October 20, 2017
Author: Gary S. Wolfe
Real estate building owners face the inevitable depreciation of their buildings over time that will require their continued investment to maintain the properties. Over a period of years, if a landlord owns a rental property, the tenants will require both ongoing maintenance and long-term capital improvements. As the property ages it depreciates and repairs and improvements are required on an ongoing basis. Buildings differ in size, value and improvements but they have standard issues that may affect any building at any time including: roof, floor, siding, air conditioning, heating, electrical, plumbing, paint and carpet.
To pay for ongoing current expenses an owner may establish a building maintenance/sinking fund which sets aside a sum of money periodically to cover ongoing expenses, capital improvements to the building and long-term structural costs. The maintenance fund is for short-term recurring costs for the upkeep of the building. The maintenance fund is to cover costs that are predictable, recurring and relatively small costs in comparison to a major capital improvement. The sinking fund component is for the long-term non-recurring or unexpected costs from emergencies or disasters.
The annual expense for the building maintenance/sinking funds include many variables which fluctuate dependent on the property but include the following: the nature, size and quality of the building, the tenant care of their units and common areas, the market cost of labor and contractors, unexpected emergencies (e.g. termites who destroy wood) acts of nature (hurricanes, rains, tornados and earthquakes).
The maintenance/sinking fund may be set aside or budgeted from the building income (and other resources including the owner’s own assets, and third party loans/financing from either banks or other lenders). The key issue is that the funds are available on an ongoing basis to pay for recurring maintenance expenses or long-term capital improvements as required.
Building owners have different strategies to pay these ongoing maintenance and future capital improvement costs, which include the following:
- Pay expenses as they occur from their resources
- Establish a banking account and sequester a single lump sum of cash to be held in the account to pay for expenses as they occur
- Allocate funds from the monthly building income to pay recurring maintenance expenses and/or capital improvements and use their own resources as a back up for the account which if not sufficient may be supplemented by a third party loan or bank/lender financing
- Sell off a percentage of ownership of the building to equity investors to cover the costs which have left them at a shortfall of resources
- Establish a joint venture or a partnership with investors to raise liquid sums of money for use in the building (and the partnership or joint venture may take title to the property with the original owner maintaining a percentage of ownership)