What Is CapEx (Capital Expenditures)?
CapEx is the big money you spend on replacements and upgrades: roofs, HVAC, plumbing, appliances, renovations. Different from operating expenses (OpEx) — property taxes, insurance, maintenance — which hit every month. CapEx doesn't reduce NOI; you model it below the NOI line. Fund it with a reserve: Total Replacement Cost ÷ Useful Life ÷ 12 gives you a monthly reserve per item. The IRS treats CapEx as depreciable improvements, not immediately deductible repairs.
CapEx (capital expenditures) are large, infrequent upgrades that improve a property or extend its useful life — like a new roof or HVAC. Operating expenses are the opposite: recurring day-to-day costs.
At a Glance
- CapEx vs OpEx: CapEx = large, infrequent, depreciated; OpEx = recurring, expensed immediately
- Reserve formula: Monthly CapEx Reserve = Total Replacement Cost ÷ Useful Life ÷ 12
- Typical reserves: $200–$500 per unit per year for multifamily, or 1.5–2.5% of property value
- NOI impact: CapEx doesn’t reduce NOI — it’s below the line. Cap rate valuation uses NOI before CapEx
- IRS distinction: Repairs = deduct now; improvements = depreciate over 27.5 years
Monthly CapEx Reserve = Total Replacement Cost ÷ Useful Life ÷ 12
How It Works
The definition. Capital expenditures are the big-ticket items that improve a property, extend its useful life, or adapt it for a new use. A new roof. A new HVAC system. A kitchen renovation. Replacing all the plumbing. These aren’t monthly costs — they hit every 7 to 30 years depending on the component. When they hit, they hit hard. A $12,000 roof replacement on a 4-plex is $3,000 per unit. You've got to plan for it.
The formula. Reserve for CapEx by spreading the cost over the useful life:
Monthly CapEx Reserve = Total Replacement Cost ÷ Useful Life ÷ 12
Example: A $20,000 roof with a 20-year lifespan. $20,000 ÷ 20 ÷ 12 = $83.33/month. You set that aside so when Year 20 arrives, the money’s there. Do that for every major component — HVAC, plumbing, appliances, flooring, exterior paint — and you’ve got a total monthly reserve. For a 16-unit building, that might be $400–$600 per unit per year. For a newer property, maybe $200–$300. For a 1980s building with deferred maintenance, $500+.
CapEx vs OpEx. Operating expenses are the recurring costs that keep the property running: property taxes, insurance, utilities, property management fees, maintenance, repairs. They reduce NOI — they’re above the line. CapEx is modeled below the NOI line. When you value a property with a cap rate (Value = NOI ÷ Cap Rate), you’re using NOI before CapEx. That’s why a property can show strong NOI and still bleed cash — the CapEx reserve isn’t in the NOI. You subtract it from cash flow when you run your numbers.
Tax treatment. The IRS treats CapEx differently from repairs. A repair maintains current condition — fix a leak, patch a hole, replace a broken appliance with the same model. You deduct it in full the year you paid. An improvement extends life, adds value, or adapts the property. You capitalize it and depreciate over 27.5 years (residential) or 39 years (commercial). So a $10,000 roof classified as an improvement gives you only $364/year in depreciation. Classified as a repair (rare for a full roof), you’d get the full $10,000 deduction now. The IRS uses the BAR test — Betterment, Adaptation, Restoration — to decide. When in doubt, assume it’s capital.
The BAR test. Does the work improve the property (betterment)? Adapt it for a new use? Restore it to like-new condition? Yes to any? It's capital. Replacing a few shingles = repair. Replacing the whole roof = improvement. Know the distinction before you file.
Real-World Example
Property: 12-unit multifamily in Memphis. Built 1995. You’re underwriting for purchase.
CapEx reserve build:
| Component | Cost | Life (years) | Monthly Reserve | |----------|------|--------------|-----------------| | Roof | $28,000 | 15 | $155.56 | | HVAC (12 units × $2,500) | $30,000 | 15 | $166.67 | | Plumbing | $18,000 | 30 | $50.00 | | Appliances (12 × $800) | $9,600 | 10 | $80.00 | | Flooring (12 × $1,200) | $14,400 | 8 | $150.00 | | Total | | | $602.23 |
Per unit: $602.23 ÷ 12 = $50.19/month, or $602/unit/year. That’s on the higher end — the building’s 30 years old. A newer property might run $300–$350/unit/year.
Impact on your deal: NOI is $72,000. At a 6.5% cap rate, value = $1,107,692. But your CapEx reserve is $7,227/year. Your true cash flow from operations is NOI minus CapEx reserve — $64,773. Didn't reserve? You'd be surprised when the roof fails in Year 3 and you've got to write a $28,000 check.
Pros & Cons
- Predictable budgeting: The reserve formula forces you to plan. No surprises when the HVAC dies.
- Accurate underwriting: Deals that ignore CapEx look better than they are. Reserving keeps you honest.
- Tax flexibility: Depreciation spreads the deduction over 27.5 years. You get a long tail of tax benefits.
- Property preservation: CapEx maintains and improves value. Deferred maintenance destroys it.
- Lender compliance: Many lenders require CapEx reserves in their underwriting. You're aligned with them.
- Cash drag: You’re setting aside $500–$600/unit/year. That’s real money not flowing to you.
- Estimate risk: Lifespans and costs are guesses. A bad winter can kill a roof faster. Inflation can spike replacement costs.
- No immediate deduction: Unlike repairs, you can’t deduct CapEx in full the year you spend it. Depreciation is slow.
- IRS gray area: Repair vs improvement isn’t always clear. The wrong classification can trigger an audit or recapture.
Watch Out
Under-reserving. The biggest mistake. Sellers and brokers often lowball CapEx to make the deal look good. A 20-year-old building with a "recent" roof might have 5 years left. Verify. Add 10–20% to your reserve for older properties. Sound familiar?
Ignoring CapEx in your cap rate. Buying a value-add deal with heavy CapEx ahead? Adjust your going-in cap rate. Pay based on current NOI without accounting for the $80K in renovations you'll need, and you're overpaying.
Mixing repairs and improvements. Doing a full roof replacement and the contractor repaints the fascia as part of the job? The IRS may require capitalization of the whole project. Document the scope. Keep repairs separate when you can.
De Minimis Safe Harbor. Under $2,500 per item, you can often deduct as OpEx. Small fixtures, minor repairs — use it when it applies. Don’t over-capitalize.
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The Takeaway
CapEx is the money you set aside for the big replacements — roof, HVAC, plumbing, appliances — that hit every 7 to 30 years. Reserve for it. Use the formula: Total Cost ÷ Useful Life ÷ 12. Don't let NOI fool you. Not subtracting CapEx from your cash flow? You're underwriting a fantasy. The IRS treats improvements as depreciable; repairs as deductible. Know the difference. When you're buying, assume the seller’s CapEx numbers are optimistic. Add a buffer.