Capital Expenditures and Residential Investments
Photo by John Matychuk on Unsplash
This article explains why capital expenditures do not apply to residential real estate.
Commercial real Estate
There are many items associated with commercial real estate that are very expensive to repair or replace. For example, the cost to replace the flat roof of a commercial building is +$200,000. Huge future expenses like roof replacement must be provisioned.
Residential Real Estate
With residential real estate, there are no planned capital expenses. There are repairs, but no planned capital expenses. For the properties that we target, most repair costs are small enough that the monthly cash flow will cover the repair costs. For example, when the dishwasher breaks, you repair or replace it ($350 for a replacement). Dripping faucets, broken sprinkler heads, many such minor repairs will occur and are too minor to provision. Note that you should plan on what I call base maintenance. These are all the little repairs like I mentioned. For the properties we target, the average is about $350 a year.
At the end of this article is a link to an article on how to determine a property specific maintenance provision.
The cost of maintenance is a function of property age, property condition, construction, and climate. Because Las Vegas is in the Mojave Desert, and we cherry-pick properties for low maintenance, repair costs are low. The Mojave Desert necessitated very durable building materials, as shown in the image below.
As you can see, there is not a lot to maintain. The two items that will eventually need major maintenance or replacement include the roof and the HVAC. I will look at these separately.
Tile Roof
The tile roofs used in Las Vegas have a lifespan of between 35 and 50 years before most start needing repair. Would you plan on replacing the entire roof at some fixed time interval? No. You do repair leaks, or better yet, repair/replace broken or slipped tiles, so you do not have leaks. We've repaired many leaks over the years, but we've never "replaced "a roof. But, if you want to replace a roof, how much would it cost?
The roof tiles are made of concrete and do not wear out. "Replacing" a tile roof consists of removing all the tiles from one roof area, replacing the waterproof membrane, and putting the tiles back. This process is known as "re-stacking" a roof. The cost depends on the size of the house, we've never done one, but I understand the cost for re-stacking an entire roof is between $4,000 and $6,000. Also, I'm not aware of anyone re-stacking an entire roof. What people do is to re-stack an area - for example, the roof over the garage. The cost to re-stack an area is much less than re-stacking the entire roof. In comparison, repairing a typical roof leak costs between $300 and $500. I would do many roof repairs before I considered re-stacking a roof, and then I would only re-stack the area having problems. But, if you want to, how would you calculate a provision for re-stacking an entire roof?
If we assume that the house was built 15 years ago, the useful light of the roof is 50 years, and the cost to re-stack the entire roof is $5,000, how much is the monthly provision? The calculation is below.
Monthly Provision = re-stack_cost / remaining_useful_life / 12Mo/Yr = $5,000 / (50 −15) / 12 = $12/Mo
I want to emphasize that re-stacking a roof is not a planned event. You would only re-stack an area of the roof if the cost to repair leaks is approaching the cost of re-stacking the specific area.
HVAC
The vast majority of air conditioning systems in the Las Vegas Valley have an energy rating of 10 SEER. Congress mandated that all new air conditioners be at least 13 SEER and that no repair parts manufactured for 10 SEER units. So, eventually, all 10 SEER air conditioning units will have to be replaced. What is the useful life of an air conditioner? There are many 30 to 35-year-old air conditioners operating in the valley and will continue to operate until no repair parts are available or the cost to repair approaches the cost to replace the unit. Note that in most cases, the most likely failure item is the air compressor. An air compressor costs between $1,500 and $2,500, depending on the size.
What if you wanted to calculate a repair provision for the eventual HVAC replacement? The cost depends on the size of the unit, but in general, new air conditioning systems cost between $5,000 and $7000.
If I assume a useful life of 30 years, the air conditioner has been in service for 15 years, and that the cost to replace the unit is $6,000. The calculation is below.
Monthly Provision = $6,000/15/12 = $33/Mo.
Conclusion
Unlike commercial real estate, where some repair costs are extremely expensive, residential real estate maintenance costs are usually minor. Also, residential real estate does not experience the wear and tear that commercial real estate does. For example, a parking lot will need resurfacing every 15 to 25 years. In contrast, unless the concrete driveway of a residence is physically damaged, the driveway will last practically forever.
For more information on how to determine a property specific maintenance provision, see the article linked below.