Capital Expenditures
Capital expenditures are large investments made to acquire, rehabilitate, or maintain a property to extend its economic life.
What Are Capital Expenditures?
Capital expenditures, or CapEx, refers to large investments made to acquire, rehabilitate, or maintain a commercial real estate property to extend its economic life.
What Qualifies as a Capital Expenditure?
The acquisition of new, major equipment for a property falls under the CapEx umbrella. Installing new air conditioning systems to create climate-controlled units, for example, would qualify as a capital expenditure.
The same is true for any other investment that extends an asset's economic lifespan. If a commercial real estate owner replaces a building's roof, that would be a capital expenditure. A new roof is a critical component to the building's lifespan.
A good portion of capital expenditures involves replacing or significantly repairing existing building elements. Investing in flooring, electrical systems, plumbing systems, and ductwork upgrades would all qualify.
CapEx also covers funds used to upgrade a property to make it more valuable. Adding new equipment — or new unit types, like vehicle storage — to a self-storage facility would generally count as a capital expense. Why? The improvements make the property more attractive to potential tenants or to entice current tenants to extend leases.
How to Handle CapEx in Accounting
Investments made as capital expenditures need to be capitalized. In accounting, capitalization means adding each investment to the balance sheet as an asset — leaving only depreciation to show up on an income statement. This is different from operational expenditures, which are fully tax deductible the year they're incurred. CapEx’s capitalization effectively spreads the investments out over the asset’s estimated economic life.
Although capital expenditures must be capitalized, some exceptions apply. If a capital expenditure only maintains a part of a building, leaving it in its current condition, the expenditure can be deducted in the year in which it is incurred.
As an example, consider expensive roof repairs that address a specific problem but don’t extend the economic life of the roof itself. Investments such as these are structured and treated more like operational expenditures — which are any expenses involving smaller repairs, payroll, daily operation, and maintenance.
Related Questions
What is a capital expenditure?
Capital expenditures, usually shortened to CapEx, are typically large investments in a property that will extend its economic life. For example, replacing the windows in a building or installing a new heater would usually be considered CapEx, as these building elements may need to be replaced someday. Funds that are used to upgrade the property to make it more valuable also count as CapEx. This could include adding new equipment to an industrial facility to make it more attractive to potential tenants or to induce current tenants to extend their lease. Other common capital expenditures include spending money to replace or significantly repair flooring, electrical systems, plumbing systems, and ductwork.
As the name implies, capital expenditures must be capitalized, meaning they must spread the cost of the asset out over its estimated economic life. Despite this, if a capital expenditure only maintains a portion of a building in its current condition (i.e. roof repairs that only fix a specific problem and don’t extend the roof’s economic life), the expenditure can be deducted in the year in which it is made. In this way, certain types of capital expenditures appear more like operational expenditures, or OpEx, which generally refers to any expenses involving smaller repairs, payroll, and maintenance.
What are the different types of capital expenditures?
The different types of capital expenditures include replacing windows, installing a new heater, upgrading the property to make it more valuable, replacing or significantly repairing flooring, electrical systems, plumbing systems, and ductwork.
For more information, please see the following sources:
What are the tax implications of capital expenditures?
Capital expenditures must be capitalized, meaning the cost of the asset or investment will be spread out over its estimated economic life. Despite this, if a capital expenditure only maintains a portion of a building in its current condition (i.e. roof repairs that only fix a specific problem and don’t extend the roof’s economic life), the expenditure can be deducted in the year in which it is made. This way, certain types of capital expenditures can be treated like operational expenditures (OpEx), which generally refers to any expenses involving smaller repairs, payroll, and maintenance.
For more information, please refer to the following sources:
What are the benefits of capital expenditures?
The benefits of capital expenditures are that they can extend the economic life of a property, make it more valuable, and potentially attract new tenants or induce current tenants to extend their lease. Additionally, certain types of capital expenditures can be deducted in the year in which they are made, making them appear more like operational expenditures.
What are the risks associated with capital expenditures?
Capital expenditures involve a certain amount of risk. If the projected net operating income decreased substantially, the owner may be liable to make principal and interest payments or even, at some point, pay back the entire loan prematurely. An investment in commercial real estate is a subject to be studied thoroughly prior to making any decision. Income taxes, possible risks, the amount of money to be borrowed, and the various financing alternatives available are the key components to consider before making a decision.
For more information, please visit apartment.loans/posts/what-are-capital-expenditures-capex and www.multifamily.loans/apartment-finance-blog/cash-on-cash-returns.
How can capital expenditures be financed?
Capital expenditures can be financed through a variety of loan products, such as bridge loans, construction loans, and permanent loans. Bridge loans are short-term loans that are typically used to finance the purchase of a property until a more permanent loan can be secured. Construction loans are used to finance the construction of a new property or the renovation of an existing property. Permanent loans are long-term loans that are used to finance the purchase of a property.
For more information on loan products, please visit Multifamily.loans and Apartment.loans.