Re: Ed, I need pricing advice… - Posted by JohnBoy
Posted by JohnBoy on March 11, 2002 at 22:07:52:
General maintenance are things like painting, carpet cleaning, repairing things that break down like a furnance, a/c unit, unclogging drains, patching holes, etc.
Deferred maintenance is to cover the cost of replacing major things like a roof, furnance, a/c unit, appliances, carpet, siding, resurfacing parking lot, etc.
These are things that eventually will need to be replaced. You need to account for the costs of these things so you can be able to set money aside from the rents each month so when these things need to be replaced the money will be there. Otherwise you’ll be coming out of pocket to pay for it or scrambling around trying to get financing somewhere just to be able to pay for these things when the time comes to replace them. If you don’t account for these things and later you end up having to replace them by paying for it out of your pocket or getting financing somewhere, your cash flow would be eaten up for years just to recoup all your costs.
Let’s say the life expectancy on a roof is 20 years before you would have to replace it. Assuming a new roof would cost $10k to replace on your building, you would then divide the number of months by 20 years, which is 240 months. Then take the $10k replacement cost and divide by 240 months which would be $41.66. So if the roof had 20 years left on it before it will need replacing you would need to take $41.66 out of the rents collected each month and set that money aside so when it comes time to replace it the money will be there.
You would do the same thing for all major items that will need replacing in the future. Take whatever the life expectancy is for each major item and divide the replacement cost by the number of months they are expected to last. Usually this averages out to be about 5% of gross income for everything.
Now if you are looking at buying a building where the roof will need replacing in the near future then you would need to account for that cost when determining the purchase price you are willing to pay. If the building will need a new roof in 2 years from now then I would deduct the 18 years use the seller has already gotten out of it since I would have to come up with all the money to replace it. So that means I would need to deduct $9k from my purchase price to cover the replacement of the roof since I will only be getting 2 years use out of it before having to spend $10k to replace it. This is why you need to account for the condition of the property when determining what value to place on it, in addition to everything else.
In my opinion this is probably one of the biggest reasons you see some multi-unit buildings that are run down so bad. The owners never accounted for setting money aside for deferred maintenance and when things needed replacing they didn’t have the money to pay for it. So the property continues to deteriorate as a result and eventually these owners become don’t wanters because they can’t pay to fix up the property and end up having problems with getting them rented out.
The 3 most common things you will usually find that sellers leave out on their expenses is, vacancy allowance, management expense, and deferred maintenance. Deferred maintenance being the most common expense of all left out.
If you don’t account for these things then you aren’t making the cash flow you “think” you are and it won’t be until you finally get stuck with absorbing these costs until you realize that! Then you will find out the hard way that what you “thought” was a good deal wasn’t such a good deal after all!