Let’s talk about my “Hell House”—the property that taught me the importance of CapEx in real estate. I bought the home for an incredibly cheap price: just $40,000. What a steal, right? I put another $40,000 into fixing it up and then refinanced, following the BRRRR strategy (buy, rehab, rent, refinance, repeat).
It was all downhill from there. I thought I was going to make a decent monthly profit on the property, but the truth is that I don’t. In fact, I lose money every single year.
Every. Single. Year.
CapEx—or capital expenditures.
Here’s how to avoid your own Hell House.
What are capital expenditures?
Analyzing properties correctly is important. Without doing the right math before investing, you’ll never get the right profit.
Most of us can estimate simple expenses like repairs, vacancy, and property management fees. But those aren’t the only operating expenses—and nearly every new investor struggles with capital expenditures, or CapEx. What is CapEx? It’s 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, or plumbing systems.
CapEx is the reason I lose money every year on my Hell House. Over the past year, I made about $1,000 in cash flow. But last week I got a call from my property manager letting me know the bathroom flooring needed 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 earned $100 per month in cash flow for 10 years, making $12,000 total, and then reroof the property—costing you $12,000—what did you really accomplish? Hopefully, the value increased during that time, but that’s an appreciation game I don’t really play. For a smart BRRRR and buy and hold investing strategy, you want to make sure the property actually produces cash flow.
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How to estimate CapEx
Like repairs, CapEx is difficult to estimate. It depends on a lot of different factors, such as the property’s condition, age, and 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 or an appliance will last. What is the condition of your plumbing? What will a new driveway cost? Divide the estimated cost by the number of years the system has left.
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.
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 its useful life. 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||Replacement cost||Lifespan (years)||Cost per year||Cost per month|
|Structure (foundation, framing)||$10,000||50||$200||$16.67|
|Components (garage door, etc.)||$1,000||10||$100||$8.33|
According to this chart, we should be setting aside $182.75 per month for CapEx for this single-family property.
The problem with estimating CapEx
However, there are limitations to estimating capital expenditures this way for real estate investors.
This chart assumes that everything was brand new when the property was purchased—but as any landlord knows, things don’t break down evenly. Your plumbing may only have a few years left. Or perhaps the paint is peeling, and the appliances are already 30 years old.
The average of $182.75 might be true on this example property over the long run, but what about immediate concerns? Let’s say you start saving today… and then are hit with a $5,000 roof replacement bill next year. Then, you wouldn’t have enough cash set aside to cover that new roof.
Therefore, it’s important to take an inventory of what will need to be replaced sooner rather than later and save extra just for those items. And this is also an important argument for why cash reserves are so important. 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. And 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 looks 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 eight percent of the gross rent for multifamily properties.
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How CapEx can make a $40,000 house a bad deal
Notice that the chart we presented wouldn’t change much for a $400,000 property versus a $40,000 property. Sure, you might need to replace more windows or a bigger roof, but that won’t hugely affect your calculations. In other words, just because with a $400,000 purchase price is 10 times more expensive than one that is $40,000 doesn’t mean its roof, windows, or paint will also be ten times more expensive.
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 percent of the income. On a home that rents for $600 per month, that $200-per-month CapEx makes up a whopping 30 percent 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.