Today’s greatest real estate investors know it, and it’s about time you did, too: you need to spend money to make money. While it may sound counterintuitive, expenses are necessary for running a successful business, and capital expenditures are no exception. In fact, capital expenditures are nothing if not integral to running and scaling one’s own real estate company. It is, therefore, safe to assume that those who can budget their capital expenditures accordingly stand a better chance at realizing success.
Otherwise known in the investor community as CapEx, capital expenditure is a fancy way of describing the money spent to maintain one’s real estate business, or at least the houses it deals in. Or, as Investopedia so eloquently puts it, capital expenditures represent the “funds used by a company to acquire, upgrade, and maintain physical assets such as property, industrial buildings, or equipment.” More specifically, however, capital expenditure is generally used to simultaneously maintain and scale business operations through fixed assets.
From an accounting perspective, however, an expense is usually only considered a capital expenditure if it is used to improve an existing capital asset or business operations for at least a year. As a result, capital expenditures are often spread out over the duration of the asset’s lifespan. Instead of getting ahead of ourselves, however, capital expenditures are those “big ticket” items that are sure to need replacement every now and then. Roofs, driveways and appliances are a great example.
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Knowing how to calculate capital expenditures has less to do with predicting the future, and more to do with making an educated guess. As an investor, it’s not your job to know exactly what will go wrong and when, but rather roughly when things will eventually run their course and need replacing. That said, the single greatest way to come up with a capital expenditure budget is to compile a list of each “big ticket” item associated with your property and its reasonable lifespan. Not only that, but you’ll need to identify where each item is currently at in its own usable lifespan. Once you have identified each expenditure, simply divide its total replacement cost by the amount of years it’s reasonable to expect it to last.
A new roof, for example, typically sets homeowners back around $5,000 and lasts about 25 years. To calculate the capital expenditures, simply divide $5,000 by 25 (the expected lifespan of a roof). That means, on average, you can expect to pay $200 a year in capital expenditures on the roof alone. Now, take the same approach and apply it to every major maintenance item you expect to encounter. What you’ll end up with is the average amount you can expect to spend on capital expenditures each year. If you so choose, you may also break them down into months, which most people are more comfortable doing.
Capital expenditures are reserved for fixed assets, not the least of which are expected to be productive for the duration of their usable life. In other words, capital expenditures are long-term expenses specifically designed to help scale a company in one way or another. Regular maintenance, on the other hand, represents more of a short-term cost. Otherwise known as revenue costs, regular maintenance refers to costs related to revenue transactions or operating periods, not unlike the cost of goods sold or repairs and maintenance expense. More specifically, however, the differences between the two can be broken down by the following:
Capital expenditures represent some of the largest expenses associated with an investment property. Having said that, they are nothing, if not necessary. It is true what they say: you need to spend money to make money, and capital expenditures are no excerption. There’s no way around them, so you may as well budget for them. Those that cannot only account for said expenses, but also budget for them accordingly, will find running a successful real estate business to be easier