Deferred maintenance is one of the things that property investors should be very cautious of when evaluating a particular property investment opportunity, because it can lead to a misleading assessment of the income-earning capacity of the property.
The income-earning capacity of a property is typically measured by its Net Operating Income (NOI), which is calculated as the difference between the property’s effective gross income and operating expenses. Maintenance and repair expenses represent a major component of operating expenses.
Deferred maintenance refers to maintenance and repair work that needs to be done, but is deferred to the future. As a result of such a deferral, operating expenses are low and the property’s NOI is artificially boosted. Thus, an investor evaluating a property with deferred maintenance will be misled in terms of the income-earning capacity of such a property, if he/she does not critically evaluate the adequacy of recent maintenance and repair expenses.
Unreasonably low expenses would most likely reveal a deferred maintenance strategy on the part of the existing landlord. In such cases, the property investor needs to appropriately incorporate in the cash flow analysis of the property the deferred repair and maintenance expenses, in order to calculate future NOI and the price that he/she would be willing to pay in order to achieve his/her required rate of return