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11/27/2024
Siena Golan
Real Estate Research Analyst
Ruben Bos
Head of Real Estate Investment Strategy
Capital expenditure (CapEx) should be a key element of allocating capital and underwriting asset-level transactions. It can be a significant drain on returns and for some sectors, CapEx can reach on average more than 20% of net rental income (NRI). Underwriting models that underestimate or ignore the impact of Capex on cash flows may consistently overstate performance. Yet while there is much discussion around increasing energy efficiency requirements and changing occupier standards, little is known about how much these trends are increasing investors’ CapEx bills. Analysis from Green Street has demonstrated that REITs with a high concentration of property sectors where CapEx is typically lower have outperformed their CapEx-heavy peers, suggesting that the market is not sufficiently pricing in the impact on returns.
To address this knowledge gap and test whether our underwriting assumptions sufficiently factor in CapEx requirements over the property lifecycle, we have analysed both existing studies and our in-house data. The analysis shows that, in general, CapEx needs are going up, with building age being a key factor. During the first decade or so of a building’s lifecycle, CapEx tends to be minimal, but we noticed a substantial rise after 10-12 years post-construction. Age has a particularly strong impact on CapEx requirements for offices and logistics, while retail tends to have higher needs on average, but the relationship between CapEx and building age is less pronounced. Residential and logistics tend to have lower requirements in general compared to office and retail.
During a property lifecycle, there are typically three main costs: recurring maintenance (part of OpEx), infrequently recurring maintenance, and redevelopment/repositioning. CapEx typically describes the latter two and is generally paid for by the asset owner in European leases. It can be expressed as a percentage of income or building value, and can be defensive, offsetting depreciation, or offensive, adding value. The long-term CapEx burden of a property should not include added square footage but should include most other costs incurred to improve or restore a property’s competitive position. The distinction between which costs are non-recurring and which are recurring is often blurred, leading to over- or under-estimation of true CapEx levels.
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