CapEx Calculation Controversy

10 Replies

I've done a lot of investigating and found that if there is one thing that will kill a real estate investor, it is CapEx. CapEx has been dubbed the "Silent Investor Killer" because many investors don't a lot enough to CapEx according to what I can find. There seems to be consensus that you should get hard numbers on CapEx from a reliable source (eg, GC) when inspecting the property but that isn't where the controversy is. The controversy is how to do a preliminary estimate of CapEx in the early stages of evaluating a property.

Upon scouring the internet, podcasts, and picking investor's brains, these are the options to do an early estimate CapEx:

1. Use 5-10% of GSI (however, I've seen as high as 15%)
2. \$200-\$400/month per door
3. \$/month per unit - this is all over the place (\$50-\$800+)
4. Calculating all CapEx items savings per month
5. \$0.67 per square foot/year

My limited criticism for each method:

1. Most common recommendation I find is 5%. But compare California and Cleveland's GSI. GSI's are wildly different but cost to replace an item is similar. However, labor will increase the cost in California - but not proportionally. If you are saving 5% of \$1500 GSI, then you only save \$900/yr (\$9,000 in 10 years). This hardly seems enough.
2. Many save ~\$200/mo per door. More reasonable (I think??), but I imagine this doesn't work when comparing a 2 unit vs 10 unit.
3. Saving per unit seems logical, but it gets a bit foggy when thinking about saving for a single roof, driveway, or other shared expense.
4. This makes the most sense, but you must be crazy accurate. Depending on how you fudge the numbers you can vary from 25%-50%+! This seems useless unless you have solid numbers. Maybe used after a walk-through with a GC.
5. Using a square footage seems easy enough. If I used \$0.67/sq ft on my double with a GSI of \$1500, I would save about 8% of my GSI (~\$1500).

Depending on which method you use (and the #s you enter), it can change your cash flow enough to make a good deal look bad and vice versa. If CapEx is the Silent Investor Killer, then many investors are underestimating their CapEx.

What are the thoughts of the BP community?

Why do you feel your method is the best?

What method used in both California and the Midwest (if possible)?

I think the best way is to just have a reserve per property of 5-10k for capex. At least in my rentals 10k would probably cover the furnace, AC unit and perhaps roof. (It’d be close). Which is most of your big items

The other option is to just replace anything that needs it when you buy it and that’ll help for a number of years too.

Thanks Caleb, do you just leave CapEx out of the equation when comparing properties?

Matthew,

Don't really have an answer for you but I have been on this soap box several times. Yes, many (most?) people don't properly account for capex and are basically rolling the dice to see if they get caught during their hold period; NOI looks great but actual return over a longer period of time - not so much.

This is especially true of lower cost investments since many items cost the same regardless (e.g. Roof)

Also, it depends on your 'strategy'; fix and flip investor doesn't care as they will generally be out of the property within 6 - 9 months and it's ALL capex to them.

As well, for some, capex is only about the basics (e.g. structure, roofing, heating and cooling). For others it is also appliances and carpeting. For yet others it is also includes plumbing & electrical or more (e.g. drainage connection). You can drive this down to a micro level (e.g. ceiling fans and light bulbs).

All things have a 'normal' operational life expectancy; some will last longer and some shorter then 'normal'. The longer your expected hold period is, the more you should be thinking about this.

All the rules / methods you list are as 'rules of thumb', 'short cuts', etc. just as you can guesstimate a roof re-shingle just by the sq footage without selecting material, taking in account specific damage or getting quotes.

Using any one of these methods is just a time saver to see if you should invest the most precious thing you have - Time. It takes time to figure out what the actual capex number should be.

I don't have any properties yet myself, but I've wondered about the same thing. As you say, the number you use for CapEx can dramatically alter the deal. Not conservative enough, and poof there goes your cash flow. Too conservative and you'll never buy anything. 1, 2, and 5 look arbitrary, whereas 3 & 4 require a detailed dataset to get right. What to do...

