Deal Analyses – Estimating Costs
A while ago I wrote a series of posts ranting about the current state of the residential income property market in Stockton, CA. In each post I highlighted a current listing and argued why I felt it was not a good “deal”. You will find those posts; HERE, HERE, HERE and HERE. The below post is a re-post from the Stockton forum, as I was hoping to get some discussion started and thought this might be a better place to solicit some feedback.
The 1% Rule is Dead – Long Live Detailed Cost Analyses!
One common thread that runs through all my posts is that Stockton property values are rapidly outpacing rent increases. With margins tightening like that, thorough analysis of any prospective “deal” has become a lot more crucial than it seemed to be when the 1% rule still held in Stockton.
While rents for listed rental properties are pretty easy to guesstimate, my biggest challenge in analyzing new opportunities has always been estimating repair and rehab costs. When I first started out, I had no historical data to draw from. The same goes for many of the readers here. That's why I thought I’d create a post and share some actual numbers and explain how I established them and how I use them to budget for the future.
Where Does he Get Those Wonderful Numbers?!
In order to keep track of the chaos that a growing property business is, I have purchased a cloud based property management and accounting system. Every single transaction goes into this system.
All bills are categorized when they are entered in as either “repairs”, which are expenses that are tax deductible in the current year, or as a type of "building improvement". This last category represents Capital Expenditures (CapX) which are written off over time. This means that when a building goes into a rehab project, two things happen. Because the rehab always contains both repairs and CapX spending; A.) Expenses go up and B.) The value of the building goes up.
So in order to do any meaningful analyses I will need to look at A.) my Trial Balance, to see what the value of the building was, and B.) my income statement, which details income and expenses. Fortunately those reports are really easy to pull up from my property management system. Unfortunately there is no slick report editor allowing me to create the type of reporting that I will share here. This means it still takes (a lot) of time to manually stick all numbers in Excel.
Individual Results May Vary…
While I hope my numbers will give the reader some indication as to what things cost, it is important to keep the old idiom about “comparing apples to oranges” in mind. My historical data is a pretty accurate predictor for *me* because I only buy one particular type of building in one particular market. Then, I apply my own, again standard, rehab formula to them. Your building type and rehab / management formula will likely be different.
Now Onto the Main Event – The numbers!
Towards the end of 2013 I bought 3 triplexes, 9 units altogether. It is important to know that all those buildings are extremely similar in every way. Then I applied my secret sauce to these buildings. This includes a pretty high end remodel for all the empty units or units that emptied out during the process. It also includes a very thorough exterior job, from roof and rafter tail ends and new gutters, to replacing all suspect siding and replacing all windows, sliders and doors. Garage doors too, even if there were only a few bullet holes. Just to make sure, I am not advocating you go this route, but as they are my numbers you need this context to understand what they mean.
First I analyzed each building separately and then I added all the numbers for the three buildings up and divided them by the number of units. This allows us to look at the more anonymous average cost *per unit*. So keep in mind that all numbers you see are per unit, not per building. Finally I rounded all numbers to the nearest $100. This makes them easier to read. Finally I annualized the numbers for 2016 by doubling all Jan-June numbers, which should be close enough.
2013 Year Zero - I bought all buildings towards the end of the year. And I can only guess as to the previous owners numbers. Only thing I am sure of is that they must not have been good because of high vacancies and low rents. The only reason that I even included the 2013 column is because it offers some insight into how much money I had into each unit by the end of that year.
2014 Rehab-O-Rama - This was a very expensive year. Two of the buildings basically got the full exterior treatment and a total of 4 units got a high end rehab. This obviously did not lower vacancies. Notice the steep increase in each units value (+11K). This year was even more expensive than it could have been. This was on account of me placing too much trust in a contractor that came highly recommended. And that same contractors gambling addiction spinning out of control. Nuff said:(.
2015 Light at the end of the tunnel? – This year still saw a lot of work. One more building got finished up. Notice that each unit’s value went up by another 4k. Also a lot of this work was smaller in scope and therefore classified as “repairs” and is qualified under expenses. Vacancies were still a problem as I had to urgently get rid of a legacy tenant who was getting a little too entrepreneurial. This of course happened while I was in the middle of a rehab of yet another unit, so I did not have cash or time to redo the other unit immediately. In the end, the unit that got vacated that way got a “quick-fix” rehab before getting re-rented. To a great tenant by the way!
2016 Smooth Sailing! – Besides a two month vacancy the first half of 2016 was pretty event-less. At least financially speaking. There was no rehab work, and very few service calls. Therefore I feel that the 2016 numbers best represent an average unit in full swing. Once it has been dialed in that is. For 2017 I fully expect similar cost numbers, only with slightly higher rents.
Duplex Comparison – The below numbers are the per unit numbers for a distressed duplex I bought for cash late 2014. This duplex is the exact same type of cookie cutter property as the triplexes. Only it is, well, a duplex:).
It's important to mention that this Duplex needed a LOT of work. A lot. However the price was right. Properties that need a lot of work actually works out well for me. This is because I don't need much of an excuse to do all the work anyway. So at least if what I am ripping out was a complete write-off I am at least getting it at a price that justifies ripping it out.
Anyway, long story short, I pre-loaded the work, as is my custom, and by the beginning of 2015 I had a fully rehabbed and soon thereafter fully rented Duplex! 2015 was a very stable year. No drama! I feel this is in large part because we did all the work upfront. I am glad to report that so far 2016 is equally drama-less, only with slightly higher rents. So I annualized the 2016 numbers based on that.
Conclusion – So How Does this Help?
First off, based on the above numbers I know I am not likely to be named "Entrepreneur of the Year" any time soon. In my defense; you should keep in mind though that I am doing true long term buy-and-hold, and that my “strategy” includes pre-loading all maintenance and rehab work where possible. Also, I do right by my tenants and I rent out units that I can be proud of. Because it's the right thing to to and because its good business as well.
Back to the numbers, here are my most important conclusions:
1.) Getting units that are in pretty-to-really bad shape fully “dialed in” my way costs a worst-case average of $18,700 per unit for my triplexes and $21,000 for my duplex. Ouch! This includes repairs and CapEx. And more new HVAC backpack units than I care to remember. Double Ouch!! This helps me estimate the real price of a listing.
2.) In a normal year a fully “dialed in" unit is going to incur an average of $2100 to $2600 in regular ongoing expenses. Never less.
3.) This allows me to predict what NOI I will have one I'll have a new building up and running. I can calculate the new building's NOI based on the rent I think I will get for each unit. Or I can simply use my current NOI range of $7,500 to $7,900. And since I will know what the current loan rates and terms are is can predict my cash on cash return as well.
Since I (vividly) remember the state all these units were in when I bought them I can now look at a new building and say: “Well I think that this building is only half as bad as that duplex.” I now know this would mean approximate $10,500 in rehab cost. I also know that when I am done with them, the cost to run a unit is never going to be less than $2100 per year. To be safe I should use the at the $2600 number.
Anyway, that’s it for now. If you are still reading, you must have found this useful. If you did , please do me a favor and click on the "VOTE" button. That will help me determine where I spend my time on in the future:). If you have any questions; let me know! Or even better, post some of your own multi year numbers for comparison...
