Capital Expenditure (CapEx)

A capital expenditure is money spent on long-lived improvements or replacements, such as a roof, a furnace, windows or a kitchen remodel. It is not an operating expense, and it never shows up in a gross rent multiplier. A rental with a failing roof and one with a new roof can post the same GRM.

Many investors set aside a capital reserve as a percentage of rent or a fixed amount per unit per year to cover these costs. That reserve belongs in net operating income, and it is one reason a property's cap rate can be much lower than its GRM implies.

Age drives the gap. An older building trading at a GRM of 8 may need a new roof, new systems and new windows in the first few years. A newer building at a GRM of 11 may need almost nothing. Before accepting a low GRM as a bargain, estimate the capital spending the next owner will face.

Further reading: Capital Expenditure (CapEx) on Wikipedia.