All Forum Posts by: Forest K.

Most landlord associations provide and update all the relevant documents and make sure they are legally compliant for your region.  

Hi All, 

There are some very helpful tips can context in this thread and I really appreciate that. I do want to push toward my initial question a bit though. I know that CapEx is a floating contextual target that no simple formula can possibly accommodate. I also know that any attempt at accuracy would require itemizing my likely future expenses, their cost, and estimating when those costs may need to be addressed. And I am doing that, also. But many investors still like to have shorthand formulas for quick evaluations, and I'm simply interested in possible little improvements to that for my own spreadsheet quick analysis. Maybe you would all push against this and feel that it simply isn't worth the effort, but I think it's an interesting problem to work on.

@Dan H. mentioned land value and that's a great point. My formula didn't account for that. It also didn't give the option to spread the difference between the Current Home Value and ARV over time. As a result, my initial formula is a bit aggressive. So here is a new formula that accommodates both of those concerns.

B1 = Time Scale

B2 = Land Value as Percentage of Property Value

B3 = CapEx as Percent of Property Value

B4 = After Repair Value

B5 = Current Home Value

=(B4 * (((((((B4 - B5)) / B4) / $B$1) * $B$2) + $B$3)) /12)

Here are the results:

Thanks, @Nathan Gesner, that's some very helpful context. 

Thanks, @Chris Seveney, I have done that to some extent, but while I was working on my property analysis spreadsheet, I noticed the somewhat large discrepancies in my various CapEx calculations (based on the standard formulas) and became interested in finding a formula that I could use easily (back-of-the-napkin), without itemizing and predicting expenses, and that would work even in cases where the gap between ARV and Current Property Value are rather wide. The standard calculations don't seem to worry about this because they (sort of) assume the property will be renovated or reasonably stable from the start.

So that's the problem that I'm interested in solving.

You are right that it would be best to nail down these real costs and land on a more reliable number. 

Part of the challenge in this case is that my partner and I purchased an unusual property from relatives that has a lot of deferred maintenance and we'll need to do some juggling for a year or more to free up the capital/equity to do a proper renovation. It's essentially a 6-unit building with only three units occupied, one vacant, two completely gutted, and the siding and roof are in pretty bad shape. So, the costs will be extensive and it will be challenging to predict which of the many things may need to be fixed/replaced before we can do a proper full renovation. 
 

I'm trying to find the best CapEx formula. I know that it can be calculated different ways. I know that the best thing to do is to make actual predictions about expected and predicted expenses rather than use back-of-the-napkin formulas. I also know that there isn't really a best answer and that calculating CapEx should depend on each property and your own landlording experience. Nevertheless, I'd like to have a reasonably reliable formula that I can use for (my analysis spreadsheet generally and) a property that I have that has a lot of deferred maintenance (short of doing a full itemized analysis).

The two most common formulas are 5-10% of gross income and 1-2% of property value.

$2,000 income * 10% = $200 CapEx (per month)

($200K property value * 2%) / 12 = $333 CapEx (per month)

Of course, for % of income to work, rent would need to be at market rate or follow the 1% rule. So this formula wouldn't work in cases where that expectation wasn't met. This is probably rhetorical, but to be more accurate, we should simply use potential ARV (After Repair Value) income (based on market rate or the 1% rule) instead, no? If so, I'm not sure why Operating Expenses would ever be calculated based on actual rent/income (rather than full occupancy, ARV, potential income).

Even more interesting and complicated is basing CapEx on property value. Typically, the formula is simply Property Value * %. However, the more a property deviates from ARV because of deferred maintenance, the less reliable the result is on two fronts: you would expect more expenses and your reduced property value would predict less expenses. This makes me think: 1. at the very least we should always use the ARV rather than current property value; and 2. if we want to be even more accurate, we'd have an escalating % based on how far the current property value deviated from the ARV. Does anyone use such a formula?

One factor is simply recognizing that our CapEx imagines the cost of a building being replaced every x years (or, said another way, it imagines that a % of the total cost is replaced each year). So, as an extreme example, if the property needed to be built (so we say the current home value is $0) but it's ARV is $200K, our CapEx could accommodate the full $200K being replaced in a single year rather than 50 or 100 years (depending on the CapEx % we like to use: 1%-2%). That would make our monthly CapEx = $200K / 12 = $16,666.

For example (we could do something like the following): 

(CHV: Current Home Value, ARV: After Repair Value)

The following formula results in a normal CapEx if ARV = CHV and $17,000 if CHV = $0 (i.e., we absorb the cost of replacing the building in a single year).

