The Ultimate Guide to CapEx on Rental Property

CapEx on rental property (also called Capital Expenses) are expenses to replace parts of the property that wear out over time.

What’s the difference between CapEx and maintenance? From a tax perspective, capex of less than the “safe harbor” limit of $2,500 per invoice or item can be written off as maintenance on the property in the year they were taken. Some expenses over the $2,500 safe harbor amount will need to be capitalized over the lifespan of the item. Talk to your CPA or read the Internal Revenue Code for more detailed information on the tax treatment of capex.

Ignoring the tax considerations of whether you can write off the entire expense in the first year or have to capitalize it over time, what’s traditional maintenance and what’s considered a capital expense?

Maintenance Examples

• Small turnover expenses – wear and tear that can’t be billed back to the tenant.
• Repairs to items that break – service calls to professional trades like plumbers, roofers, HVAC techs, electricians, handyman, landscapers and the supplies related to those repairs.

CapEx Examples

• Replace roof and/or gutters
• Replace AC and/or furnace/boiler
• Kitchen/bathroom remodels
• Replace windows
• Replace driveway
• Replace appliances
• Replace water heater
• Exterior paint

Separate Maintenance and CapEx?

Should you separate maintenance and capex when analyzing deals? Some real estate investors will and both The World’s Greatest Real Estate Deal Analysis Spreadsheet™ and the Real Estate Financial Planner™ software both allow you to enter separate numbers in for Maintenance (as a percentage of the Gross Operating Income) and for CapEx (as raw dollar amount per year that increases over time at the rate you define).

On the deal analysis spreadsheet, these are the two input fields:

The Real Estate Financial Planner™ fields for Maintenance and CapEx are located on the edit page for  Properties.

Or… you could choose to think of them together for analyzing deals and everything except taxes.

Just remember:

• Maintenance is PERCENT of Gross Operating Income
• CapEx is in DOLLARS with its own, separate CapEx Appreciation Rate (in Override tab of the spreadsheet)

Paint and Carpet/Flooring

Is repainting the interior of the property and replacing carpet/flooring maintenance or a capital expense?

Some real estate investors will include paint and carpet/flooring as a “maintenance expense” (and least when analyzing their deal).

However, realize that including paint and carpet/flooring as a maintenance expense can result in having an abnormally large maintenance percentage.

Let’s look at an example…

Impact of Price/Rent on Maintenance %

The hourly labor rate of the professional trades and the cost of materials tends not to vary much between a lower-priced, lower-rent rental properties and a higher-priced, higher-rent rental properties. For example, a hot water heater is going to cost about the same for a $100,000 property as it would for a $500,000 property. And, the cost for the plumber to connect it will be about the same too.

This can cause some interesting issues when we think of the cost of maintenance and capex as a percentage of the rent on properties with different prices/rents.

Let’s assume:

• The tenant turns over every 2-3 years (let’s use 2.5 years).
• We replace paint/carpet/flooring every 2 turns (so… every 5 years).

I do realize we could need to replace paint/carpet/flooring with EVERY tenant-turnover or could every 3 or 4 turns. We’re using 5 years to make a point.

You go to a big box store and price out the most basic, least expensive paint, carpet and flooring. Let’s say it was:

• Paint: $2/sq ft
• Carpet/Flooring: $3/sq ft

For a 1,600 sq foot 3 bedroom property, the expense for paint and carpet every 5 years is:

• Paint: $2/sq ft * 1,600 sq ft = $3,200
• Carpet/Flooring: $3/sq ft * 1,600 sq ft = $4,800
• Total every 5 years: $8,000 or $1,600 per year

And, since this is the most basic and LEAST expensive that’s $1,600 per year whether you’re owning a $100,000 property getting $1,000 per month or a $500,000 property getting $2,500 per month.

$100K Rental Getting $1,000/mo in Rent

• Gross Operating Income = $12,000 – 3% Vacancy = $11,640
• $1,600 per year just for basic, least expensive paint and carpet/flooring
• $1,600/$11,640 = 13.75% Maintenance

This is just for paint/flooring every 2 turns. It does not include any other maintenance.

