CapEx Reserves - Impact on Cap Rate

[Scott Skinger]

Hi All, 

I'm new to REI and hoping for a little clarification.

Quick background - I'm looking at 10-25 unit apartment buildings. I found a 10 unit building with 2 retail offices on the first floor that has potential. The offices are leased up (5+ years) and the apartments are 100% filled with very low vacancy. Great location. Offered as a 7.2% cap rate. I have the OM, rent roll and opex. New roof was put on building and all windows were replaced in 2017.

My question is regarding capex expenses/reserves and its impact on the expense % and cap rate. I'm using a general expense estimate of 50% or higher when I'm putting together my numbers and preparing an offer. Included in my 50% number is capex reserves. Using capex reserves as an opex lowers the NOI and therefore the cap rate. I get that I need to have a capex reserve to properly budget my expenses, however, my understanding is that capex is not included as part of opex and should not impact NOI.

The confusion sets in when I look at the cap rate on a deal and the OM from a broker. They have not included capex reserves as an expense, thus there expenses are much lower than 50% (35% in this case) and their cap rate is higher because of this. It seems like they are correctly reporting all of their expenses, they just have not included capex reserves.

Can somebody please help clarify this? I can give numbers if that is helpful.

[Jeff Greenberg]

@Scott Skinger Both the capex and the debt service is below the line and does not affect the cap rate. Cap ex is typically not an ongoing expense and should not be included in operations. Your job as an investor, is to verify what is included above the line, is appropriate and is not put into capex just to increase the NOI and therefore the property value.