If you were building a model for a 250,000 sf apt building, where exactly would you include a deferred maintenance cost of 50m, and how would that be paid for (would it require a loan that is amortized over x years, etc)? I'm trying to value the property, but am kind of lost with this big DM cost...
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At risk of sounding stupid (because I'm not 100% sure what the cost line item is), I'd say deferred maintenance costs would go into my replacement reserves that I reserve for annually. So if in year 5 I know there is likely to be a $50,000 maintenance cost then I'm going to escrow for it at $10,000/year.
Interesting timing of the topic. I was just discussing with my boss today how we should account for and pay for our future capital items. We are playing with 2 ideas: 1) funding an escrow annually with our projected future costs; or 2) since we own the building in question free and clear simply taking out a credit line when the costs arise and amortizing the costs over a set time period. Since our accounting is cash basis accounting it probably makes more sense for us to do cash escrows. If it were my own portfolio, I'd prefer accrual accounting and would favor debt financing.
So to your question, I would say the way you finance future capital or maintenance items in practice will differ based on circumstances, but if I were modeling it I would assume cash escrows.
Just my 2 cents.
Awesome, thank you! Yeah, this makes perfect sense
Are you rebuilding the whole thing?
So the situation is strange.. Can't say too much, but I'm trying to play around with value/cost of building new, or valuing it with the DM cost of fixing it in there...
I was mostly saying that tongue in cheek, because that's a crazy high PSF number.
I'm assuming OP means $50,000. Agree with DCD's answer.
For the younger monkeys, deferred maintenance can sometimes be passed through to tenants. This depends on the lease language (NNN) but one can reimburse the item based on the remaining useful life (RUL) of the item. For example, if $50K was for a elevator maintenance (10 years RUL) you would pass that through pro rata, per year to a tenant. Tenant A is 50% of the NRA, and would pay $50k / 10 years RUL * 50% = $2,500 per year until their lease expiration
Wow, for whatever reason my memory was just jogged. It's been a good few years since I underwrote multifamily deals that used the terminology "deferred maintenance", but I recall now that the term "deferred maintenance" generally refers to maintenance items that need to be fixed now. This means that at some point in the past somebody "deferred" the maintenance item, which exists now (presently) as a required maintenance item. Assuming that is what the OP means about "deferred maintenance" items of $50,000 then you would have to put that in as a cash outflow in period 1 of your financial model, usually because a lender will require an immediate repair of deferred maintenance items.
If you literally mean you will be deferring maintenance items to another point in the future then you would model it with an escrow, as I originally said. But if the reference is to deferred maintenance items that presently exist and need to be fixed presently then you would need to take care of that in time 1 of the financial model.
Hope that makes sense.
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