$500K Rental Getting $2,500/mo in Rent

• Gross Operating Income = $30,000 – 3% Vacancy = $29,100
• $1,600 per year just for basic, least expensive paint and carpet/flooring
• $1,600/$29,100 = 5.50% Maintenance

Again, this is just for paint/flooring every 2 turns and it still does not include any other maintenance.

Not Just Paint and Carpet/Flooring…

There may be some regional differences in prices/wages, but for similar-sized properties, often the price for the following are not significantly different.

For example, the following prices will be similar whether you’re dealing with $100K properties and $500K properties of the same square footage:

• Roofs
• Water Heaters
• Windows
• Hourly Wages for Trades
• Plumber, HVAC Tech, Electrician, Handyman

Such that buying a low-priced (for example $100K) property will often have a VERY high percentage of Gross Operating Income for Maintenance and CapEx compared to a similar square footage property in a more expensive market (for example $500K properties).

That’s why…

You Must Do Your Own Due Diligence

You should research how much it might cost YOU to replace a roof in your market and how long that roof will last for. Then, repeat the process for each item.

IMPORTANT NOTE: Longevity also changes based on location.

These numbers are very ROUGH estimates, but you can’t just use them as-is.

As just one example, you may be able to get discounts, do some things yourself. We don’t recommend you do work on your own rental properties for Asset Protection reasons.

Options with maintenance and Capital Expenses

When it comes to maintenance and capex on your rentals, you really have 3 options:

• Ignore Them – Head in the sand, ignorance is bliss, deal analysis becomes fantasy-land, hope you have the money or can come up with it when the inevitable occurs.
• Basic Planning – Estimate costs and determine an average amount you need to save each year. This is essentially our BASIC spreadsheet.
• Advanced Planning – Cash flow planning for your expenses. Know what your upcoming expenses are, when they’ll happen, and budget for them. This is our ADVANCED spreadsheet.

Think of maintenance and capex like you might think about your parenting expenses. You know when you have a kid that you’re likely to have many of the following: kid’s braces, sport camps, music lessons, car for kids, college entrance exam tutoring, college costs (tuition, room, board), help with first down payment, wedding, help after divorce/job loss, etc.

You also know approximately when many of them will happen. Maybe not EXACTLY when, but typically college expenses will come in about 18 years.

A wedding might be at 18 years, 22 years, 35 years or you might get lucky and never have to contribute to wedding costs.

A wedding is similar to a roof that might be needed to replaced in 18 years, 22 years, 35 years if you have an insurance claim take care of it once. Or, you might get multiple new roofs from insurance claims and sell the property without ever having to replace a roof. Uncommon… sure.

But you need to be setting aside money for these known, expected expenses of raising a child and for things like your property maintenance and capital expenses.

Maintenance and CapEx Estimator for Rental Property – BASIC

The following is a screenshot of the Maintenance and CapEx Estimator for Rental Property – BASIC version of our capex spreadsheet.

There are other websites that have created spreadsheets like our BASIC capex spreadsheet, but most of them do NOT allow you to adjust for inflation. Ours does. A $5,000 kitchen remodel probably won’t cost $5,000 20 years from now. That’s why we adjust for inflation.

Of course, you can use 0% for inflation if you’d prefer to not account for inflation. Or, change the assumption about what inflation rate to use.

Instructions for Using our BASIC Spreadsheet

How to use the BASIC spreadsheet.

1. Research and enter:
• The Cost in Today’s Dollars for each expense
• The lifespan or Frequency in Years for replacing that item
2. Include any custom expenses in spaces provided (the fields labeled “Add Custom CapEx #”)
3. Enter in your Inflation Rate
4. Use the Yearly Cost or Monthly Cost in your analysis and spreadsheet under CapEx.
5. Use your Inflation Rate for the CapEx Appreciation Rate

Shortcomings of BASIC Version

The BASIC spreadsheet is a perfect, easy way to estimate maintenance and capex.

