In this blog post, we're focusing on a vital financial concept for multifamily real estate investors: Capital Expenditures, commonly known as CapEx.
We'll explore the essence of CapEx, its critical role in the real estate sector, and offer insights on managing it to enhance your investment returns.
Understanding and effectively handling CapEx can mean the difference between mediocre and stellar performance in your real estate portfolio.
So, without further ado, let's get into the details.
What are capital expenditures?
Capital expenditures, commonly known as CapEx, are funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment. These are often large-scale expenses that a company incurs to invest in the future of the business. Unlike operational expenditures (OpEx), which are short-term expenses that are used to manage the day-to-day operation of a company, CapEx typically provides benefits over a longer period.
What does CapEx mean in real estate?
Capital Expenditures (CapEx) in real estate refer to funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, or equipment. This could include new roofs, HVAC systems, building extensions, or major equipment purchases that extend the life of the property.
Example of real estate capital expenditures:
Real-life examples of CapEx in the real estate sector include:
- Installing a new roof which may cost $75,000 but will last for 20 years.
- Upgrading an elevator system for $150,000, improving safety and efficiency.
- Replacing an outdated HVAC system with an energy-efficient model for $250,000, enhancing tenant comfort and reducing long-term energy costs.
CapEx formula + example
There isn't a universal "CapEx formula" per se, but rather a methodology for calculating the CapEx for an investment property, which is often determined during the due diligence phase before acquiring a property or during annual budgeting. Essentially, CapEx can be calculated over a period using the following approach:
CapEx = PP&E (Current Period) - PP&E (Prior Period) + Depreciation (Current Period)
Where PP&E stands for Property, Plant, and Equipment.
This formula calculates the CapEx spent during the current period by taking the difference in the value of PP&E between the current and prior periods and adding back the current period's depreciation since depreciation reduces the book value of PP&E over time.
Example of a CapEx Calculation:
Let's say you're evaluating a multifamily property and want to estimate the CapEx for the past year.
Here are the numbers you have:
- The PP&E value at the beginning of the year was $1,000,000.
- The PP&E value at the end of the year was $1,200,000.
- Depreciation expenses for the year amounted to $150,000.
Using the formula:
- CapEx = ($1,200,000 - $1,000,000) + $150,000
- CapEx = $200,000 + $150,000
- CapEx = $350,000
So, the CapEx for the property during that year was $350,000.
This amount represents the money that was invested into the property to enhance its value, not just maintain it.
CapEx vs OpEx: What’s the difference?
For accurate financial analysis and forecasting, CapEx should not be confused with routine maintenance or repair costs, which are typically classified as operating expenses (OpEx) and treated differently in accounting and tax considerations.
For instance, repairing a leaky faucet is an OpEx, while replacing all plumbing to mitigate future leaks is CapEx.
Tips for budgeting CapEx in real estate
Budgeting for capital expenditures (CapEx) in real estate is a critical exercise that requires foresight, discipline, and strategic planning.
Here are some practical tips for real estate investors and property managers when budgeting for CapEx:
- Understand Your Assets: Conduct a thorough assessment of the property to understand the condition and life expectancy of major components like roofing, HVAC systems, elevators, and appliances. This will inform the frequency and scale of future CapEx needs.
- Historical Analysis: Look at the historical CapEx spending on the property. Past expenditures can provide a baseline for what to expect and help forecast future needs.
- Create a Reserve Fund: Establish a reserve fund specifically for CapEx to ensure that funds are available when needed. This fund should be separate from the operating account and funded consistently, often as a percentage of the rental income.
- Use the 10% Rule: A general rule of thumb is that around 10 to 15% of the income generated by a property (after fixed costs and variable expenses) should be set aside for CapEx and vacancies.
- Prioritize Expenditures: Not all CapEx projects are created equal. Prioritize them based on urgency, potential return on investment (ROI), and impact on maintaining or increasing property value.
The best proptech CapEx for multifamily communities
Investing in LittleBird's advanced technology solutions represents a strategic CapEx initiative that can deliver significant benefits across a multifamily property.
- Curb Appeal: LittleBird's sleek, modern interfaces and hardware, such as smart access systems, instantly upgrade the aesthetic of entry points, contributing to a more attractive and technologically advanced first impression for prospective tenants.
- In-Unit Advancements: Inside the units, LittleBird's technology, from smart locks to climate control systems, adds a level of convenience and modernity that can command higher rent and appeal to a tech-oriented demographic.
- Community Connectivity: Beyond the individual units, LittleBird facilitates a connected community experience. Its platforms can offer residents the ability to communicate with property managers, book amenities, and engage with their neighbors, fostering a sense of community.