Budget For The Life Of Your Investment
Oct 07, 2015
Real estate brokers, individual investors, and property managers are used to looking at annual budgets or pro formas to evaluate both potential returns and the expected economic life of a property. But did you know that many of those same budgets often have significant gaps or omissions, hidden costs that may come back and bite you? Answer these quick questions to see if your budget has any of the common gaps.
- Do the reserves outline anticipated annual maintenance costs and servicing, including the time and cost to do interior and exterior inspections?
- Does the budget have line items for legal costs or reimbursements if there are landlord/tenant disputes or construction defect claims that will take the time of your owners/board members, as well as the attorney’s fees if uninsured?
- Does the budget have a line item or dollar range for the potential cost of insurance policy deductibles?
Annual maintenance costs tend to rise over time, and new county or state ordinances and laws can trigger additional upgrades that weren’t originally planned for. Potential legal costs and reimbursements in response to a complaint or lawsuit are usually vastly underestimated. Ask a local specialist who is familiar with the case law in your region what their hourly rate is, and build in a factor or flat dollar amount for your cash reserves.
What about insurance deductibles? Like the legal fees, these are expenses that may or may not happen, so they are often not included. This could leave a large deficit in the budget should something go wrong.
Here’s a common example:
General Liability Deductible: $500 per claim.
Property deductible: $2,500 per claim.
Auto Deductible: $1,000 per claim.
Earthquake deductible: 5% of your building value (on a $1,000,000 building that is $50,000), per building, per location.
Flood Deductible: 2% or $50,000, whichever is greater.
Your budget should show the potential cost of risk as a range or corridor. In this case, your potential annual deductible costs range from $500 - $50,000, and up. If you only have $75,000 in reserves, and get hit with a large claim, you may not have the money to do needed maintenance on the property for the next few years, which often leads to more claims. We advise that owners and investors have a standby LOC they can call on, or slowly build up deductible reserves.
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