Show144: How capital expenditure can ruin potential deals

When it comes to buying rental property as long term assets one of the most important things you need to pay attention to is the capital expenditures of a property.

You’ll often hear people refer to things like Cap Ex.

And really, what those are, are the big ticket items that you may eventually have to replace on a property that are going to cost a lot.

These capital expenditures are including things like the roof, electrical, plumbing or having to repave a parking lot. Depending on how big the physical asset of the property is will dictate the amount of money you'll need for those projects to be complete.

And I'd be lying if I said that we were super focused on these in the beginning of our investing journey.

We knew about them and that they were important, but we rarely even used it as a line item when we did our financial analysis on a potential deal.

Now in our defense we were buying properties that had a cash on cash return of around 20% so we had wiggle room for these expenses if they came up.

But the reality is that these capital expenses can kill your cash flow and if you're not prepared for them with the right amount of reserves they'll demolish your account or put you in debt.

One of the things that a lot of investors will do is in their property analysis, they will include every month a line item for Cap Ex expenditures.

And so, maybe they save every month a certain percentage or a certain amount of money each month from their rental income that they make and they will put it in a Cap Ex fund.

Capital expenditures is essentially saving for the idea that Cap Ex expenses are the major expenses that a property is going to entail over owning that property for the life of your ownership. If you buy a property that just has a brand new roof, that might not be something that you’re going to have to worry about or think about unless you’re planning on owning the property for 15, 20 years.

You might not even have to think about a roof. Maybe you bought a property that just had updated plumbing and electrical. Again, an issue you might not have to think about.

But you have to look at the property as a whole, make note of some of those large ticket items, find out how long the furnace has been there, how long the hot water tank has been there, those sorts of things and then that will allow you to determine how much you should be saving each month toward that Cap Ex fund.

In this podcast episode we share our own story of how the impending capital expenses on a property in our portfolio caused us to decide to sell the property.

While it was a cash flow performing property, the reality was that we were going to have to sink so much money into the property in the coming 3-5 years that it would eat up so much of our cash flow it didn't make sense to keep it.

Even though we had amazing tenants in there. Which ultimately helped us when it came to selling because we were able to talk about the great tenants that we had.

No one wants to buy a property with crappy tenants.

 

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