Seeking a more accurate CapEx formula

[Forest K.]

I'm trying to find the best CapEx formula. I know that it can be calculated different ways. I know that the best thing to do is to make actual predictions about expected and predicted expenses rather than use back-of-the-napkin formulas. I also know that there isn't really a best answer and that calculating CapEx should depend on each property and your own landlording experience. Nevertheless, I'd like to have a reasonably reliable formula that I can use for (my analysis spreadsheet generally and) a property that I have that has a lot of deferred maintenance (short of doing a full itemized analysis).

The two most common formulas are 5-10% of gross income and 1-2% of property value.

$2,000 income * 10% = $200 CapEx (per month)

($200K property value * 2%) / 12 = $333 CapEx (per month)

Of course, for % of income to work, rent would need to be at market rate or follow the 1% rule. So this formula wouldn't work in cases where that expectation wasn't met. This is probably rhetorical, but to be more accurate, we should simply use potential ARV (After Repair Value) income (based on market rate or the 1% rule) instead, no? If so, I'm not sure why Operating Expenses would ever be calculated based on actual rent/income (rather than full occupancy, ARV, potential income).

Even more interesting and complicated is basing CapEx on property value. Typically, the formula is simply Property Value * %. However, the more a property deviates from ARV because of deferred maintenance, the less reliable the result is on two fronts: you would expect more expenses and your reduced property value would predict less expenses. This makes me think: 1. at the very least we should always use the ARV rather than current property value; and 2. if we want to be even more accurate, we'd have an escalating % based on how far the current property value deviated from the ARV. Does anyone use such a formula?

One factor is simply recognizing that our CapEx imagines the cost of a building being replaced every x years (or, said another way, it imagines that a % of the total cost is replaced each year). So, as an extreme example, if the property needed to be built (so we say the current home value is $0) but it's ARV is $200K, our CapEx could accommodate the full $200K being replaced in a single year rather than 50 or 100 years (depending on the CapEx % we like to use: 1%-2%). That would make our monthly CapEx = $200K / 12 = $16,666.

For example (we could do something like the following): 

(CHV: Current Home Value, ARV: After Repair Value)

The following formula results in a normal CapEx if ARV = CHV and $17,000 if CHV = $0 (i.e., we absorb the cost of replacing the building in a single year).

CapEx = (ARV * (((ARV - CHV ) / ARV) + 2%)) /12

$333 = ($200K * ((($200K - $200K ) / $200K) + 2%)) / 12 

$3,666 = ($200K * ((($200K - $160K ) / $200K) + 2%)) / 12

$17,000 = ($200K * ((($200K - $0 ) / $200K) + 2%)) / 12

Here is a formula for your spreadsheets: =(B1 * (((B1 - B2 ) /B1) + 0.02)) /12

Of course, with a large CapEx, you'd want to simply renovate the place as soon as possible. But this at least gives a more realistic Cap Ex in most cases, from a property that's CHV = ARV and for those that don't.

I also recognize that this formula is only helpful in cases where you plan to hold the property in its current state for some time and that most investors with access to capital would rather use a standard formula and fold the CapEx extra costs (that I'm trying to include) into their assumed renovation costs.

What do you think?