Li !

If you're investing out of state, beware of cheaper properties. These are more active investments and you deal with a different class. You'll be heavily relying on your PM company and a local handyman for smaller repairs. There have been many threads of out of state investors losing money on low income properties.

As others have stated, percentages aren't a valid way to estimate CapEx. A roof will cost the same regardless of the rent being $600 or $1000 a month. But the percentages are vastly different.

If you decide to invest in out of state cheaper properties, the best money you can spend is to fly there and spend some time in the area. Spend more time building your team and connecting with local BP members. And get a free local Google Voice number so handymen don't try to upsell you immediately.

[James Wachob]

@Edmund Li both strategies work. With the current lending available (20% downpayment Fannie Mae) the monthly cost to borrow $10,000 =  approx. $60 per month. 

My thinking is that a $15,000 renovation that includes the "big ticket items" i.e. Roof, Hard-surface floors, Mechanicals cost me $90 per month vs. paying cash for these items in the next 5-7 years... 

[Mark S.]

@James Wachob  James - That idea sounds like the right one.  How are you rolling that $15K in that example into the mortgage?  Via refi after renovations?

[James Wachob]

Originally posted by @Mark S.:

@James Wachob  James - That idea sounds like the right one.  How are you rolling that $15K in that example into the mortgage?  Via refi after renovations?

 All properties are mortgaged post-renovation. The majority of properties purchased have a brand new roof, all hard-surface floors, and new mechanicals. 

In the acquisitions phase; all cashflow + my personal contribution of $5000 per month is focused on the downpayment and closing cost to acquire my next property.

In the debt reduction phase; all cashflow all cashflow + my personal contribution of $5000 per month is focused on killing off the debt on ONE mortgage, at a time. 

see the below chart that shows the sequencing of each phase: