Capital Expenditure Costs: A Case Study on SFR & 4plex - What do you use?

Question

I was surprised by the amount of long-term costs I calculated and even more surprised by what my biggest costs were going to be!!!! I also learned about better ways to estimate long-term expenses. Flooring and interior paint, over a long period, were going to KILL me! (actually, I'll be OK - but I was almost shocked by how high they were relative to roof, etc.

How do you estimate long-term costs? % of rents? $/unit/yr? $/sq ft? An estimate based on the specific property? (I kind of like them in reverse order..)

You can download the full presentation & excel file here:

http://www.meetup.com/REmeetup/files/

Some takeaways, then more info..

•Use a Cap Ex estimate that makes sense for your circumstances

•Some average costs can be estimated over a long period if the time is taken to get realistic cost information for individual property.

•Don’t confuse a good method of comparison (like % of rents) with a good method of estimation (like $/sqft or per/unit costs)

•Floors, Interior Painting, & Kitchens can cost more than Roofs, exterior paint, & appliances over the long term!

•Consider ways to mitigate these costs, such as durable flooring; durable, easy-to-clean & hard-to-notice-errors paint & color; tenant wear & deposits;

•Surprised there weren’t more savings for 4plex vs SFR!

After a discussion with @Anja Wehrmann about long-term capital expenditure costs, I decided to make an estimate for my property over the long term. And these were the results. I shared them with my meetup group in San Francisco last Thursday.

4plex:

SFH:

•Helped me understand long-term costs (& more precise costs for props)

•& ACTION STEPS TO IMPROVE!!

•Evaluate more durable flooring

•Vinyl?

•Hardwood?

•Evaluate better paint (lasts better, longer); colors (hard to notice dirt, smudges, but stylish); sheen (something that cleans easily but looks good)

•Negotiate bulk discounts on replacement of major items & coordinate

•Evaluate more durable items vs cost across the board

•Consider day labor for easier job

- Consider selling if people are overpaying for old systems?

Biggest Impact on cost for my buildings:

•Size of units (3k sqft SFH vs 900 sqft house)

•I found my largest long-term costs were driven by size: interior paint, flooring, water damage, roof. The more “stuff” there is to take care of, the more it costs to replace

•What type of Labor you use (GC? Handyman? Yourself? *not free!)

•This can easily double the cost in my area from GC to handyman. That is huge. #1?

•Cost of Labor in your area (SF labor costs more than Ohio)

•I estimate this could vary by 25-100%+ from Ohio to SF

•Quality of finishes & finish work – (high end or low end?)

•This can increase the cost of finish materials by 30-300%+ & some higher labor

•Type & # of units w/ shared systems –

•e.g., Large MF w/ shared costs

•I used to think this was a bigger impact, but how much does increased interior replacements in large MF offset savings from shared systems? (not 50%+ cost difference like earlier items, especially after utilities..)

•Durability of finishes – (e.g., pressed-board cabinets? Or real wood?)

•Weather – (e.g., TX investor said 10yr for new roof b/c hail & wind!)

•Wear from tenants – (2 tenants who treat like home; or 5 like renters?)

How do your estimates differ if you are in New York, verses San Jose, or Los Angeles? Or Kansas City?

Ben Leybovich · Answer

Sure - underwrite to the IRR. Less CF can be ok if there is appreciation. But, CapEx nonetheless needs to be covered out of cash flow before IRR calculation. Borrowing from Peter to give to Paul is no good...

Ben Leybovich · Answer

Exactly! Here's the link to the aricle @Serge S. and I wrote:

http://www.biggerpockets.com/renewsblog/2015/03/03/why-you-cant-make-money-on-30000-houses/

J. M. - you are maturing quite well as an investor, as is evident by the solid logic and conclusions you are arriving at.

I specifically wrote the article to encourage CA and Canada (and otherwise) money to think it through before coming to Ohio to buy turn-key pigs in Cleveland, Toledo, and Dayton...

Ben Leybovich · Answer

J. M. - interestingly, I've not ever underwritten a multi-family with anything less than $250/door of CapEx...and that's for a newer building without boiler, chiller, flat roof, and all the rest of the nonsense. $350 - $400 is more typical.

The difference is not in the numbers. The difference is in the market expectations. Commercial market is a more logical market (not so much now, but generally speaking), which means that everyone understands, expects, and prices CapEx into the ownership costs. Therefore, the purchase price is discounted relative to CapEx expectations. Again, hard to do today, but we don't buy unless this is so...

In SFR market, neither investors nor sellers are professionals, and CapEx is over their head. Trying to tell a seller that their property is worth less due to constraints on CF represented by CapEx is nonsensical...

This is why I play in the multifamily commercial space. Unfortunately, today, most players in this space are also somewhat less than pros and have otherwise agenda, which makes it very difficult for guys like us...

Also, in the case of small multifamily, it is possible to chose property which complies to the desirability guidelines similar to SFR, whereby limiting turn-over, vacancy. Unlikely that people will stay as long as SFR, but I have small multi in my portfolio that people have been in for 8 years - good tenants who don't damage property and don't call me about nonsense. My underwriting criteria focuses on this, not the CF pro-forma, which is why I don't buy pigs or pig equivalent in Mid-West.

Finally, CF is less important in your market. There's an awful lot of appreciation to off-set CF. In the final analysis, what's most important is the complete life-cycle of the investment, as represented by the IRR. CF will not drive the IRR - appreciation will. I would happily take less CF in exchange for appreciation. We don't have that in the Mid West, so we have to out do ourselves on CF. And key to this is: CapEx, and other economic losses!

Assaf Furman · Answer

J. M.

A layman's question: If the purpose of your investments is cashflow, can't you offset the capex with gained equity?

In other words: By the time you need to redo the floors and roof, you can get a HELOC in advance and pay them off of that.

Roy N. · Answer

J. M.

This underlays why tenant selection is so important and why turnover is so expensive.  Turnover a flat or house every year and you will always be painting:  We turned over 1 house and three apartments in the past month and have gone through 4 5-gallon pails of paint (at ~$100/pail), two boxes of mud, and over 100 hours of labour.

Fortunately it is the first time these units have turned over in 2+ years.  One of them is rented on a 2-year lease (government employee, the Crown pays), the others are all good potential long term tenants ... with the exception of the Student house which is a annual lease with the potential to renew (which happens 50% of the time).

J. Martin · Answer

@Serge S. and @Ben Leybovich

I hadn’t seen your article on CapEx before performing this study, so it’s a nice little “independent” calculation of what you had done before. I did take a look after I saw your post. Interestingly, (even without going through the details), I know some of our details and probably even some major items differ. For example, I’m sure your cost of labor is lower, and you don’t plan on any earthquake-related upgrades I’m sure. On the other hand, there may be more “weather wear,” brick tuckpointing, etc out in your neck of the woods, depending on circumstances..

Alternatively, what did you come up with for the per-unit CapEx costs for Multifamily? I was surprised to see that the 4 unit building provided little CapEx benefit in my case, but suspect that big MF has more CapEx benefits. On the other hand, MF seems to have more turnover, and the tenants may not treat the place as well as SFH renters. Then there are the utilities..   How much lower, if any, do you expect your total expenses to be, including capex, for MF? Just CapEx & Maint w/o the additional costs of MF, like utilities? Obviously, there are a lot of other great benefits to MF, but I was surprised to not see more savings, event in the 4-unit, on CapEx.

@Roy N.

Ironically, because of the market in my area, turnover costs me next to nothing, including vacancy, for this part of the cycle at least... I do not repaint the unit every time someone moves. I have never suffered credit loss (despite being in low-end areas, although I’m sure I will someday..), and have had so few DAYS of vacancy, it’s difficult to keep track of. However, I found that the 5ish year repainting (regardless of turnover) and period floor replacement are really going to add up.. The quality of the tenant has some impact on these, but I consider them CapEx instead of turnover because I do not replace them on each turnover, so do not include them in my turnover costs. They’re CapEx instead for me.. Do you repaint every turnover?

