Need some help analyzing a financial statement for an apartment complex. Just wondering if capital improvements should be part of the expenses (i.e. should they be deducted from gross income to arrive at NOI). In this particular financial report, things like HVAC contractors, plumbing contractors, and roofing contractors are included in capital improvements and not deducted from gross income. Just wondering if this is the norm. Thank you.
It is the norm in my experience, unless the roofing or plumbing contractor conducted a repair, not an improvement.
Capital reserve is not typically included in expenses, however, I personally include it in my own analysis.
What I HAVE seen recently, however, is the bank underwriting the loan include it in expenses to reduce the NOI and therefore reduce the loan amount.
Most people include sort of an "escrow" account in their NOI calculation for those long term expenses. I can see why actuals would be excluded as they aren't every year expenses, but some fraction of them should be... thus the 50% rule people use... generally sets something like 10% of rents for those big ticket items that won't happen every year but do happen.
Capital improvements are not included in NOI but are included in cash flow. However, if their FS literally describe the line items as "roof contractor" or "plumbing contractor" that makes me wonder if they are potentially combining capital improvements and repairs, just as @Ann Bellamy mentioned.
Appraisers/analysts will include in the NOI a capital improvement "reserve" based on age, condition & market to cover estimated capital expenditures, just as @Nathan Emmert mentioned.
Often on larger projects, the lender or equity partner requires a Property Condition Report in addition to the appraisal. This report will state the condition/remaining life of major components of the property and determine the amount that will be required to be escrowed.
Not much to add to the above responses (all good), but capital expenses are often referred to as "below the line," meaning on a financial statement they are factored after the NOI is calculated.
That said, you should be factoring these costs into your analysis, regardless of whether they are formally considered part of the NOI.
This is where your own best estimate needs to be used and not a sellers or agents estimate for reserves and capital expense.
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