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CapEx: Opening the Black Box

11/27/2024

Siena Golan

Real Estate Research Analyst

Ruben Bos

Head of Real Estate Investment Strategy

IN A NUTSHELL

Changes to occupier and regulatory requirements are pushing CapEx bills for asset owners up, particularly in recent years.
Underestimating CapEx can lead to poor decision-making in capital allocation strategies and underperformance relative to underwritten business plans, yet CapEx is not well understood by the market and few studies exist that measure CapEx using asset-level data.
This analysis seeks to address this gap by using analysis of real estate asset level data from DWS’s European real estate portfolio to estimate CapEx as a % of Net Rental Income (NRI) and Gross Asset Value (GAV).
The results show that sectors differ widely in average CapEx expenditure through the property lifecycle, with retail requiring the most, and residential the least.
CapEx also tends to jump at certain points in the property lifecycle either upon lease expiry and/or as key elements of building infrastructure reach the end of their useful life.

1 / Introduction

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.

1.1 What is CapEx?

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.

CapEx: Opening the Black Box

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CapEx: Opening the Black Box

IN A NUTSHELL

1 / Introduction

1.1 What is CapEx?

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