I imagine that as I gain experience and track accurate data on my portfolio this will allow for greater and greater accuracy in capex projections. I guess my thought in the meantime is to use method #2 (or #5) to make sure there's a good probability of cash flow, then just keep enough cash reserves on hand to manage risk. How much will depend on one's risk tolerance. I hear a lot of folks say keep 6 months operating expenses on hand.

So I'm thinking maybe keep that amount plus a buffer amount in case I need to sustain operations for 6mo and make a capex. Maybe as one's portfolio grows and diversifies you can fine tune this. When I have to dip into it, replenish it (from cash flow, w2, whatever) with a sense of urgency. Over time, unload any properties that aren't performing, try to get more precise with the next property.

In cases where you do a rehab or a BRRRR or something, seems like you can get a better idea of your expected capex, since you know the condition of everything.

But heck, what do I know?

Originally posted by @Oren K. :

Matthew,

Don't really have an answer for you but I have been on this soap box several times. Yes, many (most?) people don't properly account for capex and are basically rolling the dice to see if they get caught during their hold period; NOI looks great but actual return over a longer period of time - not so much.

This is especially true of lower cost investments since many items cost the same regardless (e.g. Roof)

Also, it depends on your 'strategy'; fix and flip investor doesn't care as they will generally be out of the property within 6 - 9 months and it's ALL capex to them.

As well, for some, capex is only about the basics (e.g. structure, roofing, heating and cooling). For others it is also appliances and carpeting. For yet others it is also includes plumbing & electrical or more (e.g. drainage connection). You can drive this down to a micro level (e.g. ceiling fans and light bulbs).

All things have a 'normal' operational life expectancy; some will last longer and some shorter then 'normal'. The longer your expected hold period is, the more you should be thinking about this.

All the rules / methods you list are as 'rules of thumb', 'short cuts', etc. just as you can guesstimate a roof re-shingle just by the sq footage without selecting material, taking in account specific damage or getting quotes.

Using any one of these methods is just a time saver to see if you should invest the most precious thing you have - Time. It takes time to figure out what the actual capex number should be.

Great points. It would depend on how long you hold it. For me I am holding indefinitely. It seems it is open to a lot of opinions on what is included in CapEx and this may be why so many people ignore it.

I think a 6 month reserve is appropriate and gave solid advice. Maybe it doesn't matter what method I use. The reserve can buffer any mistakes I make and I can adjust based on what I find over time. I'm just finding it hard to do an apples-to-apples comparison of true cash flow and it is driving me nuts.

Here is another thread that evaluates a 4 plex. He is running into the same (assumed) over-estimation problems I am.

Help estimating CapEx: Analysis shows \$800 for \$250,000 4-plex?

One investor said he was using 8% of GSI and didn't have any problems. Short term you would never see a problem. It is the long-term that gets you so I'm curious what a long term investor would say.

Howdy @Matthew Jure

Don’t strain your brain too much.  The headache is not worth it.

You are correct too many fail to either include CapEx (and Repair/Maintenance) or do not withhold enough.

I currently solely use the BRRRR strategy for my investments. I always start my analysis with 10% CapEx/5% R&M. If the property passes my initial screening I (or my Realtor) will go look at the property and make a list of repairs or upgrades that would be needed. We work up a preliminary Rehab estimate (with lots of over estimating).

Once a property is under contract I have it inspected. I want to determine what the life expectancy of all major components and appliances are. I use this report to finalize what needs to be repaired now during the Rehab and what can be deferred. I readjust my CapEx reserves to meet the deferred timeline. Anything not expected to last over 5 years is added to the Rehab budget. My plan is to only hold most properties for about 5 years. At that time I 1031 exchange them for a larger property.

Since I do not have many CapEx costs after the Rehab I have been able to build a significant reserves account for all my properties and future investments.

This process has worked great for me.  It might not work for every investor or in all markets.

I concentrate on two items when it comes to capex... Roof and HVAC replacement. If a roof costs \$5000 and will last 20 years, and an HVAC unit is \$5000 and lasts 15 years. So if I replace them both during rehab, those two assumptions come to \$48 per month. I feel that if I reserve \$80/mo (5% of my most recent rental), that will be more than enough to cover those items and others that may come up.

It sounds like you decrease your CapEx by being proactive. Good strategy.