by Ali Boone
As you may have figured out by now, the one and only thing that will make or break your investment in a rental property is expenses. Right? Either the purchase price is too high, making your expenses higher than the rent the property brings in from the get-go, or you experience vacancies or tenant drama, etc. Every time you have an expense of any sort, your profit potential is being affected.
While there are several sources of expenses on a property, what is one of the most common ones? Maintenance!
Oh, maintenance expenses. How we love thee. The unfortunate thing about rental properties, or any property, is that there is absolutely no way to avoid maintenance. Maintenance can range from small repairs to atrociously large big-ticket items. The latter usually leads to what people call “CapEx.” CapEx is short for capital expenditures. I’m not going to get into the details of the term or what is included or what is not. Nor will I go in to the accounting distinctions involved within that label, but just know that bigger ticket items are usually categorized as such.
Most often people will include estimates for CapEx in their initial projections when shopping for a rental property. It’s a good idea to do so because it’s unrealistic to assume a property isn’t going to experience CapEx. This would be in addition to allocating some percentage points for smaller on-going repairs.
So think — for the purpose of this article, I am specifically referring to big ticket items needing repair as being classified as CapEx. Replacing roofs, if the whole house needs siding, hot water heaters needing replacing, HVAC and electrical, in-depth plumbing issues, etc.
Now, a major caveat to the strategy I am about to present:
This is only one example of a strategy. It is not the only option of how to maximize profits. It doesn’t pertain to all properties or to everyone’s buying goals. It also isn’t the way to maximize rental property profits to an all-time max because usually BRRR methods do a better job at that. This is simply to get your brain juices stirring. Adjust or edit the strategy in any way you would like so that it best fits your situation and goals!
Did you hear that? I don’t think this strategy will give you better profits than successful BRRR methods. This is simply another option. Not everybody has time or desire, or risk-tolerance, for BRRR investing. I know I don’t. So for those of us in the non-BRRR boat, there are options. Also, this is just a very generic relay of this strategy — you can literally tailor it any way you need.
How to Maximize Rental Profits by Avoiding CapEx & Taking Advantage of Appreciation
I’m going to spell out this procedure in numerical bullet format so you can see the process in order. I’ll speak to each process step as we go. Then we can discuss more after I’ve laid it out. Before I do though, I want to clarify that this strategy is NOT good for the following investors:
- Those interested in BRRRR methods or flipping. Anytime you are willing to put work into something, you have a better chance of forcing appreciation and maximizing returns. But not everybody has the time or willingness (or interest) to do that. This strategy is solely geared toward those investors who don’t want to get their hands dirty and put much work into it. This strategy is specific to those who are willing to pay a higher purchase price upfront in order to minimize work required by buying an already-rehabbed property.
- Those who are buying solely for appreciation. For example, anyone buying specifically in Los Angeles or San Francisco or NYC or any other city that is notorious for high appreciation levels. In those cities, you will not see positive monthly cash flow on the property. You are losing money every month waiting on that appreciation. This strategy is not for that situation. This one is for properties that are seeing positive monthly cash flow. Investing solely for large sums of appreciation is a different method and has different avenues of profit. It is not a method I am referring to here with this strategy.
Again, I’m not comparing different methods here or which is better for maximizing profits. I’m only talking about how to maximize profits with one particular buying method (one that isn’t often known for maximizing profits). Here goes!
Buy a fully/freshly renovated property in a market that is in the infant stage of a growth cycle.
Don’t worry, I’ll explain. The fully/freshly renovated part is pretty obvious — there should be no items needing repair in the near future. These properties would be considered “turnkey” because they are ready to go. You can certainly buy these through turnkey providers (like I do), but you can also buy them through agents or other avenues. Of course, make sure the numbers on the property you are buying work. (If you aren’t sure how to run the numbers, check out “Rental Property Numbers So Easy You Can Calculate Them on a Napkin.”)
You want to buy it in a market that is at the closest to a pending boom cycle as possible. Meaning the market has enough solid evidence to say there is going to be a boom, but the boom hasn’t happened yet. It’s rumbling, and it’s close, but it hasn’t happened yet. This is when you jump. For a really clear picture on what I’m talking about here, check out “Warning: The Market You Should Be Buying in Has CHANGED!” Understanding the concepts outlined in that article will help you in understanding this strategy, so be sure to read up.
