What are Capital Expenses (CapEx)?
Capital expenditures (CapEx) is an accounting term commonly used in real estate investing. It applies to costs that are also investments made by property owners or investors to acquire, upgrade, or improve physical assets. These expenditures differ from operating costs in that they are typically significant and have a long-term impact on the property. They usually impact value, tenant satisfaction, and overall profitability.
What are Capital Expenditures in Real Estate?
Capital expenditures (also called capital improvements or capital expenses) refer to expenses that act as investments that enhance the value or extend the useful life of a property.
These expenditures are distinct from operating expenses, which are ongoing costs necessary for the day-to-day operations of a property, such as utilities, maintenance, and management fees. Because they are considered an investment and not a regular cost, they are treated differently for accounting purposes.
Capital expenditures usually involve significant amounts of money and are intended to improve the property’s functionality, aesthetics, or efficiency, thereby increasing its market value. Examples of capital expenditures in multifamily real estate include upgrading HVAC systems, replacing roofs, installing energy-efficient features, and modernizing amenities.
Capital Expenditures and Value-Add Investment Properties
Fish Capital’s value-add projects involved considerable capital expenditures as these undertakings usually involve the partial or complete renovation of common areas and units.
Common capital expenditures that Fish Capital undertakes include:
- Updating Rental Units: New kitchens, bathrooms, flooring, window coverings, and appliances are all considered capital expenditures. These upgrades improve the property’s attractiveness to tenants and help ensure strong rental returns for years to come.
- Exterior and Structural Upgrades: Investments in roofs, facades, foundations, or parking lots fall under exterior and structural upgrades. These ensure the property remains in good condition, preventing water damage, structural deterioration, or safety hazards.
- Mechanical Systems and Utilities: Upgrading HVAC systems, plumbing, and electrical systems or implementing energy-efficient features like solar panels are crucial capital expenditures. They improve the overall efficiency of the property and reduce operational costs.
- Common Area Improvements: Renovating lobbies, corridors, elevators, or landscaping common areas enhances the aesthetic appeal and functionality of a property.
- Amenities and Recreational Facilities: Adding or improving amenities such as fitness centers, swimming pools, rooftop gardens, or community spaces. These additions enhance the lifestyle offering and the desirability of the property.
- Accessibility Enhancements: Making a property accessible to individuals with disabilities by installing ramps, elevators, or accessible bathrooms is not only a legal requirement but ensures inclusivity and widens the potential tenant or buyer pool.
The purpose of capital expenditures is to increase the value and usability of an asset. By investing in capital improvements, Fish Capital provides tenants with better amenities, functionality, and comfort. This, in turn, increases tenant satisfaction, encourages lease renewals, and reduces vacancy rates. Furthermore, in a competitive real estate market, properties with superior amenities have an edge over their competition.
While capital expenditures may require a significant upfront investment, they can also result in long-term cost savings. Upgrading to energy-efficient systems, for instance, can reduce utility expenses over time, leading to lower operating costs and increased profitability.
Capital Expenditures & Taxes
When a capital expenditure is made, instead of being recorded as a regular operating expense, it is added to the property’s cost basis and recorded as an asset on the balance sheet. The cost is then allocated over the asset’s useful life through depreciation.
Depreciation provides tax advantages by allowing us to deduct a portion of the asset’s cost each year as a depreciation expense on tax returns. On the other hand, operating expenses must be claimed in their tax year of occurrence. Depreciation recognizes the gradual loss in value of the asset over time and reduces taxable income, resulting in lower tax liability for years to come.
Under the 2017 Tax Cuts and Jobs Act allows for Bonus Depreciation deductions, we can deduct a substantial percentage of the property’s qualified capital expenses in the year they occur. As of 2023, Bonus Depreciation is at 80% and will drop by 20% each year until the program ends.
In real estate investing and value-add syndications, capital expenditures play a pivotal role in shaping success. These investments are the backbone of property enhancements and help us transform properties to drive value to new heights. But it’s not just about the upfront cost; it’s about the strategic accounting and tax advantages that lie within capital expenditures that make them a useful tool for Fish Capital syndication projects.