Repairs & Maintenance is any expenditure needed to restore/maintain regular operating condition of a property. Things like fixing an existing appliance, patching certain parts of the roof, painting, re-caulking or re-grouting tiles replacing door knobs/light fixtures, etc.
The cost of these items and labor can be fully written off in the year it occurred.
Cap Ex is, on a high level, larger items that are structural/systems related in nature. It’s mostly considered items that prolong useful life, restore to “like new” condition, adapt to a new use or add value to the property. Things such as a new roof, new boiler/hot water heaters, new electrical panels, new kitchen appliances, etc.
The cost of a Cap Ex item canNOT be taken as deduction of the full cost in the year it was purchased. It has to be depreciated over the useful life of the product. For example, the average life expectancy of a refrigerator is 14 years. So if you need to replace the fridge in one of your units, you wouldn’t be able to write off $500 in the year it was purchased, you’d only be able to write off $35.71 per year for 14 years (yeah that sucks!).
Above the Line / Below the Line
In multifamily, everything is about the NOI (net operating income) – the value of your asset is based on this number… the more you can increase the NOI, the more you increase the equity. As the saying goes, cash flow pays the bills, but equity makes you wealthy!
R&M is above the line, Cap Ex is below the line. But what does that mean? It’s all in how it affects the NOI.
Why You Should Care
Yes you need to know these differences for the operations/business plan of your building.
But this is the point:
You need to be aware when you are looking to purchase a building or someone is presenting an opportunity for you to invest in one.
Some people like to be “creative” with the numbers and where they place R&M vs Cap Ex when it comes to above/below the line, depending on their objective.
If the seller is trying to increase the NOI so it justifies a higher sales price, they’ll try to sneak some R&M items below the line into the Cap Ex bucket. If you buy the building based on that inflated price, once you do your books correctly you will end up with a lower valuation than when you bought!
Or an owner/operator may try to move some Cap Ex items above the line into the R&M bucket, so when they file taxes they have a larger amount to write off. If you are invested in a deal with an operator who plays these games, you may end up owing back taxes if the IRS finds out. Make sure you invest with an operator with integrity!
At the end of the day, you need to educate yourself and keep your eyes open so you can sniff out when something doesn’t seem up to par. These “little” things can have real life consequences to your investments!
Hope this was helpful and until next time… invest wisely!