The reason for doing this is so that you can maximize any appreciation potential available to you. Typically when you buy fully rehabbed properties, they are priced closer to market value (meaning no immediate equity). There is nothing for you to improve on them in order to force appreciation because everything is already done. So the best way to shoot for some appreciation gain is to buy at the beginning of a boom cycle.
Hold onto the property at least through the boom, and for as long as you continue to be profitable with your cash flow.
If you don’t buy in a major boom cycle, or there isn’t a major boom market available to buy in, you’re still okay for this method. Even minimal or no boom still works. So what you are doing here is racking up as much positive cash flow as possible while you still have little to no repair expenses. The fewer expenses you have, the more you bank. All the while, if any appreciation is happening, you are gaining that in equity. While all of your profit centers are continuing to build with your property, hang onto it.
Ponder the sale.
There is no specific time as to when this needs to happen, if it even needs to happen. But here’s where your pondering begins. When you want to think about selling the property is when any of your profit centers start to plateau or go negative. No matter how freshly rehabbed your property was when you bought it, eventually things will start having to be replaced. Roofs, hot water heaters, etc. What are the lifespans on those — 10-20 years? Let’s use 10 years as our mark to be conservative. Your freshly rehabbed house, ten years down the road, is going to require some expenditure to keep it up. It may not all happen at once, but at the ten-year mark you may start to expect a few years of a lot of expenses coming your way.
Let’s say you are at year 8 or 9. You’re starting to anticipate this chunk of expenditure starting. All the while, the market you bought in has already boomed. There is minimal to no appreciation going on right now. See how your two primary profit centers are about to go negative or plateau? The repairs are about to get costly (compare the cost of big ticket items to how much cash flow you bring in every month) and you don’t have a lot of appreciation/equity carrying you through anymore. You are simply pondering at this point.
You are now done pondering and figuring out your timing. What you have decided is to get out right before the big wave of CapEx hits. At this point, you’ve maximized your cash flow because you’ve had minimal repair expenses and you’ve maximized what appreciation you can get out of the house. You kept it through the boom and while more appreciation may be available in small quantity, it won’t make up for what you are about to spend in CapEx. Jump ship, quick! Take your profits and run!
Use your profits to buy a fully/freshly renovated property in a market that is in the infant stage of a growth cycle.
Take the money from the sale and 1031-exchange those funds into buying a new property. You are maximizing profits this way by avoiding as much in taxes as you can. Then, you buy a freshly rehabbed house so you are right back to minimal maintenance expenses (no CapEx). You’ve also now just bought in a newinfant stage market that is getting ready for its boom. Different markets will always be going through different phases of their growth cycles at various times. Obviously the overall real estate economy plays a role, but there are usually different opportunities in different areas. So while the market you bought in initially is topped out, other markets aren’t. Switch to those markets in order to maximize appreciation potential — again!
Rinse and repeat.
See how this can turn into a snowball effect? At all times, you are keeping maintenance/CapEx expenses to their utmost minimums, you are constantly profiting off of appreciation, and you are paying minimal in taxes. What else can you do to further maximize profits? Nothing! Not for this method anyway. So you are constantly rolling your purchases every ten years or so.
I am asked all the time about the long-term plan and/or CapEx because I work with turnkeys. This is what I tell people — I don’t necessarily plan on keeping my turnkeys through big bouts of CapEx. Maybe I will, maybe I won’t. It just depends on the current value of the property, how much cash flow it’s bringing in, how extensive of capital expenditures are anticipated, etc. No two houses will pan out exactly the same.
For instance, I just had one of my (non-turnkey, actually) properties get fully rehabbed thanks to an insurance payout because the tenant lit the fireplace without the flue open and the entire house got covered in smoke damage. So I just bought myself however many more years — on someone else’s dime! Thanks, insurance. So now I won’t have to plan my exit as soon as I thought. Plus, the value on that house is sky-rocketing due to some things going on in the area. So I’m definitely not selling anytime soon. Realize that every situation is different, and I can’t tell you how long to hold onto the house or when to sell it. But think about these things.
So, that’s one method of maximizing profits if you are investing in the non-BRRRR and non-flipping worlds and still want to bring in as much as you can!
Has anyone done this? Anyone who started investing 10 and 20 years ago have any input about expenses versus income, and when or if to sell?
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