(The following is an excerpt from the new book from BiggerPockets, The Book on Rental Property Investing. If you are looking to buy more rental properties this year, pick up a copy today!)

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!

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like… seriously… a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of “The Book on Investing in Real Estate with No (and Low) Money Down“, and “The Book on Rental Property Investing” which you should probably read if you want to do more deals.

1. I still think that’s why appreciation is a key component.

• I agree David. I’m not a huge fan of buying in areas where there is no hope for appreciation. However, I still want it to make sense even if appreciation never happens!

2. Brandon,

We appraisers use “CapEx” estimates with every apartment or commercial property we appraise, we call them “reserves”. I wish that more investors understood these issues that you have presented. An investment needs constant attention and you must budget for these “big ticket” items.

Many times I have a borrower/investor call and tell me that the reserves I have estimated have reduced his NOI and he can’t get the loan he wanted. I try to explain that he is probably going to have to replace the roof within a year, plus other expenses. The only thing investor/borrowers care about is qualifying for a loan.

Please keep getting this information out there, its very valuable.

John C. Carlson

• Good point, John. From the POV of the investor, that’s ammunition to bring down the offer on the property. If you can’t account for CapEx and qualify for the loan, the property isn’t worth the price.

• Thanks John! Great to hear your perspective. I’ll keep shouting this from the rooftops!

3. Is been my experience that appraisers don’t stick around a property long enough to check the life on items. Half the time they don’t go in. A quarter of the time they take a pic of each room, then leave. Lol

Not saying all appraisers are that way, just been my experience, in my limited experience.

4. I completely agree, it’s the capX unknown that makes the really affordable turn keys, no longer so affordable. Most people advertising to not factor in capX…

• Agreed John. That CapEx will kill ya!

5. This post is so helpful! I’m looking at purchasing my first investment property soon and have been thinking about those extra expenses. Your chart really helped break it down and give me more of an idea of how to budget, and what to look for during my house hunting times.

• Thanks April! this is the kind of post I wish I had read when I first started!

• April and Brandon:

I am on all fours with April’s comments. She and I are in the same position. I have been practicing with the property analysis tool and still am not sure that I have the right numbers. This cost breakdown adds great comfort but useful caution about how much more work I have to do. Thanks Brandon.

6. Hahaha – Look who is paying attention. Wait – I’m calling Serge to tell him our baby is growing up. Daddy be so proud 🙂

Couple of points:

1. The only thing that off-sets CapEx issues is appreciation. If you have organic appreciation, consider yourself lucky. If not, as in the case of the Mid West, forced appreciation is a must. If not, CapEx will eat returns – period! This is why I am so critical of TK model…

2. I could buy copper for a hell of a lot cheaper 4 years ago than I can today. Guess what that does to pricing of wiring/electrical work? CapEx, as you’ve explained it, is a statistic number. In reality it is not. It’ll cost more to do the same work 10 years from now. And again, appreciation (this time of rents) is what’s going to save the day. If rents aren’t enough to withhold sufficient amounts for CapEx, then over time you will stop making those improvements and become a slum lord 🙂

• This is exactly what I was about to post about – need to account for inflation of materials.

• Thanks Ben – I do listen to you 😉 And yes -good point on the prices going up. Very true! (Stupid Copper…)

• Thanks for the post Brandon, and the extra points Ben/BrandonH. I am curious though how we are supposed to practically account for the inflation of prices?

Do we just pad them with some kind of percentage increase? Do we also weigh in the potential for rent increases too? Or do we assume if the numbers work today, they will work in the future….

Thanks again guys for all the content.

7. This could just as easily been written as a reason to avoid that kind of leverage in your real estate deals. For it is not the CapEx that is your true problem in this deal you’re overborrowing has created this “hell house.”

The types of cash flow you’re describing are simply not worth pursuing and the cashflow you describe wouldn’t help an investor with a \$40k house or a \$4M house. High leverage is not a sustainable model.

8. Excellent article Brandon, you really laid it out for everyone and that chart will certainly help people in the future. CapEx is real and needs to be accounted for before an acquisition and throughout the hold period.

The two problems I see with your method is that you are not taking into account inflation of the cost of materials and the interest rate received from the money sitting in your CapEx reserves. For instance, your \$5,000 roof in 25 years at a 2.5% inflation rate really costs \$9,270. If you had not accounted for inflation, you would be \$4,270 short, assuming your reserves earn 0% interest, which is unlikely and will also need to be accounted for.

Complicated? Yes. But everyone can do it via a few formulas in MS Excel. It’s an imperative step when determining your monthly CapEx accrual.