But, it does have some limitations. For example:

• What if you’re buying a property where everything is not new and at the beginning of their life cycle? Like a resale property that has some deferred or upcoming maintenance?
• What if certain items will increase in price faster than others (different inflation on different items)?
• What if you’re starting with some money set aside for known repairs?
• What if you’re earning a return on money you have set aside for expenses?
• What if you’re going to increase how much you’re saving each year as rents go up?

That’s why I created the ADVANCED version!

Maintenance and CapEx Estimator for Rental Property – ADVANCED

The Maintenance and CapEx Estimator for Rental Property – ADVANCED gives you the ability to override each expense on the Override tab.

Override Instructions

While in many cases, you won’t need or want to, you can modify ANY expense INDIVIDUALLY with the ADVANCED version of the spreadsheet.

For each year through year 40 (even through we are only showing through year 3) of each expense you can modify:

• Inflation Rate
• Cost
• Current age
• Lifespan (aka replacement frequency)
• When you had the expense
• How much you spent on that expense

Override for Expense Account

With the ADVANCED version of the spreadsheet we are really doing Cash Flow Planning for maintenance and capex.

We keep a “savings account” that we deposit money into so the money is there when we have a capital expense in the future.

For the expense account, change any of the following for any year through year 40 (even though we are only showing the first 3 years in the image above):

• How much to increase the amount you’re saving each year
• The amount you’re saving
• The yearly rate of return for the account you’re storing your expense money
• The balance in any given year
• Or, the deficit in any given year

Plus, you can see, at a glance, the most expensive year and largest deficit.

Capital Expenses – Magnitude and Frequency

With the ADVANCED version of the spreadsheet you can see each expense, how much it is and when it happens in one, easy-to-read chart.

Each bar represents a maintenance or capital expense. Groups of bars show multiple expenses in the same year. The height of the bar shows the relative size of that expense.

Capital Expenses – Total By Year

With the ADVANCED version of the spreadsheet you can see the total of all maintenance and capital expenses by year. Plus, easily see the relative size of all the expenses for that year compared to other years.

Each stacked bar represents a single year of maintenance and capital expenses. Each portion of the stack is a different expense. The height of the bar shows the relative size of all the expenses for that year.

Capital Expenses Savings Account Balance

With the ADVANCED version of the spreadsheet you can see a running balance of your capex savings account balance.

As you set aside money each month for your maintenance and capital expenses the capex savings account balance increases. You may even be earning a return on the money you have in this account (defined by you).

When you have expenses, they are subtracted from the capex savings account.

See when you are flush and when your account balance is low or has a deficit.

Identify Deficits

IMPORTANT NOTE: If your capex savings account balance ever goes below zero, that means you have a deficit and you’re not saving enough.

The spreadsheet will also tell you with a red warning block if you are not saving enough.

Instructions for Using our ADVANCED Spreadsheet

How to use the ADVANCED spreadsheet.

1. Research and enter:
• The Cost in Today’s Dollars for each expense
• The lifespan or Frequency in Years for replacing that item
• Age at Start in Years
2. Include any custom expenses in spaces provided (the fields labeled “Add Custom CapEx #”)
3. Enter in a combination of your Starting Balance, Monthly Amount saved and Rate of Return on Account. Adjust these numbers until you have “No Deficit” (green bar).
4. Use overrides on the Override tab if desired
5. Use your Starting Balance in the Rent Ready Costs section in your analysis
6. Use the Annual or Monthly Cost in your analysis and spreadsheet under CapEx.
7. Use your Inflation Rate for the CapEx Appreciation Rate

Transferring to Deal Analysis Spreadsheet

So, how do we take the numbers we need from the ADVANCED Spreadsheet and transfer it to be used on The World’s Greatest Real Estate Deal Analysis Spreadsheet™?

Easy… just take the Annual amount from the ADVANCED capex spreadsheet and copy that to the CapEx field on the deal analysis spreadsheet.

And, then take the Starting Balance and ADD IT to any Rent Ready Costs you already have in the deal analysis spreadsheet.

Why A Starting Balance?

What if you bought a resale property that you KNEW needed a new roof in the next 2 years?

