Tackling the Cost of Deferred Maintenance

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In a recent post, we began our look into the impact that functional obsolescence and deferred maintenance can have on commercial properties. The former has to do with functional aspects of a property that fall below the standard of the day for properties in a given product type. The latter relates to issues of maintenance that, for various reasons, are left unattended. Functional obsolescence is the more difficult of the two to rectify, but both can be expensive for you as a property owner to correct, and as a result, deserve your full attention.

While the near term upside to deferring maintenance is higher cash flow, the downside risks are generally harmful to your property’s long term performance and resale value. Let’s take a look at some deferred maintenance items with an eye for measuring their impact on the performance of your real property asset.

Making Your List

A good first step is to closely scrutinize the current condition of your property from a maintenance perspective and create a list of those items that, if addressed, could potentially increase the return on your invested capital by making it more marketable. Once you have generated a comprehensive list of items needing attention, you can reach out to the appropriate professionals to determine their cost. It could be that there are a few things you can do at minimal cost that will improve your project’s competitive position.

Some examples include re-carpeting and repainting of common areas, slurry-coating and striping parking areas and trimming or replacing exterior landscaping. These are items that fall under normal operating expense parameters, and not addressing them can send the message to existing and potential tenants that you lack pride of ownership.

Paying Attention to Detail

As property managers, we are the primary interface with tenants and we know that most tenant dissatisfaction relates to routine maintenance and repairs of basic building systems. Our experience tells us that prompt attention to small maintenance issues keeps minor tenant frustrations from mushrooming into ruined relationships. So, if you are getting frequent complaints about the same issues, the ultimate expense of deferring routine maintenance can be far greater than the cost of repair.

Evaluating Capital Replacements

Staying on top of routine maintenance is vitally important, but there are some larger items that are also worthy of your attention. We refer to big capital expenditures like replacing HVAC systems, the roof, re-paving the parking area and the major remodeling of lobbies, hallways, and restrooms. The frequency of repairs can get expensive and test the patience of your tenants. Properly maintained, all these building systems will last a long time.

Keeping Your Tenants in Mind

Perhaps the best example is the frequent breakdown of your HVAC system. Nothing will test the relationship with your tenants like no air conditioning on a hot summer day. They will tolerate minor roof leaks and deteriorating pavement more readily than breaking a sweat at their desks on a regular basis. So, climate control should be a high priority and the investment in new HVAC equipment will probably be worth it in terms of keeping your tenants happy and inclined to renew their lease terms when the time comes. These systems are not cheap, but under the recent tax reform legislation passed back in 2017, you can fully expense the cost of a new HVAC system or roof replacement in the year you incur the expense rather than depreciating that cost over time.

Upgrading restrooms, common area lobbies, hallways, and elevators are another area of deferred maintenance that can positively impact your relationship with your tenants along with improving ventilation, installing new fixtures, hardware in your restrooms. Changing out lighting fixtures, carpet, wall coverings, and entry doors will also be a big help, as will a refit of elevator cabs. All these items are front and center to your tenants because they are things they see, touch and use all day long. Their condition also reflects on them as it relates to clients who visit their location to conduct business, therefore, the better the image your building projects, the more likely you are to get a higher incidence of renewals.

Pay Now or Pay Later

The failure to address issues of deferred maintenance, big or small, can trigger a negative income spiral. Most owners who choose not to do so are concerned primarily with their cost. That is entirely understandable, but not taking care of what needs to be done will reduce occupancy and income over time, making it increasingly difficult to tackle these issues as time goes by. Every dollar of net operating income (NOI) lost at a market cap rate of 5% reduces the value of a property by $20 at the point of disposition. Any prospective buyer for a property will be certain to identify deferred maintenance issues and adjust their offering price accordingly. So, it is safe to say that it is a pay now or pay later conundrum.

Solutions

How to go about tackling deferred maintenance is peculiar to each property owner. The best course of action is ultimately up to you. You might want to access the equity in your property through a refinance and take care of everything at once. Or, you may choose to begin reserving cash from the property’s current income stream to address each item one at a time over time. That decision will depend on market metrics like the cost of accessing capital, the vacancy rate, projected rent growth and transaction volume within the competitive set of properties in your immediate area. Some owners decide they are not in a position to take on major renovations and decide to exchange into another property that does not have deferred maintenance or functional obsolescence. Does that come at a price? Yes, it does. But, it might be one worth paying depending on your situation.

Functional obsolescence and deferred maintenance are substantive issues that deserve your careful attention. We are uniquely qualified to assist you in the evaluation of your options, as we have extensive experience in major asset retrofitting and repositioning along with all the tools and resources to provide you with a comprehensive strategic plan. We are just a phone call away at (949)668-1110