Capital expenditure in real estate investing is almost a given. Unless you strictly buy performing properties and keep them for a short period of time, at some point, you should expect to add value by expanding, make significant repairs, or replace large appliances and equipment.
When it comes to real estate financing, you’ll want to understand capital expenditures for the purposes of planning and accounting. Below, you’ll find everything you need to know about CapEx in real estate.
What Is a Capital Expenditure (CapEx)?
A capital expenditure, or CapEx, is the money a company spends to obtain, upgrade, and maintain physical assets for the business. These assets can be things like property, equipment, buildings, or technology, and they’re often purchased for new investments or projects.
Examples of such undertakings can be to buy new equipment to improve a manufacturing process, repair a roof that’s reached the end of its life, or expand a factory to accommodate new business. A business would do any of this to broaden or grow operations or realize some type of economic gain.
A company will have different levels of CapEx depending on its industry. Among the most capital-intensive sectors are telecommunications, oil exploration and production, manufacturing, and utilities, not to mention CapEx real estate.
What Is the Formula for CapEx?
To calculate CapEx, use this formula:
CapEx= ΔPP&E* + Current Depreciation
* Change in property, plant, and equipment (PP&E)
You’ll find your company’s CapEx amount in its cash flow statement for investing activities. Keep in mind that CapEx is expressed differently between investors and analysts. You might see it under terms like acquisition expense, capital spending, or property, plant, and equipment (PP&E) purchases.
It’s possible to calculate CapEx with data from the balance sheet or income statement. You’d be looking for the current depreciation expense on an income statement, while the balance sheet will show the period’s balance for property, plant, and equipment (PP&E) as a line item.
First, find the previous period’s PP&E balance, then take the difference between it and the current figure to determine the PP&E balance change. Add this number to the current period’s depreciation expense, and you’ll have the CapEx spend for the current period.
How Do I Use CapEx in Real Estate?
CapEx is not only useful when analyzing a company’s fixed-asset investment, but it’s also a figure used in many different ratios to analyze how well a company is doing financially. For instance, the cash flow-to-capital expenditures (CF/CapEx) ratio indicates how well a company can secure long-term assets with pure cash flow. This CF-to-CapEx ratio typically changes as a business makes small and large capital purchases.
If your company has a CF-to-CapEx ratio higher than 1, it’s likely a positive indication that the business is creating the cash needed to fund the assets it’s acquiring. A lower ratio could mean the opposite – that the company has cash flow and asset-funding issues and needs to pay for its capital assets with borrowed funds.