Do you underwrite capex growth at rent appreciation or inflation?

[Jon Schwartz]

Hi gang,

I'm reviewing some of my underwriting spreadsheets, and I'd love your opinion on this:

When you're projecting income and expenses into the future, how do you calculate the growth of capex? Do you base its growth on inflation or on rent growth?

For example, let's say you're underwriting capex at 15% of rental income, which is currently $100K/year. You're also underwriting rent appreciation at 4% per year and inflation at 2.5% per year.

(Let's not get into a disagreement over how reasonable these numbers are. This is just a hypothetical.)

In three years, rental income will have grown to $112,486. If you continue to calculate capex at 15% of rental income, then capex comes out to $16,872. However, if you increase capex at the inflation rate for three years, you come to $16,153.

In this example, it's not a huge difference, but what if you're projecting income and expenses 10 years into the future? What makes more sense? Tying capex to the rate of inflation or tying capex to rent appreciation? (And let's assume that rent is appreciating at a faster clip than inflation. Let's assume we're in Phoenix!)

Looking forward to your thoughts!

Best,

Jon