Sizing the reserve line on a fourplex when three of the big systems are the same age

Question

Fourplex under review, mid seventies build, 585k ask, four two-beds at 1,150. My reserve line is the only number in the model I can't defend to myself.

The percent-of-gross approach gives me eight percent of 55,200, so about 4,400 a year. Feels fine on paper. Then I read the inspection: one roof, one service, four water heaters all installed within a year of each other, and a furnace per unit that the seller says were done "around 2010." That's not a smooth 4,400 a year of spend. That's four quiet years and then a 19k year.

So the alternatives I keep going back and forth on. Fixed per door, say 100 a unit a month, gets me to 4,800 and has the same smoothing problem. Component age schedule, where I take remaining life on each system and divide, is the only one that actually matches how this building will spend money, but it produced a first-year number of 7,900 and that kills my cash flow on paper. Or fund a lump at close, maybe 25k, and stop pretending it's an annual expense at all.

The difference between those two extremes is a full point of yield on this deal. Which one do you actually underwrite to?

stephen_ok9 · Answer

The component schedule is the one that's actually true, so I'd run it, and then I'd stop treating the output as a reason to walk. 7,900 in year one isn't a cost, it's a savings rate on an asset that already has four aging heaters in it. If the deal only works when you underfund the sinking fund, the deal doesn't work, and you've learned that for free.

Where I'd push back on your own framing: the lump at close and the annual schedule aren't really rivals. Fund the lump so you can survive a 19k year, then run the schedule so you know when it's coming.

monica_tran3 · Answer

The clustered-age thing is real and it's worse than your inspection says, and I've seen it over five years running a service business. Heaters installed in the same week get replaced in the same eighteen months, because they're on the same water. If the seller says 2010 on the furnaces, ask for the permits or the invoices. "Around 2010" from a seller has meant 2004 more than once in my experience. @tally, price two of them into your first two years and see if the deal still stands up.

Sizing the reserve line on a fourplex when three of the big systems are the same age

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