What are Capital Expenditures?

What are Capital Expenditures? 

In real estate, Capital Expenditures, or CapEx, refers to expenses incurred to create future value. These expenses are long-term investments intended to increase the profitability of a property in the long run and can include things like upgrades to the property or material improvements. 

Capital Expenditures can be used for growth or for maintenance of real estate properties:

•  Maintenance - CapEx can be used to maintain the property. Examples of maintenance related Capex include replacing the roof or floors and replacing elevators or HVAC systems.

•  Growth - CapEx can also include expanding existing buildings and acquiring new property that will increase future cash flow generation, and in turn, the value of a property. Tenant Improvements and Leasing Commissions are examples of Growth CapEx.

As previously stated, expenses related to CapEx are long-term and, thus, are depreciated over the holding period of the investment rather than at the time they are incurred.      

What are Capital Expenditure Reserves?

CapEx reserves refer to funds that are set aside for future capital expenditures or long-term capital investments in a property. To create a CapEx reserve, an amount of money, usually on a per square foot or per unit basis, is reserved monthly or annually. 

CapEx reserves are sometimes required by lenders. For example, a lender may require that an office investor set aside $30 per square foot annually to prepare for future capital improvements. Another example of a CapEx reserve is a multifamily investor budgeting $25 per unit monthly to cover future improvements to the units. 

CapEx reserves serve as a way for investors to reserve current cashflow so that they can fund future property updates and material investments as needed without the need to call capital or make equity contributions into the investment.

 

Capital Expenditures vs. Operating Expenditures

Operating expenses are the expenses at a property related to everyday operations and maintenance. These expenses include utilities, payroll, and short-term maintenance like plumbing repairs or painting. Unlike CapEx, operating expenses are short term, deal with the present rather than the future, and are expensed in the month they are incurred.  To learn more about operating expenses, click here.

Unlike CapEx, OpEx may be reimbursed to the property owner by the tenant depending on the lease structure at the property. For example, some office tenants sign NNN leases that make them responsible for paying their share of operating expenses in addition to base rent.  

Furthermore, like project management fees, CapEx reserves are expenses incurred at a property that are unrelated to daily operations. Therefore, CapEx reserves hit “below the line”, meaning they are not included in the Net Operating Income. Operating expenses, however, are related to the day to day operations at a property and affect the Net Operating Income. To learn more about Property Management Fees, click here, or to learn more about Net Operating Incoming, click here.

 

Conclusion

CapEx Reserves are funds set aside on a per unit or per square foot basis to cover future expenses at a property incurred from property or material improvements. Capital Expenditures do not relate to the day to day operations, so they do not affect the NOI of a property. Because they are long term and pertain to the future, CapEx expenses are depreciated over the holding period of an asset rather than at the time the expense is incurred.

---

About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions on capital expenditures or if he can help you with your modeling needs.