Cost Provisions
There is no “standard” for maintenance, vacancy, or renovation cost. And, there is no relationship between the amount of rent and maintenance, vacancy, or renovation cost.
Vacancy is a function of
- Tenant pool segment the property attracts
- Length of tenant stay
- Time to rent
- Debt service
- Skill of the property manager
- Construction materials
- In between tenant renovation cost
Maintenance cost is a function of
- Property condition
- Property age
- Climate
- Construction materials
- Length of tenant stay
- Tenant pool segment
- Skill of the property manager
- Local wage rates
Renovation is a function of
- Cost to make the property market ready for the target tenant pool.
- Current rental competition when the property goes on the market.
- Cost to comply with health and safety regulations
- Age of the property
- Landscaping
Our properties have low vacancy and maintenance costs because of the tenant pool we target and the properties we select. Below is a typical property. As you can see, there is not a lot to maintain.
We account for maintenance and vacancy costs by not including tax benefits. Based on our research, if you divide the average maintenance and vacancy costs by the annual rent, the result is between 3% and 4%. Depreciation alone typically increases the effective return by 3% to 6%. So, by not including any tax benefits and padding closing costs to 2%, we account for vacancy and maintenance costs reasonably well.
Rent Multiplier Method Always Fails
Rent multiplier methods not only fail, they also distort or invalidate return calculations. The assumption of the rent multiplier method is that the lower the rent, the lower the maintenance and vacancy costs will be. This is the opposite of reality. The reason rents are low is that the property is older, in poor condition, and located in a distressed area. Such properties will have higher maintenance costs than newer properties, which rent for more. Additionally, tenants in older properties in poor condition have shorter stays than those in higher-rent properties. So the rent multiplier method falsely increases return for low-rent properties and decreases return for higher-rent properties.
If you do not have a factual basis for a cost, leave it out. Return calculations are primarily useful for comparing properties, not estimating your actual return, which is heavily influenced by your tax situation.