Capital expenditures, or CapEx, are the big, infrequent costs of replacing or upgrading major parts of a property: the roof, heating and cooling system, water heater, appliances or flooring. They are different from routine repairs like a leaky faucet. Because these bills arrive years apart, investors set aside a monthly reserve for them.
Monthly reserve per item = replacement cost ÷ useful life in years ÷ 12
- Roof: $12,000 ÷ 25 years ÷ 12 = $40 a month
- Heating and cooling: $7,200 ÷ 15 years ÷ 12 = $40 a month
- Water heater: $1,200 ÷ 10 years ÷ 12 = $10 a month
Those three items come to $90 a month, or $1,080 a year. On a house renting for $1,500 a month, that is 6% of rent before you count appliances, flooring or paint. These costs and lifespans are examples, so get local quotes and check the age of each component.
The most common mistake is budgeting nothing because nothing broke this year. Many investors use a flat 5% to 10% of rent as a shortcut, but an older house can need more. Strictly speaking, CapEx is not an operating expense and is not subtracted when figuring NOI. Many investors, and DealLitmus's analyzer, include a reserve with the expenses anyway so returns are not overstated. All figures are pre-tax.