You might find it difficult to “save” enough with cash flow in 2 years to fund a new roof purchase.

Instead, you could set aside money (as Rent Ready Costs) to initially seed your expense account.

Then, use the Maintenance and CapEx Estimator for Rental Property – ADVANCED spreadsheet to see how much you’d need to save monthly to avoid having a deficit.

Repeat this for any known upcoming or deferred maintenance.

Your expense account is a combination of the amount you start with and the amount you save each month minus the expenses you have coming up.

Cash Flow Isn’t Everything

Maintenance and CapEx show up in the Cash Flow quadrant of the Return Quadrants™.

The more maintenance and capital expenses you have, the lower your cash flow will be.

Having a lot of maintenance and capital expenses can make your cash flow very small or in some cases negative. But cash flow isn’t EVERYTHING.

You still have the 4 other areas of return:

• Appreciation
• Debt Paydown
• Tax Benefits
• Return on Reserves

See our article on Return Quadrants™ and/or the class on Beyond Cash Flow – The Return on Investment Quadrant™ for more information.

Comparing New Construction to Resale

You’ll want to run your own numbers to see how these would compare for your unique situation, but let’s look at one example in my local market.

If you compare buying a new construction property—where everything is new—to a 5-year-old resale property—where everything is 5 years old—how does that impact how much you need to save for maintenance and capital expenses?

Here’s the new construction expenses:

And, here’s the 5-year-old resale property:

Notice the age of all expenses is set to 5.

Changing the age changes when the expenses come up for you. Here’s the new construction total expenses by year.

And, the 5-year-old resale property.

Finally, and most importantly, let’s look how the savings account balance behaves for each if we save the same amount each month toward maintenance and capital expenses.

We have enough money to cover all the maintenance and capital expenses with the new construction. However, that’s not true with the resale property.

With the resale property, we have a $38,000 deficit in year 36. That’s the largest deficit. But, you can see in the CapEx Savings Account Balance chart above that we first drop below zero and are “short” in year 11. We also have deficits in a number of other years (where the chart is below zero).

You’d need a little bit of money to take care of the immediate deferred maintenance and, additionally, about $80 more per month (up from $433) to not have a deficit with the 5-year-old resale property.

That $80 works out to be about $16,000 more in purchase price you could afford to spend for the same $80 per month by converting the maintenance and capex savings into a payment instead.

As Home Price/Rent Declines, Maintenance and Capital Expenses Tends To Get Worse

Comparing less expensive and lower rent properties to higher priced and higher rent properties, you are likely to find:

• Same hourly rate for trades (and attorneys for evictions/disputes)
• Same court eviction costs
• Same cost for tax returns and accountants
• Same cost for asset protection
• Same cost of materials for many expenses
• But smaller rents
• Maintenance and Capital Expenses as a percentage of Gross Operating Income is MUCH higher as compared to higher priced and higher rent properties

Portfolio Planning

How does this maintenance and capex planning impact your portfolio planning? In other words, what types of properties do you want in your portfolio?

Do you want older properties with high maintenance and capex?

Do you want a larger number of less expensive properties or fewer more expensive properties? Fewer, but more expensive properties means:

• Fewer loan spots
• Fewer (or at least less complicated) tax returns
• Simpler and less expensive asset protection (less entities, fewer tax returns and less overhead)
• Same/similar dollar amount in maintenance and CapEx but very different percentages of Gross Operating Income

For more information on establishing your buying criteria, see entire class Establishing Your Buying Criteria Workshop.

Not Market Timing, But Maintenance and CapEx Timing

If you don’t know, I’m NOT a fan of trying to time the real estate market (see my Cash Flow Versus Appreciation and Should I Wait for a Real Estate Dip to Invest in Real Estate? classes for more on that) but, can you “time” maintenance and capex?

For example, could you sell your properties at the red arrows (before a big spike in maintenance or capital expenses)?

Or, could you buy after the years with big expenses (when the seller has done that maintenance)?