Regardless, your article will certainly help people who aren’t doing this already, or just apply a random number to their CapEx estimates. Thanks for writing and I’m looking forward to your book!

9. Thanks for the article Brandon. There is a lot of guessing when it comes to cap ex reserves; remaining life, useful life, future inflation rates, replacement costs. Pretty much every factor is an educated guess at best which is why I think it’s extra important to reserve more and be safe in the calculations.

If anyone wants to use my cap ex spreadsheet you can find it in the FilePlace.

• Thanks Sam! Appreciate the link 🙂

• Very nice spreadsheet, thank you for sharing!

10. Brilliant! Narrowed my focus even more and given the framework for CapEx calculations, not simply making a guess as to the percentage of rent to reserve. I look forward to picking up the new book when it hits the shelves.

11. Finally someone puts CAPEX into perspective. Best article I have read so far on here.

Thanks Brandon and thanks Ben Leybovich for always stressing this.

• Dude – what do you mean this is best article ever here. Maaaan…you should know better than that, Shai! lol

12. Great article. This is something that is so overlooking in residential rental properties.

13. I bought my first rental last August at a discount to the market. I had to put in all new electrical and separate out panels on 4 units and add a house panel and meter. Then on January 1st of this year, the furnace blew out. A couple months later, the water heater started acting up and needed a pressure relief valve and expansion tank installed. Now, I’m installing new windows in the whole building, replacing old single pane windows. Some windows were breaking/broken and I pay all the heating costs. With all that said, I’m cash flow negative about \$5600 since I purchased the property (accounting for all the above costs and closing costs not down payment). I don’t have any other major expenses coming up (I’ve checked) and believe I’ve added conservatively \$10,000 in equity by updating the property, so I like to think I’m positive overall, but positive cash flow would be nice! Next year looks like the year I’ll break even and start making money. This does remind me to budget for a new roof, retaining wall, and plumbing repairs down the line and I think I’ll incorporate some of these CAP EX items into my valuations moving forward. Thanks for the post!

14. I just want to point out that the driveway useful life number is not conservative. Concrete is usually designed for 50, while asphalt driveways are usually 20 – 30. The rest of it is pretty good from what I can see. Costs will vary by location obviously. Great article!

15. This is awesome! I habe been searching for this info for a while, and definitley gives something to think about.

16. I own 6 little pigs in Richland county Ohio. I am a contractor so I can get things done cheaper than most people. But if I looked at that chart I wouldn’t buy anything. I saw this same chart in another article earlier. I laugh at the costs. When do you replace your plumbing? When do you replace your structure. My properties don’t have central air, and we don’t supply appliances. In my area a 3 bedroom 2 bath house wouldn’t cost 5 grand to roof. Your floor estimate is the only one I think is low. When we rehab a house we use materials assuming they are going to tear the place up. We use semi gloss paint, tile floors in kitchen, baths and basements. Laminate floors of same color are installed throughout the house. I’m kind of a newbie, but that is my 25 cents.

17. Your post is helpful, but as I am rather new in US investing , estimating the Capex cost is very difficult for me.
In this paper, you are assuming that we should be setting aside 182 \$ per month. Taking as an example a 1000 \$ a month rent. That represents a 18% cost which is pretty high and not sustainable in my case without being in the red.
In another blog sent the same day by Allison and called “the ultimate guide analyzing rental properties”, you took an example assuming a 5% Capex which is in contrediction with the previous number.
How do you reconciliate both numbers and what assumption should I took ?
Have a good day

18. For me, as a person looking for his first rental, reading this information and the comments is invaluable. This info definitely will turn a lot of possible “Good Deals” into “Terrible Deals”. Thank you Brandon and all the people who share their knowledge.

19. Great write up!!!!

20. This article is a great reminder of the importance of liquidity. So often we put so much focus on finding the next deal and stretching ourselves to grow our portfolios. We need cash to obtain a deal (our own or someone else’s). We have to keep a certain level of liquidity to maintain what we already have. It is so hard to track when the HVAC or a roof will need to be replaced or when a tenant is going to flake on you. If you have a mature portfolio, it could happen out of the blue in consecutive months. I recommend having at least \$3,000 per property liquid at all times with adjustments made for property type / size.

21. Taking into account capex, management, maintenance, and vacancy rates take a huge blow to the potential cash flow. I am glad I ran into this article. I had maintenance and management figured into my spreadsheet but not capex or vacancy. That turned a potential annual net return from 23% to a more modest return of 9% annually. What do you look at for a return? I have heard anywhere from 10%+ to nothing lower than 15%

22. Regarding this part: “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?”

Why does nobody talk about the equity that’s being built in the home? Even a property with neutral cash flow and zero appreciation will be building thousands of dollars in equity every year.

