I answer a lot of questions about owning real estate, either a primary residence or rental property. One subject that folks often don’t consider is how much long-term capital expenditures matter. I thought I should make a spreadsheet to help people make a capital expenditure plan. And then I realized that my friend Dave Pere would be much better at building this spreadsheet. Dave is a successful real estate investor with way more experience than I have.
And in addition to build a great spreadsheet, he wrote a whole article to go with it. (You do have to sign up for his email list to get the spreadsheet. I’m OK with that because I think it is worth it. You can always unsubscribe if his emails don’t provide you value.)
Thank you, Dave!
Why Capital Expenditures Matter
Are you a homeowner or a residential rental property owner? Understanding the importance of capital expenditures, or CapEx, is crucial to the long-term value and upkeep of your property.
These expenses go beyond routine maintenance and involve significant improvements or additions to your property. The impact of these expenditures on your home or rental property can be substantial over time.
I know, I know. You’re probably wondering who this Dave guy is? And what qualifies him to talk about something as exciting as replacing water heaters and the occasional roof?
Introducing Dave
Well, I operate the largest military real estate investing community in the world, the Military Millionaire Community! We started out as this simple blog documenting my journey from broke, enlisted Marine to “Millionaire” (that’s still a cringy buzzword to me.) More importantly, I achieved financial freedom in 5.5 years and walked off active duty at the 13 year mark without ever having to take a job again!
Now, how that pertains to the writing of this article is twofold, maybe trifold.
Firstly, I have completed over 60 real estate transactions. I either have owned—or still currently own—over 15 residential properties (single-family homes, duplexes, and a fourplex), 3 small apartment complexes, a 40-unit hotel, an RV park, and more passively invested in 2 large multifamily syndications totaling another 816 units (6 complexes in 3 different states).
Secondly, I see firsthand what questions are reoccurring themes within the Military Millionaire Facebook group. The group has over 60k members in it— and I can assure you, CapEx is often an overlooked item!
Thirdly, I have been coaching service members and veterans more closely within the War Room mastermind group I host. I posted in that community to crowdsource thoughts for this article, which helped me round it out even more!
So, let’s get started and learn why capital expenditures matter to homeowners and residential property owners.
The “Guru Math” Trap: Phantom Cashflow
A common trap I see new real estate investors fall into is believing the “guru math” used in a lot of online marketing for courses. These supposed real estate wizards will show you simple math equations with great returns on investment to showcase how simple real estate investing is, and reel you into their expensive programs under the old get-rich quick guise.
Here is an example of what that math will often look like:
Rental Income: $2,000
Mortgage: $1,200
Cash Flow: $800!
…WRONG!
That is $800 in what most seasoned investors call “phantom cash flow.”
Here’s why.
(A quick aside before we get into the breakdown: I’m giving these Guru’s the benefit of the doubt that when they say “mortgage” in their crappy examples, they do in fact mean the entire principle, interest, taxes, and insurance (PITI) monthly payments that homeowners are on the hook for.)
The Real-Real Estate Math
Now here’s what that equation should really look like:
Rental Income: $2,000
Mortgage: $1,200
I would actually break this out as a line for principle/interest, a line for taxes, and a line for insurance on my calculations when analyzing properties.
Vacancy: $140
It is standard practice to budget 5-7% of your gross monthly rent for vacancy in the unit. That being said, over time you’ll get a better feel for how often your units are vacant, how long it takes you to rent them, and how much money it costs you to turn them over (i.e. paint, carpet, showings, and make them ready for the next tenant to move in) and then I would adjust the percentage for all properties accordingly.
Repairs: $140
I budget 7% for repairs on my properties when I analyze them. Repairs (maintenance) includes all of the standard filters, lightbulbs, and home upkeep. It also includes the tenants breaking the toilets, sinks, windows, and other unexpected items they manage to break while living in your home.
CapEx: $140
As a rule of thumb I guesstimate 7% for CapEx until I dig in with the spreadsheet you’ll be able to download from this article after I receive the inspection report.