Selling Before Major Expenses

To determine if you can outsmart maintenance and capital expenses, you’d need to model it for your unique situation. Here’s how:

First, compare your “Costs of Sale” to the “Expenses”.

In other words, calculate your True Net Equity™. Figure any vacancy you might have if you’re selling it without a tenant, real estate commission (if any), closing costs (if any), depreciation recapture tax and capital gains tax (unless you defer them by doing a 1031 exchange).

Calculate the maintenance and capital expenses you’re likely to pay.

Is it better to keep it and pay the expenses or sell it and pay the costs of sale?

A practical consideration is that in hot markets it is easier to sell with upcoming/deferred maintenance. In softer markets it is much harder to sell with upcoming/deferred maintenance. If you try to sell a property right before you need a new roof, the inspector for your buyer may say the roof is at end-of-life and you may need to provide a credit for the new roof cost anyway. This is more likely to happen in a softer, buyer’s market then a hotter, seller’s market.

You could save some of your expenses of sale by doing FSBO? Could you change your strategy to always be selling properties to a tenant-buyer on a lease-option? Or, sell it with owner-financing where they’re responsible for maintenance and capital expenses?

Selling the property can help improve your Return on Equity if that’s something you’re trying to optimize for.

Buying After Major Expenses

When you buy matters as well. For example, buying a property that just got a new roof, kitchen remodel and AC is preferred to having to take on those capital expenses yourself after you own the property.

Unless, of course, you get a big enough discount to justify doing the repairs yourself.

In general, the smaller the size of the expense and the lower the frequency the less it matters.

Some expenses are large-in-size but low-in-frequency (like a $12K roof every 20 years).

Some expenses are small-in-size by high-in-frequency (like $2,000 in landscaping every 7 years).

Some expenses are medium-in-size and medium-in-frequency (like a $5,000 exterior paint every 10 years).

One way to normalize this is to look at the amount you’d need to save per year to be prepared for that expense. This is like the BASIC spreadsheet.

You need to run your own numbers with each property, but for example… here’s how the CapEx Savings Account Balance compares for buying a property with a new roof versus 10-year-old roof. Everything else is the same.

Purchasing a property with a 10-year-old roof would result in a $25K deficit in year 31 saving the same amount for maintenance and capital expenses where you would not have had a deficit if the roof was new.

Alternative to Saving Expenses

Some real estate investors would prefer to borrow the money for expenses instead of saving for them.

You could “borrow” from yourself (like from your own reserves) and pay that back over time. In that case, you’re still have to put aside money… this time in paying back what you put you in instead of doing it in advance.

And, this reduces the reserves you have for your properties.

Or, you could borrow from a bank, a HELOC, a credit card, cash out refinance of this or another property. This results in you paying a premium (the interest you own to wherever you got the money from) versus you being able to earn interest (or another return) on the money you’re saving.

Borrowing your maintenance and capital expenses also increases risk by reducing reserves and/or having debt with interest.

Insurance Claims

Not every time, but sometimes you get lucky and a roof that is partially through its lifespan will qualify for an insurance claim. A common one here in Northern Colorado is a hail claim.

Then, you can rerun your spreadsheet with your current expense savings balance and the current age, lifespan and cost of all your expenses to see if that changes how much monthly you should be setting aside.

This same principle can apply to other expense items as well.

Home Warranties

Some real estate investors prefer to purchase home warranties on their properties to shift some of the irregular nature of maintenance and capex to more regular insurance premiums. This only applies to SOME expenses that are covered by the home warranty insurance policy.

Another option could be to try to time buying the home warranty for when you’re more likely to benefit from it.

If you have a home warranty company that will allow you to buy a policy at any time, you could choose to buy a policy as you approach your larger “home warranty” covered expenses.

For example, if you’re lucky enough to have your AC last to its full life expectancy you could buy a home warranty that covers your AC knowing that you’re very likely to have an expense to replace your AC in the next few years.

Think of it as buying the home warranty for the years just prior to major spikes in expenses… just make sure they are expenses covered by the home warranty and the cost for that warranty seems like a reasonable use of your CapEx Savings Account money.