How to Plan out Your Real Estate Capital Expenses over the Years – Part II

Published on Friday, 6 December 2013 14:15:28    Written by Marc
  1. Know what the amortization periods should be for each capital expense you make and keep in mind your horizon. If you own the building, you normally amortize the capital expense for a defined period or for the normal lifespan of the item. For example, if you own a building you might amortize a roof replacement for the normal life of the roof (say 15 years), but your company might have a policy that says its 10 years for roof. So knowing the periods you will use is important.

    Click here to read Part I

    Plan your capital expensesIf you lease your building, many companies will only amortize the capital expenditure up to the remaining term on the lease, sometimes adding the first option, but this is company specific. For example, if you have six years remaining on a lease, there is a chance that your company will not want to amortize anything for a longer period that the six years left on the lease. The main reason for this is that if you decide to leave the building at the end of your lease, you do not end up with items that are not yet fully amortized. Again, knowing the amortization period is key.
  2. Delay or advance dates. This is where capital expenditure planning takes shape. Once you have done your building audit, have in hand a detailed list of all the items you will need to replace or repair for as far in the future as you can see (up to your maximum horizon as per point #1). Once you know your amortization periods you can now plan you capital expenses and lay them down for each year to see what you will need to spend and amortize in each of the coming years.

    If you make a 10-year plan, budget all the forecasted capital expenditures for the next 10 years, placing each expenditure in the year you think you will need to do the expense. Add up the planned expenses for year each and see what the picture looks like. Without additional planning, you will probably notice that some years you have more capital expenditure than others do.

    For example, you may have four capital expenditures in year one, two in year two, and five in year three. It is not so much the number of items that is important but the total cost for each year of your plan. If you see that for some years your total cost dramatically increases or decreases and then jumps back up the following year, you might want to do some additional planning and take a look at what you can delay or advance in time, in order for your total capital expenditures to be more even year after year.

    For example, if your total capital expenditure is too high in year three but seem lower than normal in year two, you could look to see what expenditure you could advance in time (do sooner than initially planned) so that your year two total expenditures increases and your year three expenditures decreases. By playing a little with some of the expenditures and advancing them or delaying them, you can end up with capital expenditures that are similar year after year or, depending on what you are looking for, increase a little each year to take into consideration the inflation factor.

    In doing this process, look to see if there are capital expenditures, which you can split into smaller portions or expenses to help you even out the total costs of each year. For example, if you are planning roof replacement, chances are you do not need to replace the entire roof at once and can plan to replace small sections of the roof each year. If you have a proper roof audit, you will be able to know which section of roof you could advance or delay a little in time to help even out your total annual capital expenditures.

    There are often many capital expenditures, which you can split in smaller expenses, like parking, floor replacement, elevator replacement (doing one per year instead of all of them at once), vac systems, even energy saving retrofits. In some cases, you might need to consider some increase in the costs by doing smaller capital expenditures since you will not have the same buying power towards some of your suppliers, but if you manage more than one building, then you could potentially regroup work from a number of properties to get a fair price. For example, if you do only 10 percent of roof replacement each year, but do this for a portfolio of 10 buildings of the same size, you could combine the roof replacement work of the buildings to try to get good pricing from suppliers.

  3. Review each year your plan. Once you have completed your capital expenditure planning for the coming years, you will need to review it each year and make adjustments as you go along. You might not need to do a complete building audit each year, but at least come back to your plan and see what has changed. That transformer your consultant was giving between three and five years.

    Guess what, the same consultant now thinks it can live another four years extra. Good news, now you can go back and push back the scheduled replacement a little. Maybe one or two years, knowing you will be revising this in a year or two anyway. As I mentioned, building audits do not need to be done each year, some parts of the audit can be done each few years only. For example, I used to do thermo scans on roofing each three years only, so having a portfolio of roofs I would do thermo scans on about one-third of the portfolio each year (trying to even out the costs of the consultants each year). You will need to plan for each component and define how often you want to redo an audit on them.

Conclusion

When done correctly, capital expenditure planning cannot only save you a good deal of money, it can also help you see the future with greater clarity and avoid some unexpected costs. Of course, you will always have something that will break or leak for which you did not plan. However, if you do your capital expenditure properly, you should be able to plan for the vast majority of your capital expenditure. With some fine-tuning, you can arrange for these expenses to happen progressively, in order to avoid having years with high expenses. In addition, the good thing about capital expenditure planning is that once you iron out your plan, the following years you only need minimum work to keep your plan up to date.