How much to set aside for capex on a rental

What capex is

Capex is short for capital expenditure. It means replacing a major part of the property, not fixing a small problem.

• Capex examples: a roof, a furnace or air conditioner, a water heater, new flooring, exterior paint, a driveway.
• Repair examples: a leaky faucet, a broken lock, a patched wall, a tune-up.

Repairs happen often and cost little. Capex happens rarely and costs a lot. Both are real costs of owning a rental.

Why a reserve matters

A roof does not fail on a schedule that fits your bank account. If you spend all the monthly rent profit, a $12,000 roof arrives as a shock.

A reserve spreads the cost out. You set aside a little each month and the money is there when you need it. It also gives you a truer picture of cash flow, because a deal that looks fine without a reserve can look weak with one.

Two ways to size a reserve

Method one is a percent of rent. Many investors use a rule of thumb, such as setting aside a few percent of gross rent for capex, plus a separate percent for repairs. The right number depends on age and condition. This is a rule of thumb, not a guarantee.

Method two is by component. List each major part, its likely replacement cost, and how many years it may last. Divide cost by years to get a yearly amount.

Method two takes more work, but it fits the actual building. An older house with a worn roof needs more than a newer one.

Worked example

These are made-up round numbers. A house with these parts:

• Roof: $12,000 over 25 years is $480 a year.
• Furnace and air conditioner: $8,000 over 16 years is $500 a year.
• Water heater: $1,600 over 10 years is $160 a year.
• Flooring and paint: $6,000 over 10 years is $600 a year.
• Exterior and driveway: $4,400 over 22 years is $200 a year.

The total is $1,940 a year, or about $162 a month. That is close to 8% of $2,000 monthly rent ($1,920 a year, or $160 a month), so 8% is a fair stand-in here.

Now see the effect on a rental. Price: $250,000. Down payment: 20%. Loan at 7% for 30 years. Rent: $2,000 a month. Vacancy: 5%. Repairs: 5% of rent. Property tax: 1.2% of price. Insurance: $1,500 a year.

• With no capex reserve, year-one cash flow is about $1,133.
• With an 8% capex reserve ($1,920 a year), cash flow is about -$787.
• Rent needed to reach zero cash flow rises from about $1,895 to about $2,080 a month.

Same house, same rent. The reserve turned a profit into a loss. That is why leaving it out is a costly mistake.

Reserve versus a real bill

A reserve is not the same as paying for the work. It is money waiting in an account. When the roof is replaced, you pay the bill from the reserve. If you have only owned the house for two years, the account may hold less than the bill. That is normal. The goal is a habit that builds the fund over time.

Some investors hold the reserve inside the deal and count it as a cost. Others keep one fund for all their rentals. Either way, count it when you judge a deal, or the cash flow will look better than it is.

Tips for sizing yours

• Get an inspection. Ask how old the roof, furnace and water heater are.
• Raise the reserve for older homes and lower it for recent rebuilds.
• Keep the reserve in its own savings account so it is not spent.
• Review each year. If you replace something, reset its clock.

Reserves also change how a deal looks on paper. See how How to calculate cash flow on a rental property counts them. For a rental that books by the night, see Short-term rental break-even occupancy.

FAQ

Is capex part of operating expenses?

It is a real cost of owning a rental. Some people count it in net operating income and others list it separately, so check which method a number uses.

What percent should I use?

There is no single right number. Many investors start with a rule of thumb and adjust for the age and condition of the building.

What if I never need a big repair?

Then the reserve stays in your account. A good reserve covers the years when something big does break.

Is capex the same as repairs?

No. Repairs are small and frequent. Capex is large and rare, such as a roof or furnace.