Property Management: $140
My property manager charges me 7%. Find out what a property manager in your area will cost, and then factor that in when analyzing your properties…even if you plan on living in the home, or self-managing the rental. You never know what the future may hold. Most property managers charge between 8-12%, I have a discount for bringing a lot of business to my manager, haha.
Cash Flow: $240!
Personally, I budget 7% across the board for Vacancy, Repairs/Maintenance, Capex, and Property Management. I’ve always done it that way when analyzing properties, and while I could probably do 5% on all but the property management at this point, it works for me so I leave it alone.
This property still cash flows $240 as it sits, which isn’t bad. However, I also didn’t include utilities in the expenses, and this is assuming there are no major CapEx items right around the corner which would dramatically increase your budgeting for that expense.
A Quick Aside
If you’re wanting to build wealth with your VA Loan and have the best chance for some cash flow while in the military, my absolute favorite strategy to jump into real estate—and how I personally bought my first house—is house hacking! I can go on about that for hours, so check it out, or hit me up if any of that interests you…but I digress, let’s learn more about how to avoid losing your ass on CapEx 😊.
Home Improvements
Every homeowner understands the importance of budgeting for home improvements. CapEx, in the context of homeownership or residential rental properties, refers to significant property upgrades or renovations that go beyond routine maintenance and repairs. This could include installing a new roof, updating the HVAC system, or replacing the water heater. Allocating a portion of your income for CapEx ensures you have the necessary funds for these important improvements when needed.
CapEx is boring. There’s no doubt about that.
You know what isn’t boring?
Having your heat go out in the dead of winter, or your HVAC go out in JULY…roof start leaking all the way through to your living room and dripping into a pot during a rain storm.
None of that is boring…
Sometimes, boring is good.
CapEx is not the sexiest part of owning real estate, but it is one of the most important aspects to prepare for due to the nature of the cost associated. You only have to replace a roof every 15-40 years—it varies that wildly based on what type of roof we are talking about, what climate you live in, etc.—but it also costs exorbitantly more to replace a roof than it does to fix a leaky faucet. You will be glad that you were budgeting for it over time when you finally have to replace it.
To manage capital expenditures effectively, you need a long-term plan that anticipates future expenses and prioritizes investments based on potential return on investment (ROI). This strategic approach can maximize your property’s value over time.
Beyond Routine Maintenance
Routine maintenance is critical for keeping your property in good shape, but have you considered the value of improvements beyond the basics? By budgeting for CapEx, you protect your property as a long-term asset.
Here are four reasons why it’s worth considering CapEx:
Increased Property Value: Strategic CapEx investments will help maintain the overall value of your property, making it more appealing to potential buyers or tenants.
Improved Tenant Satisfaction: If you rent out your property, investments in upgrades like modern finishes or updated appliances can lead to happier tenants, boosting tenant retention and reducing vacancies.
Reduced Operating Costs: Upgrades like energy-efficient HVAC systems or low-flow plumbing fixtures may have a higher upfront cost, but they can significantly reduce operating costs in the long run.
Compliance with Regulations: Some CapEx investments, like safety upgrades, may be necessary to comply with changing regulations in your area.
Don’t Spend Just To Spend
I need to make something clear here, I’m not advocating for you to spend money on these items unnecessarily. Take the third bullet point for example, I’m not advocating for you to upgrade the appliances just because it will reduce the energy bill a little bit. What I do personally, is something that David Greene over at BiggerPockets coined “Upgrade Hacking”. Upgrade Hacking just means that if an item needs to be replaced anyway, I will look at spending a little extra to get the more efficient/durable version, if it means a better return on investment over the long haul.
For example, if I have to replace a water heater for $1,500 and the really efficient version is only $1,750, I will do the math to see if the extra $250 will pay for itself over the life of that water heater, and most likely upgrade to that version. In most cases I’ve also found these upgraded models have a longer life expectancy, so it becomes a no-brainer.
