Many property owners are blind-sided when, after a few years of owning their property, the air conditioner breaks and needs to be repaired or replaced.
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Whether it's the air conditioner, the roof, the sprinkler system, the parking lot, or the exterior skin of the building – planning to repair capital items is vital for the long term success of your real estate.
What Qualifies as Capital Repair and Replacement?
A capital repair or replacement involves items which deal with the physical structure of your real estate and are not regular upkeep. For instance, regular schedule maintenance to clean carpets in your building is not a capital repair. Neither is regularly scheduled upkeep of the grounds.
If a furnace goes out, however, it is a capital repair. The same can be said for repairing major damage to your parking lot, roof, skin of your building, or any other big ticket physical item. In accounting terms, a capital repair is when you have to perform repair or maintenance of an item that is on the books as an asset and is being depreciated. Or, after being repaired or replaced it will be depreciated.
A list of items that could be considered capital repairs includes, but is not limited to, the following: sidewalks, roof, building skin, windows, water heaters, air conditioner, heater, structural issues, and the parking lot.
How Should I Budget for Capital Repairs?
One of the simplest ways to budget for capital repairs is to look at the major capital items your property has and establish a life-cycle repair and replacement program. For instance, if you purchase a water heater for a certain space, it will have an associated estimated life – say ten years. You will want to budget then so that in ten years you replace that heater.
If you compile one of these budgets with all of the capital items in your building you will know exactly when you will need the cash. The key, then, is to save the money in a way so that you are not burdened in the year of replacement. If you have a fifteen year HVAC system that costs over ten thousand dollars, you don't want to take that hit to your income all in one year.
One method that works is to lay all of the repair items and estimates out in a spreadsheet and budget a set amount to set aside for capital repairs each year. This money should be taken out of revenues and deposited into a bank account especially for capital repairs. Another simple method is to agree to set aside a certain percent of revenues (say 3-5%) each year into the capital repair account.
Limits and Caps
Sometimes water heaters and parking lots last longer than you think they will. Since that is the case, you may also want to put a cap on how much you will set aside for capital repairs. You could consider putting aside 3% of your net revenues each year until you hit $50,000 in the account. At that point you stop making deposits until you have expenses that draw the account balance below the limit.