CapEx reserves included in expenses?

[Kyle Lewis]

I've used a variety of deal analysis calculators and many of them include CapEx estimates/reserves in the 'Expenses' category, like this:

Income - Expenses (including CapEx estimates) = NOI

But shouldn't CapEx estimates/reserves be factored in after NOI is calculated? Even if this money isn't being spent immediately and is being set aside as reserves for future CapEx work, they will someday go towards CapEx, so I don't think it's accurate to include this as an expense. Shouldn't the calculation be:

Income - Expenses = NOI; NOI - debt service - CapEx = Cash ROI

Is there something I'm missing? This seems like a no brainer to me, but wanted to confirm because a lot of deal analysis calculators seem to have it structured incorrectly. 

Thanks!

[Immanuel Sibero]

@Kyle Lewis

Like you I'm in the "below the line" camp, except that I feel more strongly about it :-) The definition of cap rate is Net OPERATING Income/Price. So it's clear to me that cap rate calls for operating items ONLY. If a capital expense is to be included in NOI then why do we call it capital? To me it's just that simple.

However, as pointed out by some earlier posters in this very thread there are reasons why some people include capital expense in NOI, some legitimate others misguided. My take is to just understand the people you're dealing with as far as whether they include or exclude cap expense in NOI and adjust your understanding accordingly.

@Jeff S.

As stated above I'm in the "below the line" camp, therefore the fair value of the property would be as you stated (i.e. $1,150,000). I'm assuming you have verified NOI and apply the prevailing market cap rate in the area. But this doesn't mean you have to offer $1,150,000. If you think there are deferred capital expenses, you would then adjust this value downward by the capital expense amount, wouldn't you? So yes deferred capital expense does reduce the value of the property but more importantly it does so regardless of where you put it (i.e. above or below the line). You either take it off of NOI or take it off of the value to arrive at your offer price.

I have stated one reason above why capital expense should be excluded from NOI (i.e. just the sheer definition of NOI). Your example actually brings up another good reason. IMO it is more accurate to take capital expense off the property's value because you would be working with the exact amount of capital expense in total. If you were to include capital expense in NOI (i.e. above the line), you would have to use some annualized or averaged amount which leads to less accurate result. The more accurate you are the more competitive your offer will be.

Cheers... Immanuel