@Assaf Furman  “If the purpose of your investments is cashflow, can't you offset the capex with gained equity?”

I think we’re mixing up things like cash flow, funding sources, income, & equity vs CF.

For these purposes, I’m not trying to determine my periodic cash flow, how to fund expenses, or where to get liquidity.. And yes, I expect my property prices to appreciate over time. But I estimate the two separately. I’m just trying to understand the average costs of maintaining the property. So this is more of an income perspective than cash flow or liquidity. How much will sh*t cost me over the long term? Whatever cost that is, it has to paid with some part of the profit (CF or HELOC on appreciated equity). I can have all the HELOC’s in the world, but would not matter if the thing isn’t making money one way or another. Alternatively to Ben’s point though, I don’t mind borrowing from Peter to pay Paul a little, as long as Peter is paying me a sh*t ton of money! Lol

@Charles Worth,

you are correct that the ratio of appreciation to cash-out refi is not 1 for 1. It’s more like .75:1 @ 75% LTV for qualified borrower. But again, I think this misses the point of the actual costs, vs how to fund.. How do you budget cap ex expenditures? (not source of funds.)

@Ronald Perich

I agree that bad tenants can increase some CapEx, but I think your point about evictions is more focused on the turnover/credit loss/short-term costs than the capital expenditures topic here. How do you budget CapEx for your houses? (aside from short-term items..)

@Dustan Marshall

You seem to be leaning towards small multis in your area instead of just SFH after seeing this. Yet I stated that I was surprised between the relatively small difference in CapEx expenses between MF and SFH (I thought they should be more.) What was it that made you think more about small MF?

Serge S. · Answer

Interesting. @Ben Leybovich and I did a similar study and posted an article in the blogs and came up with your exact amount of around $170 per month on a small SFR. The point here was that the $600 rental and $30k purchase price home is not what it seems. With nearly $200 in just capex there is little to no real return with this investment class after factoring in repairs, taxes and turnover. We were called crazy for providing such "inflated" capex numbers. The reality over the long term is pretty much exactly as you document. Thanks

Dustan Marshall · Answer

J. M. i have always been intrigued by the way MF spread the cost of cap ex, repairs, VACANCY across multiple units as opposed to 100% of a single family.  I also really like the idea of having things centralized to reduce costs/ time (which leads to higher cost when hiring things out.  you still pay for the contractors drive time).  What has stopped me thus from getting into the MF's is the initial cost of entry. I have mainly focused on sub 50K units.  And I am able to get a SFR that rents for 700/mo or higher.  with MF you will pay about the same per unit and get 550/mo.  but that is changing rapidly as of late.  i have seen a 15-20K rise in prices of SFR.  so i am taking a step back to see where to deploy my capital.

The only thing i did have a hard time accounting for in the MF space in the expense of shared items that the LL will have to cover.  examples may include: snow removal, landscaping, trash.  these items are all covered by the tenant in my SFR but would need to be covered by the LL in MF.  and like i mentioned above the exit strategy of a SFR is much easier (in my opinion) that with a MF.  So i will just have to keep running the numbers on properties i like and see how the chips fall.

Roy N. · Answer

J. M.

We do not do a full repaint every turnover, but there are always touch-ups ... the more furniture moves in-and-out, the more touchups that will be required.   The tenant also makes a huge difference.  Students tend to hang lots of posters and knick-knacks; be hard on walls, doors,etc.  In our student house which is turning over this month, we ended-up repainting all but one bedroom; the hallways and bathrooms.  The kitchen and living room only needed a few touch-ups.

Dustan Marshall · Answer

great post.  I have always been interested in MF.  But I have only boight SFH this far because of the ability to resell to a wider spectrum as opposed to MF.  But now,  I think I will have to take a much harder look at small multis in my area

Capital Expenditure Costs: A Case Study on SFR & 4plex - What do you use?

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