CapEx Calculation Controversy

[Matthew Jure]

I've done a lot of investigating and found that if there is one thing that will kill a real estate investor, it is CapEx. CapEx has been dubbed the "Silent Investor Killer" because many investors don't a lot enough to CapEx according to what I can find. There seems to be consensus that you should get hard numbers on CapEx from a reliable source (eg, GC) when inspecting the property but that isn't where the controversy is. The controversy is how to do a preliminary estimate of CapEx in the early stages of evaluating a property.

Upon scouring the internet, podcasts, and picking investor's brains, these are the options to do an early estimate CapEx:

1. Use 5-10% of GSI (however, I've seen as high as 15%)
2. $200-$400/month per door
3. $/month per unit - this is all over the place ($50-$800+)
4. Calculating all CapEx items savings per month
5. $0.67 per square foot/year

My limited criticism for each method:

1. Most common recommendation I find is 5%. But compare California and Cleveland's GSI. GSI's are wildly different but cost to replace an item is similar. However, labor will increase the cost in California - but not proportionally. If you are saving 5% of $1500 GSI, then you only save $900/yr ($9,000 in 10 years). This hardly seems enough.
2. Many save ~$200/mo per door. More reasonable (I think??), but I imagine this doesn't work when comparing a 2 unit vs 10 unit. 
3. Saving per unit seems logical, but it gets a bit foggy when thinking about saving for a single roof, driveway, or other shared expense. 
4. This makes the most sense, but you must be crazy accurate. Depending on how you fudge the numbers you can vary from 25%-50%+! This seems useless unless you have solid numbers. Maybe used after a walk-through with a GC.
5. Using a square footage seems easy enough. If I used $0.67/sq ft on my double with a GSI of $1500, I would save about 8% of my GSI (~$1500).

Depending on which method you use (and the #s you enter), it can change your cash flow enough to make a good deal look bad and vice versa. If CapEx is the Silent Investor Killer, then many investors are underestimating their CapEx.

What are the thoughts of the BP community? 

Why do you feel your method is the best?

What method used in both California and the Midwest (if possible)?

[Oren K.]

Matthew,

Don't really have an answer for you but I have been on this soap box several times. Yes, many (most?) people don't properly account for capex and are basically rolling the dice to see if they get caught during their hold period; NOI looks great but actual return over a longer period of time - not so much.

This is especially true of lower cost investments since many items cost the same regardless (e.g. Roof)

Also, it depends on your 'strategy'; fix and flip investor doesn't care as they will generally be out of the property within 6 - 9 months and it's ALL capex to them.

As well, for some, capex is only about the basics (e.g. structure, roofing, heating and cooling). For others it is also appliances and carpeting. For yet others it is also includes plumbing & electrical or more (e.g. drainage connection). You can drive this down to a micro level (e.g. ceiling fans and light bulbs). 

All things have a 'normal' operational life expectancy; some will last longer and some shorter then 'normal'. The longer your expected hold period is, the more you should be thinking about this.

All the rules / methods you list are as 'rules of thumb', 'short cuts', etc. just as you can guesstimate a roof re-shingle just by the sq footage without selecting material, taking in account specific damage or getting quotes.

Using any one of these methods is just a time saver to see if you should invest the most precious thing you have - Time. It takes time to figure out what the actual capex number should be.