Again, not worth spending $1,750 if my water heater is still working fine, but if I have to replace it anyway, an extra $250 for a longer life expectancy and more efficient unit seems like a win to me!
Budgeting for capital expenditures is a crucial aspect of long-term financial planning for your property. These strategic upgrades can lead to increased property value, improved tenant satisfaction, lower operating costs, and compliance with local regulations.
Financial Planning
Managing a property, whether it’s your home or a rental property, requires a solid financial plan. This should include budgeting for capital expenditures. Allocating funds for these significant improvements can help prepare for large expenses.
On the strictly investment side, having a financial plan that includes CapEx also allows you to prioritize long-term investments. Identifying where you want to invest, such as upgrading landscaping, installing new appliances, or renovating common areas, can increase your property’s value and justify higher rental rates, if applicable.
A good financial plan also anticipates future expenses, helping avoid unexpected costs. Regularly setting aside funds for capital expenditures can prevent the need to dip into your operating funds unexpectedly, ensuring routine maintenance doesn’t interfere with larger projects.
The Capital Expenditures Worksheet
This is where our CapEx Worksheet comes in!
As you can see below I built this to allow you to build out really detailed capital expenditure budgets based on every possible item in your properties. You can identify how many of each item you have for this property, what the cost to replace that unit of measurement is, what the expected (useful) life is, and from there it will tell you how much you should set aside each year/month in order to budget for these items.
I have 22 line items on this capital expenditures worksheet to ensure you have adequate coverage, and you can add or subtract items from the list as needed.
You’ll note that the screenshot above is from a duplex, which is why there are two HVAC units identified, haha.
As you get better with CapEx calculations you’ll see firsthand how much more you need to budget for a property that hasn’t been updated and has an older roof, older water heater, older HVAC unit, etc. as opposed to a property that has been completely renovated, or is a new build home.
When To Use This Worksheet
I would recommend completing one of these worksheets after you receive your inspection results with the age of all items in the home, for every property you purchase.
If nothing else, you should do this at least until you have a firm grasp on CapEx and a large reserve fund to cover any “what ifs” that may arise within your rental portfolio!
Long-Term Asset Value
Want to increase your property’s value over time? Prioritizing smart investments can make your property more appealing and justify higher rental rates, if applicable.
Capital expenditures, which involve long-term investments beyond routine maintenance, can provide substantial returns in terms of increased property values and potentially greater rental income. These expenses may seem daunting, but they can significantly contribute to your property’s long-term value.
To make these long-term investments effectively, you need a realistic budget. Determine how much you can allocate toward capital expenditures each year without compromising your financial stability. This will ensure that you’re able to cover any unexpected expenses and maximize the potential ROI on your investment.
Investment Strategy – Capital Gains Tax…yuck!
Some capital expenditures can be utilized to offset your capital gains tax when you get ready to sell the property down the road.
Specifically, these capital expenditures must have been used for the purpose of improving the property, rather than repairing it, in order to count as a capital gains tax offset.
A good example of this would be replacing the flooring in the property, or paving a driveway that had previously been gravel, etc.
Conclusion
Congratulations! You now have a better understanding of why capital expenditures matter in maintaining and enhancing the value of your property.
Remember, CapEx not only increases the aesthetic appeal of your property but also boosts its long-term asset value. By including these expenditures in your financial planning and investment strategy, you can make informed decisions and maintain your property’s integrity over time.
Consider these key factors as you navigate the world of homeownership and residential rental property ownership, and you’ll be well on your way to success!
Don’t forget to snag your free Capital Expenditure Worksheet template to avoid buying a property on the false promise of “phantom cash flow”!
Thanks for reading, I’d love to give you a free copy of my book The No B.S. Guide to Military Life: How to Build Wealth, Get Promoted, and Achieve Greatness for being a part of Kate’s awesome community!
About the Author
David Pere “The Military Millionaire” is a financially free Marine Corps veteran of 13 years. He now spends his time helping service members and veterans learn how to build wealth through real estate investing, entrepreneurship, and personal finance.
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