The following is an excerpt from BiggerPockets Publishing’s The Book on Rental Property Investing. If you are looking to buy more rental properties, pick up a copy today! Want more articles like this? Create an account today to get BiggerPocket's best blog articles delivered to your inbox Sign up for free Let’s talk about my “Hell House.” I bought it for an incredibly cheap price of just $40,000. What a steal, right? Then I put about $40,000 worth of work into fixing it up and refinanced it, a strategy I call “BRRRR” (buy-rehab-rent-refinance-repeat). And then it was all downhill from there. You see, although I thought I was going to make a decent monthly profit on the property, the truth is: I don’t. I lose money every single year. Every. Single. Year. Why? CapEx. The purpose of this post is to teach you what CapEx is and what you can do about it to avoid your own Hell House. What Is CapEx? (Capital Expenditures) Everyone knows analyzing properties is important. After all, if you don’t have the right math going into an investment, you’ll never get the right profit coming out of it. And most of us can estimate expenses like repairs, vacancy, and property management fairly easily. But the one area nearly every new investor struggles with is CapEx. More formally known as capital expenditures, CapEx are those expensive “big ticket” items that need to be replaced every so often, but not every month or year. This could include roofs, appliances, driveways, plumbing systems, or any other large item you should budget for but that do not occur enough to be easily accounted for. CapEx is the reason I lose money every year on my Hell House. For example, I made about $1,000 in cash flow over the past year. And last week I got a call from my property manager letting me know the flooring in the bathroom was finally shot and would need to be redone. Total cost of this expense? $1,200. Another year of losing money on the Hell House. Another way to think of CapEx: If you were to earn $100 per month in cash flow for ten years ($12,000) and then needed to put on a new roof for $12,000, what did you really accomplish in those ten years? Hopefully, the value has increased during that time, but that’s an appreciation game I don’t really play. I want to make sure the property is actually producing cash flow. Related: A Real Life Example That Proves the Importance of Underwriting Multifamily Numbers How to Estimate CapEx Like repairs, CapEx is difficult to estimate because it depends on a LOT of different factors, such as the condition, the age, and the property type. Your investment property might be a 3,000 square foot single family house built in 2005. Mine might be a 1920 five-plex that hasn’t been updated in thirty years. Is the CapEx going to be the same? Of course not! While there is no single “CapEx” number you should stick to, you can sit down and estimate how many years a roof will last, how many years an appliance will last, what the condition of your plumbing is, what a new driveway will cost, and so on—and then divide these out by the number of years. To do this, start by listing every “big ticket” item that might need to be replaced in the next 20 years. Use the following chart to get started, but understand that your area might have different expenses than these. (Special thanks go out to Ben Leybovich and Serge Shukhat for illuminating this CapEx estimation process for me!) The following chart lists 13 of the major capital expenditures that a typical property has, then looks at the total replacement cost for that item and how long that item will likely last. This tells us how much per year we should be saving to replace that item. We can then break that figure down into a monthly price. Capital Expense Total Replacement Cost Lifespan (years) Cost per Year Cost per Month Roof $5,000 25 $200 $16.67 Water Heater $600 10 $60 $5.00 All Appliances $1,000 10 $100 $8.33 Driveway/Parking Lot $5,000 50 $100 $8.33 HVAC $3,000 20 $150 $12.50 Flooring $2,000 6 $333 $27.75 Plumbing $3,000 30 $100 $8.33 Windows $5,000 50 $100 $8.33 Paint $2,500 5 $500 $41.67 Cabinets/Counters $3,000 20 $150 $12.50 Structure (foundation, framing) $10,000 50 $200 $16.67 Components (garage door, etc.) $1,000 10 $100 $8.33 Landscaping $1,000 10 $100 $8.33 TOTAL $41,100 $2,193 $182.75 According to this chart, then we should be setting aside $182.75 per month for CapEx. (Of course, this chart was designed for a single family home. A multifamily home may have some CapEx expenses that are common across multiple units, like the roof, and others that are specific for each unit, like the water heater.) The Problem with Estimating CapEx However, there are limitations to estimating capital expenditures this way. This chart tends to assume that everything was brand new when the property was purchased, but as any landlord knows, things don’t break down evenly. What if the plumbing only has a few years left? What if the paint is peeling, so the property needs new paint next year? What if the appliances are thirty years old? Although the average of $182.75 might be true on this example property over the long run, what about immediate concerns? If starting today you only saved that much each month, and then you were hit with a $5,000 bill for a roof replacement next year, you wouldn’t have enough cash set aside to cover it. Therefore, it’s also important to take an inventory of what will need to be replaced sooner rather than later and save extra just for those items. This is also an important argument for why cash reserves are so important to have for real estate investors. Things don’t break down evenly. Finally, keep in mind: The $182.75 in this chart is just an example for one fictional property. Each item may cost more or less for you. You may have expenditures that I didn’t list. The point of this chart is to merely show how to calculate CapEx for a property. I would recommend that you sit down with an Excel spreadsheet and determine what CapEx in your area would look like. Over time you’ll come up with a general ballpark number that you can use for “most deals” in your area. For example, when I’m using the BiggerPockets Rental Property Calculator, I typically assume about $200 per month for CapEx for single-family homes and about 8% of the gross rent for multifamily properties. Related: #AskBP 080: What Are Capital Expenditures and How Do I Estimate Them Correctly? How CapEx Can Make a $40,000 House a Bad Deal I have one final note about CapEx: Notice that the chart we presented wouldn’t change much if the home were a $400,000 property or a $40,000 property. Sure, you might need to replace more windows or a bigger roof, but this differential is not as large as the cost difference between a $40,000 property and a $400,000 property. (In other words, just because a house worth $400,000 is ten times more expensive than one that is $40,000, that doesn’t mean a roof, windows, paint, or anything else will also be ten times more expensive.) What this means is that CapEx is a much greater percentage of the income when dealing with lower-priced properties. On a home that rents for $2,000 per month, the CapEx of $200 per month is 10% of the income, but on a home that rents for $600 per month, the CapEx of $200 per month will be a whopping 30% of the rent. So all those $15,000 houses for sale in the Midwest might seem like a screaming deal, but be sure to run the numbers and make sure it pencils out AFTER CapEx. After all, you don’t want to end up with a Hell House like mine! Do you take CapEx into account for every single property you purchase? Have capital expenses ever burned you? Let me know with a comment!