Is this a good way to estimate Capex?

8 Replies

I am working on a project for BiggerPockets (stay tuned!) that is requiring me to estimate Capex (which for this exercise includes maintenance) across US cities. There is not too much data to go on, simply the median rent in that city. That's it! After talking it over with @Scott Trench we came up with a few thoughts. 

  1. Using a simple percentage of rent won't work, because in our minds, Capex does not scale linearly. Let's use 10% as an example. If rent is $500/month and you estimated 10% of rent, you'd have only $50/month. That's only $600/year, which in my mind is far too little for estimate, no matter what the value of the home is. Even a $50,000 home needs a new boiler, roof, water hear, and to repair regular wear and tear. However, 10% might work perfectly fine for a property with $2500 of rent. That would amount to $3k/year. Might work great in some markets, and poorly in others.
  2. If we did a higher %, say 30%, the opposite effect would likely happen. It would be accurate for lower-end rents ($150/month for $500/month in rent), and too high for higher rents ($750/month for $2500 in rent). 

These are just two random examples, but you get the point. So what I decided was that first, we needed to set a 'floor' for Capex. I came up with a number doing some back-of-the-envelope math of around $150/month (but I welcome input on that). Secondly, I decided that Capex should not scale linearly with increases in rent. Instead, the % of rent needed for capex should decrease as rent increases.

I won't get into the specific math here cause its nerdy and not necessary, but I spent some time 'fitting a curve' to our data and here is what I came up with: 

Here's what is going on in this graph: 

  • The labels on the X-axis are the median rent for a given city (I am purposely omitting the city names here). 
  • The orange bars show the estimated Capex
  • The blue line shows the % of rent that I am using for that particular rent price. 

As you can see this is not a straight line, it's a curve. The left side of the graph starts around 23% of rent being used, and on the right side it decreases to about 13%. 

So what does everyone thing about this approach? Is $150 a good floor? Is my curve diminishing fast enough? Too fast? Would love to hear what everyone thinks. 

** and before everyone says that estimating capex at a city level is impossible, that certainly has merit. It's very difficult, but despite the challenges, that is still what I am trying to do so would appreciate feedback about this specific project. 

Originally posted by @Dave Meyer :

I am working on a project for BiggerPockets (stay tuned!) that is requiring me to estimate Capex (which for this exercise includes maintenance) across US cities. There is not too much data to go on, simply the median rent in that city. That's it! After talking it over with @Scott Trench we came up with a few thoughts. 

  1. Using a simple percentage of rent won't work, because in our minds, Capex does not scale linearly. Let's use 10% as an example. If rent is $500/month and you estimated 10% of rent, you'd have only $50/month. That's only $600/year, which in my mind is far too little for estimate, no matter what the value of the home is. Even a $50,000 home needs a new boiler, roof, water hear, and to repair regular wear and tear. However, 10% might work perfectly fine for a property with $2500 of rent. That would amount to $3k/year. Might work great in some markets, and poorly in others.
  2. If we did a higher %, say 30%, the opposite effect would likely happen. It would be accurate for lower-end rents ($150/month for $500/month in rent), and too high for higher rents ($750/month for $2500 in rent). 

These are just two random examples, but you get the point. So what I decided was that first, we needed to set a 'floor' for Capex. I came up with a number doing some back-of-the-envelope math of around $150/month (but I welcome input on that). Secondly, I decided that Capex should not scale linearly with increases in rent. Instead, the % of rent needed for capex should decrease as rent increases.

I won't get into the specific math here cause its nerdy and not necessary, but I spent some time 'fitting a curve' to our data and here is what I came up with: 

Here's what is going on in this graph: 

  • The labels on the X-axis are the median rent for a given city (I am purposely omitting the city names here). 
  • The orange bars show the estimated Capex
  • The blue line shows the % of rent that I am using for that particular rent price. 

As you can see this is not a straight line, it's a curve. The left side of the graph starts around 23% of rent being used, and on the right side it decreases to about 13%. 

So what does everyone thing about this approach? Is $150 a good floor? Is my curve diminishing fast enough? Too fast? Would love to hear what everyone thinks. 

** and before everyone says that estimating capex at a city level is impossible, that certainly has merit. It's very difficult, but despite the challenges, that is still what I am trying to do so would appreciate feedback about this specific project. 

 How about a specific dollar amount times square footage? e.g. 10 cents x 1500 square feet = $150  

You also have at least five more problems:

1. How to factor in the age of the property, because older properties require more maintenance.

2. How to factor in build quality, because better-built custom properties requires less expensive maintenance on average than often-shoddy tract construction.

