Capital Expenditures (CapEx)
Also called: CapEx, Capital budget
Capital expenditures are investments in a property that extend its useful life, improve it, or reposition it, and they sit below the net operating income line rather than being treated as operating expenses.
CapEx covers both the unavoidable and the discretionary: a roof replacement is capital maintenance, while a unit renovation program that supports higher rents is value-add capital. Both consume equity and both belong in the return model, but only the second is expected to generate incremental income.
Because CapEx falls below NOI, it does not affect cap rate or DSCR, which is precisely why a deal can look clean on those metrics and still be a poor use of capital. The full picture requires yield on cost, which puts the capital budget back into the denominator.
Rules of thumb
- Separate the capital budget into immediate needs, value-add scope, and ongoing reserves. Lenders will escrow the first category at closing.
- Add a contingency of 5% to 10% on the renovation budget. Scope creep on unit turns is the norm.
Related terms
- Replacement Reserves
Replacement reserves are an annual per-unit allowance set aside for the periodic replacement of major building components such as roofs, HVAC systems, and appliances, deducted as an operating expense by most lenders.
- Yield on Cost
Yield on cost is stabilized net operating income divided by total project cost including acquisition and capital expenditures, measuring the unlevered yield a business plan produces once complete.
- Value-Add
Value-add is an investment strategy that acquires a property with identifiable operational or physical upside and invests capital to raise its net operating income, increasing value beyond market appreciation.
- Net Operating Income (NOI)
Net operating income is a property's effective gross income minus all operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes.