As humans we tend to pay mind to what is right in front of us as opposed to whats on the horizon. That can cost you some serious coin when it comes to your rental properties though.
We often speak about allocating for future expenses, but how you estimate them is just as important though.
Estimating CapEx is Vital for Rental Property Profits
Capital Expenditures (CapEx) are your big ticket items when it comes to real estate, things like roof, plumbing, HVAC and so on.
These items generally have long shelf lives, but at some point do need to be replaced. When that time comes they put a big dent in your wallet.
Why it is so important to allocate and estimate
Picture this – you have a property that brings in $150 a month in cash flow, giving you $1,800 a year.
Things are going great when, boom in year 5 the HVAV blows out. There’s a $3,500 replacement cost right there wiping out your profit for that year and the next. Ugh, not fun but atleast you collected profits the first four years, right?
Then in year 10 the existing roof that was already 10 years old when you bought the property goes and a $8,000 bill hits your desk to replace that. Ouch, no more profits for a while!
Setting money aside (even if its only on paper)
To know if a property will truly cash flow then estimating CapEx is vital. To do so we can take the total replacement cost and divide it out by the expected lifespan of each item to get a yearly estimate.
Take these examples:
Obviously the list can go on, but you get the idea.
If we take the items in the example and total up the average yearly cost for all of them it works out to $1,255 a year.
Allocating that much per year for CapEx in the operating costs will give us a truer estimate of the actual cash flow over the long-term for this rental property.
How do I account for all the variables?
Every property you buy will be in different condition. Getting an idea of the age and remaining useful life of each CapEx item will enable you to make a buy offer that makes sense and fits a budget that allows you to cash flow.
There is no magic bullet for costs. Best you can do is put all the information into a spreadsheet and run the numbers. Whatever annual number you come up with can be used to see what kind of cash flow can be made over the long-term.
They key is that there is some cash flow!