CapEx = (ARV * (((ARV - CHV ) / ARV) + 2%)) /12

$333 = ($200K * ((($200K - $200K ) / $200K) + 2%)) / 12 

$3,666 = ($200K * ((($200K - $160K ) / $200K) + 2%)) / 12

$17,000 = ($200K * ((($200K - $0 ) / $200K) + 2%)) / 12

Here is a formula for your spreadsheets: =(B1 * (((B1 - B2 ) /B1) + 0.02)) /12

Of course, with a large CapEx, you'd want to simply renovate the place as soon as possible. But this at least gives a more realistic Cap Ex in most cases, from a property that's CHV = ARV and for those that don't.

I also recognize that this formula is only helpful in cases where you plan to hold the property in its current state for some time and that most investors with access to capital would rather use a standard formula and fold the CapEx extra costs (that I'm trying to include) into their assumed renovation costs.

What do you think?

You can pull money into (via capital contributions) and out of (via distributions) an LLC at any time (generally speaking). There are no real tricks to this. You just keep your bank accounts separate and make notes in your bookkeeping. As you'll learn, LLCs are all about limiting liability. On the finance/money side, they are "passthrough," meaning you do need to keep your personal finances separate from the business side in order for your business (and thus liability) to be respected. But business profits will be taxed just like normal W2 income. So, if you want to spend your LLC money/funds/profits personally, you can (generally speaking) have your LLC write you a check noted as a "distribution." Of course, if you're trying to grow your business or wealth, you shouldn't pay yourself more than necessary and you should try to offset your profits with expenses inside the LLC (so that you're not paying more taxes than necessary).

I'm not suggesting that I want tenants to do what the form says (and have them deduct interest on their own). I'm also not suggesting that I want to include this text in my own form. I'm simply wondering why my landlord association would have included such language. I assume they wrote this in consultation with an attorney. So, I have to assume there is a reason and I'm simply curious what that reason might be (if any). Thanks. 

My landlord association in MA has a security deposit receipt form that states the following: "To save time, you should deduct the interest amount from your rent check each year. Ask me and I will tell you how much to deduct!" 

This sounds like rather casual and unprofessional language to me. Is there a legal motive for this language? For example, does putting the onus on the tenant alleviate responsibility if the landlord forgets to pay the interest? 

Note: I know that I should ask the association why, and I will, but their website is currently down. I figure the BP community will have broader advice, as well.  

Here is the full text on their form: "You are entitled to interest on the security deposit at the rate of either 5% per year or, if the rate at which the bank holding your deposit pays less interest, the rate paid by the bank. To save time, you should deduct the interest amount from your rent check each year. Ask me and I will tell you how much to deduct!"

Thanks!
 

Thanks @Ed Tamayo

I hadn't heard of a quitclaim deed. If I'm going to try to work with the owner via an attorney, is a quitclaim deed the only deed approach? I did a little searching and it looks like that is a higher-risk option that is often used when there is little risk of a deed issue (such as transferring property between family members). I would assume that if the owner is open to selling, I could simply pay off the taxes (there isn't a lean yet) as a part of the sale and then give the owner some nominal amount of money for selling?

I did get the sense from the County Attorney that they do sell properties for less than the taxes owed (i.e., whatever the auction price is). But maybe that happens more in cases like these where it's a vacant lot vs a larger property that either has a home or can be easily developed. But I may be mistaken. 

There is a vacant lot behind my home and I'd like to own it and I wonder if the BP community has any advice. 

I live in Lexington, KY. The vacant lot is valued at $15K by the city. It has been handed down through a few generations and the current owner stopped paying taxes about 10 years ago. The back taxes owed are > $13.5K. It's worth noting that the lot is small enough (~0.04 acres) that a developer couldn't purchase it and build on it as zoning wouldn't allow.

I've talked to a few of the city offices (County Clerk, County Attorney, and Department of Law). Because the city knows it isn't likely to auction for > $6K (the legal fees that the County Attorney estimates it will cost to claim and auction the property), they don't think it's worth the effort. I assured them we would be happy to pay that amount or more, but because legally the property has to be auctioned, there is no way for us to commit via contract.

I could try to purchase the property from the current owner and pay the back taxes. But, $15K is a lot to pay for such a small lot (nevertheless, we did try to get ahold of them with little luck). So this is a bit of a catch 22.

Here is where I could use some advice. Short of trying to purchase from the owner, the only solution seems to be to encourage the city to put a lean on the property and get it to auction. I received some advice that Code Enforcement is the most likely department to put a lean on the property if they deem it an unreasonable expense to enforce/maintain. Has anyone had any luck with this? I feel like it could take forever to actually get a lean placed and then wait for the city to go through the formalities of giving the owner a chance to pay and then going to auction. I suspect that it would be a minimum of two years if we were lucky.

Any perspective or strategies are welcomed.