Maintenance Provisioning

5 min read

There is a common belief that you can create a universal constant for future costs like vacancy and maintenance that will apply equally well to all properties. Despite such universal constants being touted on various websites, it is not true. A simple example will demonstrate the problem.

Suppose you were tasked to determine a single annual maintenance amount that would be accurate for the two cars illustrated below.

One is a new small car and the other is an older wrecked Humvee. If you chose an annal amount to match the new car, it would be insufficient for the Humvee. If you chose a maintenance amount that would match the Humvee, it would be way more than what is needed for the small car. If you decided to use a average of the maintenance cost for the small car and the wrecked Humvee, you would be wrong on both. This is a demonstration where "population" averages, like the universal constants for maintenance or vacancy, do not work.

Universal constants or population averages fail for the individual population members, even when the members are similar. For example, suppose that the table below is the 2 year annual maintenance cost of each identical unit in a 10 unit apartment building. As you can see, if you add up all the maintenance costs for all 10 properties and divide by 10, you get an average of $500/Yr. for both years. So, knowing that the average maintenance is $500, you set aside $500/Yr for maintenance costs. However, as you can see, the actual maintenance cost for each unit is very different. Look at unit #6 in year 2. This example demonstrates that the average maintenance cost for a population has little relationship to the maintenance cost for any individual member of that population.

Unit #Year 1Year 2
11000
22750
36500
43250
58000
66004500
75500
86000
9400500
107000
Average Cost500500

Another problem with the concept of using a percentage of rent for maintenance is that there is no cap. Suppose you decide that 10% of the rent should be set aside for maintenance. Also, assume that the rent is $1,400/Mo.or $16,800/Yr. The table below shows how much you are accumulating in the maintenance account.

Year #RentMaintenance RateAnnual AmountTotal Accumulated
11680010%16801680
21680010%16803360
31680010%16805040
41680010%16806720
51680010%16808400
61680010%168010080
71680010%168011760
81680010%168013440
91680010%168015120
101680010%168016800

Since you have no method of estimating the actual cost to maintain the property, you would continue to set aside 10% every year, with no limit. Over time, this will accumulate to a significant amount which in reality is part of your profit.

Even when you were evaluating the property, you deducted 10% from the estimated return, for all time. This distorted the actual value of the property by a fixed amount that had no relationship to the actual cost of maintaining the property.

In summary, there is no single universal constant that is right for all properties.

A Better Method for Determining a Maintenance Provision

The method used with commercial properties is a better approach. The method is to establish a "reserve" fund to cover future repair costs based on remaining useful life of the expensive components. The following example shows the two most expensive repair cost items for our typical residential properties. Also included is the useful life, which comes from a national source.

Cost ItemCostUseful Life (Yrs)
AC Compressor$2,50015
Water Heater$80012

Suppose you want to determine a maintenance provision for a property and you know the age of the existing units. From this you can determine the remaining useful life.

Cost ItemCurrent Age (Yrs)Remaining Useful Life
AC Compressor411
Water Heater93

Based on the above, you need to accumulate the replacement cost of the AC compressor ($2,500) within 11 years. You also need to accumulate the replacement cost of the water heater within 3 years. So, how much do you need to set aside each month to handle both repairs?

  • AC compressor: $2,500 / 11Yrs / 12Mo/Yr = $19/Mo.
  • Water heater: $800 / 3 Yrs / 12Mo/Yr = $22/Mo.

The total for each month is: $19 + $22 or $41/Mo.

Using this approach, once you have accumulated enough funds ($2,500 + $800) to replace the two units, you do not keep accumulating funds.

The cash flow from the property has an impact on how much of a maintenance provision you will need to accumulate. Suppose the cash flow for the property is $300/Mo. You could thus cover the replacement cost of the AC compressor with $2,200 plus one month's cash flow ($300). Let's expand that to multiple properties.

Suppose you have 8 properties and you create a single spreadsheet with the useful life, remaining life and replacement cost for major component for each property. To keep things simple the following example contains only one item, the AC compressor for each property and the replacement cost is always $2,500.

Property #AC Compressor
Current Age
Remaining Useful
Life
Annual ProvisionMonthly Provision
121319216
210550041
351025020
47831226
59641634
611417814
76927723
831220817

Suppose you have significant cash flow from the properties and the table below shows the cash flow from each property by month and the total monthly cash flow.

Property #Cash Flow
1200
2350
3275
4330
5180
6290
7400
8435
Total2460

In this example, the total monthly cash flow is sufficient to cover the replacement cost of one AC compressor. Since the odds of two AC compressors failing in the same month are low, in this simplistic example you may not actually need a maintenance provision. The lesson here is that as the number of properties increases, you actually need a lower maintenance provision since the combined cash flow will cover most repairs.

The same method can be applied to base level repairs, such as dripping faucets, etc. Estimate the annual cost for such repairs and add that to the maintenance provision. For example, if you assume 2 repairs each year and each repair costs $100, the repair provision for the earlier property can be revised as follows:

  • AC compressor: $2,500 / 11Yrs / 12Mo/Yr = $19/Mo.
  • Water heater: $800 / 3 Yrs / 12Mo/Yr = $22/Mo.
  • Base maintenance: $200/Yr / 12Mo/Yr = $17/Mo.

Total for each month is $19 + $22 + $17 or $58/Mo.

Note that this method of maintenance provisioning:

  • Is based on the condition of each specific property
  • Is not related to the rent
  • Does not distort return calculations

Summary

There is no universal constant (3%, 5% , 9%, etc.) that will accurately represent the future maintenance cost for any specific property. The method used with commercial properties is a better approach because it reflects the actual condition and components of each individual property.