I know, I know, you don’t like math. We’ll keep it manageable.
Landlords lose money on their rental properties for many reasons, but the most common is that they failed to factor in
all the costs of owning, managing and maintaining the property before they bought it.
Far too many landlords just subtract the monthly mortgage bill from the rent, and even those that factor in vacancies, maintenance, property management fees, accounting costs and the likelihood of rent default are still getting it wrong.
Let’s beat up on a landlord named Bill to illustrate this point. Bill bought a property that leases for $1,000/month, and his mortgage payment is $750/month. Bill thinks he’s a genius who’s about to earn $250/month.
In reality, Bill is in big trouble. He has other expenses, before we even get into CapEx:
Vacancy Rate: 10% = $100/month
Maintenance: $1,000/year = $83.33/month
Property Management: 8% = $80/month
Accounting, Bookkeeping, Administrative & Misc: $400/year = $33.33/month
(Psst: We have a free
rental property calculator, that includes CapEx!)
Before CapEx, Bill’s property will cost him an average of $1,046.66/month. We’ll be generous and give Bill the benefit of the doubt that his property taxes and insurance are included in his mortgage payment of $750. But he’s still cash flow negative.
And the news gets worse from here for our simple-minded friend Bill.
So What Is CapEx?
CapEx, or capital expenditures for non-finance-nerds, are large-scale property repairs and replacements. They only need to be made rarely, but recurring, since everything in a home eventually needs replacing or repairing.
For example, maybe the roof only needs replacing every 20 years or so… but it costs a
lot of money. And then there are furnaces, air conditioning condensers, flooring, framing, electrical systems, plumbing systems, HVAC and ductwork, kitchens, bathrooms, windows… every component in every home needs to be replaced or updated, and on a largely predictable schedule.
Landlords are always taken by surprise when a furnace breaks, or the roof needs replacing, or the AC condenser drops out. Last year, it was the roof, and after shelling out the $5,000 to replace it, Bill consoled himself by saying “Well, this was an off year because of that roof bill, but next year will be better.”
But this year, the furnace broke, and he’s howling in frustration after the $2,500 bill to replace it.
I’ve been burned by not calculating CapEx before. I think most new landlords are! But my investments since learning how to calculate cash flow and CapEx have been way, WAY better. Super important lesson for new rental investors!
It really is one of the most important lessons new real estate investors can learn. I’m sorry you learned it the hard way, but better late than never, right?
I love how the blob fish represents “ugly truths” 😉
Indeed :-p
For years I tried calculating out individual CapEx costs. Now I just budget 5% for capital expenditures and call it a day.
Great article and Rental Property Calculator which really helped me a lot. I’m now able to more accurately calculate how much I am really making from my rental property.
One question I had was about this line “As you find ways to trim expenses and boost revenues, you may find you can afford to spend closer to $700 on the mortgage, even while your competitors can only spend $500 on it.” I guess this means you are able to use the extra income to make extra mortgage payments. I am now (after reducing my insurance costs and increasing rent) to pay another $300/month off my mortgage. Do you recommend this as a strategy for a rental property?
You certainly can pay down your mortgage faster. Or you can put the additional cash flow toward buying your next property.
But what I meant by that line was by losing less money in property management expenses than other investors, it frees you to consider deals that other investors can’t make work mathematically.
If you do decide to pay off your mortgage, here are some strategies to help you do it faster: https://sparkrental.com/4-strategies-to-pay-down-your-mortgages-faster/.
Hope that helps!
Brian
I am wondering if it makes sense to do most cap expenditures, improvements all at once or space them out over a few years. What is the best tax strategy for this?
Hi M., it depends on when you want the depreciation to start. Personally, I would make this decision based on business reasons rather than tax reasons. If your property needs updating now and you have the money, I’d do it now. There are also usually efficiencies in knocking out several rounds of repairs or property updates at the same time, rather than sending out contractors multiple times for separate jobs.
Hope that helps!