3. How to factor in the nature of maintenance -- the veteran DIY fixer is always going to spend less than the guy who doesn't know what a scope of work is relying on a property manager to hire preferred contractors who are kicking back to the PM, the incompetent DIYer is always going to spend more than the competent one, the guy fifteen states away with no boots on the group managing major rehabs remotely is always going to get the shaft.

4. Differing county and municipality requirements: what's fine and legal in one county isn't allowed in the next county over, the same with cities.

5. Small multifamily versus SFR versus large multifamily construction difference. 100-year-old 10-unit Manhattan apartment building versus 100-year-old Mississippi Delta kudzu-eaten termite-ridden clapboard makeshift duplex begging for the wrecking ball.

The challenges will be daunting.

I have come across using shelf life of items to estimate my CAPEX. For example, if I assume that a water heater has 5 years before replacing, I will save enough for that particular item in 4 years. I will sum all of the typical CAPEX items and save that amount monthly.

Originally posted by @Scott Trench :

@Will Barnard - Interested to hear your thoughts on this! 

The problem here is that it is just literally impossible to come up with an accurate number, percentage, or chart for all rental units in all areas. I’m not sure of the purpose of the exercise or what is the intended result. Single family homes vs garden apartments vs high rise apartments will all have different ratios and within those classes, will all have different results in different states.

It is not possible to get the number you are looking for as an accurate across the board of all investment classes for cap ex or repairs/maintenance.

That said, here is a blurb copied form the NAA (National Apartment Association) which puts out data on operating and cap ex expenses for apartments of garden style and high rise: 

“Capital expenditures, which can include anything from concrete and masonry work to amenity upgrades to extensive rehabs of some units or a clubhouse, has steadily increased since 2010 when measured against GPR. At 11.1 percent, it’s at the highest level since 2005. Competition from not only new properties but other highly-amenitized communities has kept the pressure on owners to improve their assets more frequently, and with an eye toward differentiating themselves from their competitors.”

This comes from a 2018 survey by NAA. It states that cap ex averages 11.1% of rent and repairs/maintenance an additional 9% of rents. That totals 20% of rent for apartments.

Another thing to consider is expected holding time of the asset which can dramatically affect the number. Short hold periods vs long and condition at purchase make a big difference, therefore, using scaled charts may work in some cases and not in others, placing us right back where we started.

I do like the floor figure of $150 monthly, however, that may be too low in some cases too. This task is no easy one and rather than making it too complicated, for argument sake, it may be better to just go with published NAA figures to plug into your data. The problem there is, that does not include single family rentals with Mom and Pop investors or even small multi family properties as the published stats were taken from garden style apartments of 50 or more doors. I have a feeling this study is an attempt to fill in data for small multi family and single family numbers which are simply not published. The only way to get that would be to get your hands on data form a large operator in many states with holdings of property types of SFR and small multi units.

@Dave Meyer , how about creating an incentive for the people who have the specific data to share it with you, the aggregator?

For example, if you can define the data points that you want to capture (location, age, property type, etc.) and ask BP members to share that then you could aggregate it and create value by offering the aggregate data, via a subscription to other interested parties. You could then share the proceeds with the contributors.

So many opportunities to make the real estate investment lifecycle more efficient! Good luck, interesting problem.

Basing capex on rent is a non-starter. It would be less fuzzy to have it based on percent of median rent for the market, since older lower end units cost much more proportionally. Still, what I do (which let's be frank, is still somewhat trash) mirrors other comments: square footage, age and life of components, and vacancy rate based. 

Square Footage: No comment required, although multi stories and multi units cost somewhat less than single famile ranch house style. They simply have less exterior attack surface to defend.

Age and life of components: I sourced average useful life for a laundry list of components from InterNACHI and a few other sources to fill in, as well as my own professional experience. I suppose you can use median age of housing in a market for an extremely wide overview as well.

Vacancy rate: Turnover budget is your primary capex expense on virtually every property, and if units are turning over faster, you need to include a bump for that. Stats are available for average length of residency for individual markets, and this is a better stat to hang your hat on here. I use 2.5 years if I have not looked it up for the individual market. I note as an aside that too many people calc actual vacancy without taking into account their PM fees on each vacancy, which adds a month of economic vacancy in general. For these reasons I calculate general capex, opex, and turnovers as 3 separate buckets in my spreadsheets.

I agree that the NAA surveys are a goldmine for this. Remember smaller properties will be at least 20% more expensive since there is no economy of scale - either on the structure itself or the vendor relationships. This is offset by stricter MF standards, but if your stats don't fall above 25% listed rent for opex and capex (+ turnovers if using 3 buckets) based on their 20%, you can be certain you are too optimistic for a decent business plan. Many properties will cost more than this.