Tuesday, March 10, 2009

The 1% Solution - Maintenance Costs on Single Family Rental Properties

If you have a single family investment property you need to consider the "1% rule". If a property is less then ten years old you should set aside about 1% of the value of the home each year for ongoing maintenance and repair expenses. You may go 1, 2, or 3 years with no more than $200-$300 in minor repairs, but you will eventually get hit with some larger repair costs. Go to this link How Long Does a Dishwasher Last? If you read the document at this link you will know what to expect going forward.

If your property is more than twenty years old you may have additional costs since you may need to update the property in order to keep the home up to date from a marketing standpoint.

What can you do to reduce your maintenance expenses? The number one thing which impacts maintenance costs is tenant turnover. The current change in the economy is a favorable trend for our clients. Tenants are staying longer and taking better care of the homes they rent. Higher tenant turnover = higher maintenance costs. This is primarily because more minor maintenance expense is uncovered/created when a new tenant moves in. If you have had a few tenant turns in your rental property you have found that the new tenant tends to uncover a group of small maintenance items which the old tenant lived with.

Frequent tenant turnover can have the most significant impact, but it is not the only factor to be considered. A poor tenant must be replaced as the costs of maintaining a poor tenant will be higher (over time) than costs associated with replacing them. The replacement costs of a poor tenant can only be deferred and the sooner you get the new tenant in the better off you will be. Remember, there are exceptions to every rule and in this business there are more than the usual number of exceptions. If your property manager is recommending you leave a poor tenant in the house, there is probably a good reason, so feel free to ask.

The other issue associated with more frequent tenant turns is that "normal" wear and tear is usually higher for carpet and paint. Different tenants use a house differently, so if you have four sets of tenants over a ten year period you will have higher "normal" wear. A judge explained to me that his definition of normal wear (and what we use as a measure) is based on the question of "what is the intended use" of the item. Although it may be normal for a dog to chew on a door (puppies tend to do this), the intended use of a door is to provide access from one space to a next, so damage caused by the dog is not normal wear and tear. It may be normal for children to run their dirty hands along the wall, but the intended use of a wall is to provide separation between spaces, protection from the elements and a place to hang photo's, so the grease on the paint from the children is not normal wear and tear.

One thing you can do as a landlord is to not accept marginal tenants. Unfortunately you cannot tell who will be a good tenant and who will bad until after they move in. In spite of our best attempts to provide a complete background check you can't tell how they will really behave until after they move in. If you have a tenant who is continually late paying their rent they are also, as a general rule, not taking care of the house

I define a good tenant in very simple terms, 1) they pay their rent, in full and on time 2) they keep the house and yard clean and in accordance with their lease and 3) they report any problems. When we had higher vacancies rates in 2004-2006 I was happy if I got two out of the three things. I now expect better compliance. If there is a tenant who is not conforming we will replace them. Over 90% of the tenants are good tenants, with the remaining 10% failing on one of the three basic criteria. The most important measure is item #1, if they are failing on rent payment it is a good indicator there will be other issues. If a tenant fails on timely payment of their rent and other financial obligations we are moving quickly and aggressively to replace them with new tenants.

Returning to my original thought, maintenance. The proper tenant can have a significant impact on your ability to keep your maintenance costs within the 1% range and the most important indicator of a tenant being responsible is if they get rent in on time and in full. The next thing we do is to educate the tenant on how to maintain the property in a manner which keeps your costs low. We explain to tenants they do have an obligation to report all problems, but if they participate in helping keep costs low it encourages their landlords to keep their rent reasonable. Tenants participate by unclogging drains, resetting disposals and replacing/repairing minor items under our guidance. Most people can replace a toilet seat with nothing more than a screwdriver.

One of the other methods to reduce repair costs is to combine repair items. If a home has a minor, non-urgent, repair, we encourage the tenant to save this item on list for later. If we have a more urgent repair in the future we may be able to add the minor repairs onto the punch list and provide a very cost effective solution for tenant and landlord. The largest cost of many repair is the cost to put a repair person on site. It may be $75.00 for the first repair item, but we may be able to get another three items completed at a small additional cost.

In the end, with all of this effort the goal is still to keep maintenance/repair/replacement costs at or below 1% of the value of the home/year over time. This includes annual service to HVAC and yard, new carpet every 7 years (on average), a new AC unit every 10 years, fresh paint every 7-10 years, a disposer here and there and a new roof every 20.

There are other options to a strategy of proper maintenance of a home, including doing absolutely nothing unless required by law and letting a property deteriorate. A financial case can be made for this alternate method, but if you plan on selling the property in the future for anything other than a tear down the financial rewards do not appear to work any better. Even if you plan on selling the property as a tear down you can be well served by providing proper maintenance as you will tend to attract more responsible, better paying tenants to your home, which reduces tenant turnover and leading to a lower overall cost of ownership.

I hope this provides a better understanding of what to expect as a landlord and how we focus our efforts to minimize this specific expense area of being a landlord. Before you finish this thought, I want you to take this idea and think about how it impacts our recommendation that investors try to keep their invetments focused on the $100,000 to $250,000 price point for the homes they purchase. More expensive homes have more expensive repairs, two and three HVAC units and water heaters, upgraded materials, etc. Think about it and you will begin to see the advantages of the sweet middle range!


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