Capex versus repairs
A repair returns something to working order — patching a leak, replacing a faucet washer. A capital expenditure replaces or materially improves a component with a life of years: the whole roof, a new furnace, a full kitchen. The distinction matters operationally, because repairs are frequent and small while capex is rare and large, and it matters at tax time, because repairs are generally deducted in the year paid while capital improvements are usually added to basis and depreciated. The line between the two is a genuine gray area with rules and safe harbors that change — have your tax professional classify the big items rather than guessing.
How to reserve for it
The rigorous method is component-based: list the major systems, estimate replacement cost and remaining life for each, and divide. A house with a 15-year roof, a 10-year HVAC, and an 8-year water heater generates a per-month number you can actually fund. The fast method is a percentage of gross rent, commonly 5–10%, with older properties and harsher climates at the top of that band. Either way, the point is to move the money — a reserve that lives only in the spreadsheet is not a reserve. A newly renovated property justifies a lower near-term number, but never zero, because the clock starts the day you close.
Monthly capex reserve = replacement cost ÷ remaining useful life in months, summed across components. A $9,000 roof with 15 years left is about $50 a month. Many investors shortcut the whole exercise as 5–10% of gross rent.
Where projections lie
Seller projections routinely omit capex entirely, which is the most effective single way to make a mediocre rental look like a good one. A property showing $300 a month of cash flow with no capex line is realistically closer to $150. That is also the logic behind the 50% rule, which assumes roughly half of gross rent disappears into operating costs and reserves over a full ownership cycle. When you underwrite, put capex on its own line so you can see it, argue about it, and stress it.
Capex on the buy side
Estimating capex before you own the property is inspection work, not spreadsheet work. Get the age of the roof, the furnace, the water heater, the electrical panel, and the sewer line, because those five items carry most of the risk on a typical house. A property priced as though every system is new but inspected as though every system is twenty years old is not a bargain — it is a deferred bill with a mortgage attached. Investors who buy distressed usually front-load this spending during the rehab, which is exactly what makes the ongoing reserve smaller afterward.
Put it to work
Rental operating expenses, explained →
Related terms
- Pro forma — A projected income and expense statement for a property — what it should do, not what it has done.
- Operating expense ratio — Operating expenses divided by gross operating income, shown as a percent.
- 50% rule — A rule of thumb estimating that operating expenses — taxes, insurance, maintenance, vacancy, management, and capex — consume roughly 50% of gross rent over time, excluding the mortgage.
- Depreciation — An annual paper deduction that writes off the cost of a rental building — never the land — over a fixed recovery period, currently 27.5 years for residential and 39 for most commercial property.
- NOI (net operating income) — Annual rental income minus all operating expenses, but before mortgage payments and income taxes.