❌ You Could Be Categorizing All Wrong
Happy Monday!
Here is an Idea, an Action, and a Question to consider this week.
Idea
When it comes to real estate investing, understanding the nuances between capital expenditures (CapEx) and Normal Expenses is foundational to creating a sustainable and profitable investment strategy. Categorize incorrectly, and you could be leaving a lot of money on the table.
CapEx Defined
CapEx is the cost for repairs to or replacement of substantial items on your property that are not handled on a regular basis. Some examples include roof replacements, HVAC replacements, repaving roads at a Mobile Home/RV park, large renovation projects, foundation repairs, etc.
Normal Expenses Defined
Think of Normal Expenses as your regular monthly bills, such as management fees, utilities, basic maintenance (i.e. fixing leaking toilets, repairing HVAC units, etc.), regular contractor fees (i.e. lawn care, pest control, etc.), administrative costs, payroll, insurance, taxes, etc.
There’s a lot of confusion amongst investor-agents about how to categorize expenses. And I understand the confusion! The space between CapEx and Normal Expenses is a vast gray area. When should you categorize expenses as CapEx? When should you categorize expenses as Normal? In some circumstances, the categorization is obvious. But oftentimes, there’s not a clear answer.
Here’s what I do when the decision isn’t clear-cut:
In the period leading up to refinancing or selling, I prioritize allocating a larger portion of funds into the Capital Expenditure (CapEx) budget. This strategy is aimed at bolstering our net operating income (NOI), which in turn can elevate our valuation. The reason behind this is that capital expenditures are not deducted from the net operating income, therefore showcasing a higher income level. Adopting this approach ensures that when we decide to refinance or sell, our financials reflect a higher value.
When I'm in a phase where I'm merely holding onto an asset, my goal is to decrease my taxable income. To achieve this, I report as many Normal Expenses as I can. By doing this, I present a reduced income, which in turn lowers my tax liability.
As an investor-agent, understanding the dichotomy between CapEx and Normal Expenses can pave the way for a financially healthy and compliant real estate portfolio. Make sure to consult with a financial advisor or an accountant to guide your strategy. They’ll help you to make the most out of your investments.
Action
Consider your next three expected CapEx items on one of your investment properties. Calculate how much each item will cost. Determine if you have enough money in reserve to pay for those items when they come up. (If you don’t, work backwards and start saving.)
Question
It’s important to save for your investment expenses, but are you also saving for your home expenses? If your HVAC went out today, would you have the reserves to replace it?
See you next week,
Matt “Roar” Gardner
Real estate investor-agent, Author of Supersonic Real Estate: Light Your Afterburner to Accelerate Your Investor-Agent Career (Coming Soon!), and keynote speaker.
PS: Never forget.
