lecture recording on 05 March 2025 at 12.28.38 PM

Arguments for Capital Expenditure (CapEx) Treatment

• Placement of CapEx in Financial Statements

  • CapEx is often debated whether it should be placed above or below the line in the income statement.

  • Common argument for placing CapEx below the Net Operating Income (NOI) line:

    • It's seen as non-recurring and not necessary for normal operations, not part of Operating Expenses (OPEX).

  • Ownership Variation:

    • CapEx needs can vary based on owner intentions (e.g., renovations vs. maintaining as is).

Influence on Financial Ratios

• Effect on OPEX Ratios:

  • Differing ownership decisions can lead to different CapEx treatments, affecting OPEX ratios.

  • Example:

    • If one owner maintains a property while another renovates (e.g., adding a pool), their financial outcomes will differ, causing a disparity in operational comparisons.

Arguments for Placing CapEx Above the Line

• Inclusion in Operating Expenses:

  • Supporters argue that CapEx, even if infrequent, is essential to operating the asset, thus should be included in OPEX.

  • This approach helps provide a more comprehensive view of net operating income.

Valuation Considerations

• Impact on Asset Value:

  • How CapEx is reported can significantly influence asset valuation, particularly in calculations involving cash flow and IRR.

• Cap Rate Analysis:

  • Cap rate changes when CapEx is placed above or below the NOI line.

  • This discrepancy can result in drastically varied investment returns.

    • Example:

      • If an asset is marked at $5 million with a cap rate of 10%, moving CapEx below the line may decrease the perceived value compared to when placed above.

Case Comparison for Cap Rate Determination

• Asset Valuation Calculation Example:

  • When calculating the cap rate with CapEx treated differently:

    • Asset price of $5,000,000 with a 10% cap rate results in differing valuations based on CapEx treatment.

    • Example Calculation:

      • If treated above the line, cap rate could fall to around 7% and thus lower ultimate property valuation to approximately $5,800,000.

      • Conversely, if below the line, it could maintain higher valuations.

Financial Implications for Investors

• Clarity on Return Expectations:

  • Knowing how CapEx is classified affects anticipated returns and valuation comparisons in the market.

  • Decisions about placement should always consider the asset management strategy and investment criteria.

Understanding Core Factor and Load Factor

• Definition of Core Factor:

  • Indicates the amount by which rentable space exceeds usable space due to common area allocations.

  • Landlords often charge tenants for these additional spaces, which can range from lobbies to shared bathrooms.

• Calculating Load Factor:

  • Calculate by dividing total square footage by usable square footage, which establishes how much space tenants are paying for compared to what they occupy.

  • Example: A total building size of 6,500 square feet with 5,500 square feet usable space results in a load factor of 1.18, indicating additional square footage charged for common areas.

Practical Application in Leasing

• Tenant Awareness of Rent Structures:

  • Tenants need to understand how shared space affects their rent and ensure fair calculation with the landlord.

  • Relating load factors to rent can help negotiate better terms in lease agreements.

Role of BOMA Standards in Leasing

• Building Owners and Managers Association (BOMA):

  • Provides standards for measuring building space which affect how landlords can charge for space.

  • Changes in BOMA measurement standards can lead to increased rentable areas, affecting tenant costs.

Conclusion

• The Importance of Clearly Defined Expenses:

  • Correct classification and understanding of CapEx impact financial assessments and investment decisions.

  • Both landlords and tenants should stay mindful of how CapEx, load factors, and pro-rata shares are established to ensure balanced agreements and valuations.