Operating Expense vs. Capital Expense

Michael Coffee
October 26, 2022

The most common challenge we see when reviewing Profit and Loss statements is Capital Expenditures being mixed in with routine maintenance or turnover expenses. If the numbers are mixed and the categories aren’t clearly marked as “Replacements”, the lender (and potentially the appraiser) will assume that it was routine maintenance, and they will then use that historical number for underwriting which can cut into your loan proceeds.

A good practice is to have every category properly marked as either routine R&M or “Replacement” so it is clear to anyone that is looking at the Profit and Loss Statement. The best practice, though, would be to have a separate section on the P&L for “Capital Expenditures” and within that section have different categories for Appliances, Unit Rehab, exterior work, special landscape projects, etc. There is always a question about unit renovations and what would qualify as a capital item versus a regular turnover item. Most lenders will use a standard number for turnover; this would include touch-up painting, small repairs (drywall, carpet stain removal), unit cleaning, etc. Anything beyond that, we would consider a Capital Expenditure, for example, flooring replacement, cabinets, countertops, appliances, fixtures, re-painting of the unit, etc. These should all be included in the Capital Expenditures category in addition to any labor charges associated with that work. If you are doing a major renovation that requires an additional dumpster from your trash service, include that additional pickup or dumpster in the CapEx as well.

If it is a sale transaction and we don’t have the ability to go back into the historical numbers and detail out the CapEx, we can usually get a list of Capital projects done (roof, siding, # of units rehabbed) over the period covered by the P&Ls. We could then back out some of the R&M based on the Capital Expenditure List. If I am reviewing the P&L for your property and the maintenance figures are higher per unit than expected, be prepared to help me dig out the Capital items (because the lender won’t). TIP: the more detailed you are in the categorization of your expenses, the easier it is to maximize the loan proceeds.

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