US Navy sailors spend a lot of time painting. A-lot. A US Navy ship is in a constant cycle of refurbishment and replacement. It’s what keeps the ship afloat for decades. It’s what makes the US Navy the most powerful in the world.
As a real estate investor, are you prepared to keep your ship afloat for the long-term? Today’s blog post will examine capital reserves for investment properties.
Capital reserves are used for capital expenditures, or “capex” as it’s known in the industry. Capex can be defined as money spent to upgrade or materially improve a property. Capex is typically a one-time, major purchase.
Capex differs from routine operating expenses. For tax purposes, a capital expenditure must be depreciated over the useful life of the asset. A routine operating expense will be entirely deducted in the tax year it is incurred.
Replacing an entire HVAC system or a roof are examples of capex. A plumbing service call or touch up painting after a tenant moves out are examples of operating expenses.
A single family real estate investor doesn’t need a complicated budget to figure out how much money to set aside for capital expenditures.
The best way to determine how much to hold in reserve for your property is to take a look at the remaining useful life of the “big ticket” items in your property. Here is a list and an estimate of useful life:
Asphalt shingle “3-tab” roof: 15-20 years
Asphalt shingle “Architectural” roof: 20-25 years
Windows: 30 years
HVAC condensing unit: 15-20 years
HVAC furnace: 20 years
Wood siding: 20 years
Vinyl siding: 25 years
Exterior paint: 5-10 years
Exterior doors: 25 years
If you have a property that has a lot of big ticket items that are nearing the end of their useful lives, you need to set aside more than if you have a new construction property.
On average, an investor should expect to budget 8-10% of gross annual rent toward capital expenditures. So, if you have a property that rents for $1000 / mo, you should budget $960-$1200 / year for capital expenditures.
However, capital expenditures don’t typically happen every year, and when they do happen it’s typically a lot more than $1000. For example, the cost to replace an HVAC system (compressor and furnace) might range from $3000 – $6000 in a typical single family property. A new roof can cost $5000-$10,000+.
By evaluating the age of the capital assets of your investment property, you should be able to arrive at a number you feel comfortable with to put aside for capex. The important idea here is to have an idea of what systems might need replacing soon and to be prepared to pay for the replacements when needed.
You don’t want to have $0 in capital reserves when your 20-year old HVAC system dies in the middle of summer, nor would you want to only have $1500 on hand when your 25-year old roof finally gives up the ghost.
Keep your ship afloat for the long-term by maintaining proper capital reserves!
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