23. I just got this article referred to by a BP fellow and i can not be happier to have came across this. I was completely going to be screwed in the near future if I did not encounter for this. I will use this to bring the price down during negotiations on my deal and redo the numbers from there. Thank you for sharing Brandon.

24. Thanks, B. Another excellent article. Good lookin’ out!

25. Thanks, B. Good lookin’ out!

26. Very helpful article. I’m working on getting my first property and this will be extremely helpful. Here is a very silly question: how did you come up with \$182.75? Thanks!

27. In my area, I think this metric has never been used as amount of overpriced rentals is absurd which then leads to stagnate and run-down homes because any wise investor won’t buy.

28. Brandon,

I’m having difficulty seeing how you could actually find deals with this CAPEX criteria. A \$80k-\$120k house that rents for \$1000 would have 22% eaten by Capex, 10% for vacancy, then 10% by management, 5-10% by insurance, 10-15% by property taxes, and another 10% for repairs/maintenance (more if you’re in lower class neighborhoods). This places you at around 67%-77% of rents… then deduct debt service and you’ll have negative cash flow.

In what markets are you seeing A-B class properties that you can buy for \$50-\$60k that gross you \$1000 per month? Or are you in effect saying that the time to invest has passed and we need to wait for the market to tank before investing?

• Joseph I was thinking the same thing…why am I doing this.? But I also realize that each property has it’s own number, the point is to accurately as possible determine what it is.

You can’t just plug in 185 bucks a month on a deal. As you said, there would be no deals. But by looking at the individual property with an eye towards what is obviously in new shape and what is not, you can dial it in for the individual property.

I essentialy look at ‘systems’ replacement and as time goes on and some are replaced, others will get in line for replacement, so that the number is more or less a rolling number. Some systems are more costly than others.

A CapEx fund is a necessary expense so that you have the liquidity to cover what has to be done. If it isn’t in your analysis in some form, you are destined to lose.

29. I see these charts that essentially mirror my own spreadsheets and the only conclusion one can draw from this is that now, at the end of 2016, there are no more investment properties left on the market that even remotely resemble the returns demonstrated. Unless you’re attracted by a 0% (or more likely, negative) cash on cash return, there’s nothing really you can buy right now.

30. Many deals I’ve analyzed leave me with only \$100/m after plugging in roughly \$150/m for CapEx… I also use \$1,000/yr in repairs too. Maybe I’m going overboard with my estimations?

31. I just went through this exercise in order to analyze potential CapEx for turnkeys, with the following adjustments:
– I’m considering a max holding period for the rental, e.g. 10 or 15 years. I’d expect to sell sometime between breakeven and this max period, depending on market conditions.
– If any of the items above will likely need replacing within this holding period, then I weight it at 1.0. If not, e.g. maybe the roof was new on purchase, then I instead weight it on an exponential scale as a simple approximation of probability of this being an issue. e.g. if I’m expecting to hold for 10 years, and that the roof has 20 years to go, then my roof weighting would be 10^2/20^2 = .25. This is a simple form of risk weighting, i.e. I’m probably not going to have to replace the roof, I’m building in some additional cap ex reserves just in case… it’ll suck if I do have to replace, but at least I’ve set aside some money for it, and then I can dip into my pooled reserves for the remainder.
– I then inflation adjust the item cost and apply the weighting factor to come up with an expected cap ex expense.

This still is just a model, but what this allows me to play with is seeing how my expected holding periods might change the capex factor used against gross rents.

Oh, and for those curious, the turnkeys I’m evaluating went from an advertised 14.2% CoC in year 1 to my projected 3%. By year 10, I’ve got a calculated 4.7% CoC return, with a total annualized exit return of 11%. Definitely shows the stark difference between advertised returns on TK vs a more conservative approach.

32. Fantastic Brandon! This helps a ton. Cap Ex can be an elusive thing. Thank you!

33. Great post!

I was factoring in 5% of gross rental income as my cap ex reserve. That is a pretty close approximation to the figures I’m getting using your chart (and would account for inflation as well), but the level of detail when breaking it down by each item is better. I’m a big fan of added granularity, especially when it comes to something as abstract as estimating cap ex. Now I can run scenario analyses on what the total cap ex figures might be by estimating the age/remaining useful life of individual items. Thanks Brandon.

34. Maybe my math is wrong but are we sure that the total is 41k? I got \$42,100 total replacement costs of all big ticket items.

35. Thank you Brandon! This is great information and presented in a format that is easy to understand. Also very helpful in conjunction with the BRRRR calculator.

36. Thank you, Brandon ! What a useful post, esp. for new investors.