in your market, are reserves for replacement factored into the NOI calculation, or in the cap rate?
im taking some online CE and brushing up on income analysis and this came up.. text said to make sure they are accounted for on one side ofhte equation or the other.  Im looking to expand my footprint (property tax consulting) to the greater Gulf South region and would really like to know who does what, where..

Edit: it looks like commenters are treating capital expenditures and replacement reserves as the same thing.  CapEx is something like adding a tennis court to a condo associations land, a deck to a home, an elevator to a multi story building.  they are a one time cost, likely to have the same economic life as the building itself. Replacement reserves account for (1/remaining useful life)  of the cost of things that wear out more quickly.. carpets, appliances, etc.
[{"id": "fygtif5", "text": "To my knowledge replacement reserves are calculated below the line (after NOI), therefore they would not affect either your noi or your cap rate.", "replies": [{"id": "fygtygt", "text": "Exception is for hotels, hotel NOI is calculated after 4% reserve on GOR.", "replies": [], "depth": 2}, {"id": "fygx03r", "text": "my question was seeking to confirm if any local markets bake the replacement reserves into the cap rate, based on the discussion in the course im taking. you definitely include replacement reserves into operating expenses (above the line) if it's not factored into the cap rate. otherwise you would be capitalizing an artificially high NOI into a value..\n\n&amp;#x200B;\n\nIRS and state income tax, mortgage payments, depreciation would be below the line", "replies": [{"id": "fyh0roq", "text": "Reserves are a capital item like leasing costs/CapEx.  They always go below the line and do not impact NOI.", "replies": [{"id": "fyh4zzf", "text": "what market are you in?", "replies": [{"id": "fyhmzsv", "text": "Dallas", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "fyh1csl", "text": "Yeah this is wrong.  Capital reserves go below line.  If you are able to pass them through to the tenant that is great and can be entered as a reference line and the reimbursement would considered part of the gross revenue but the expense itself is still below NOI. Same with actual capital items, leasing, debt, TI.", "replies": [], "depth": 3}, {"id": "fyha3z0", "text": "I mean not to complicate it but from an acquisitions underwriting perspective it would get baked into your cap rate because you\u2019re discounting future cash flows to derive a value for a property, so from a DCF perspective the value today is impacted by future capital spending ove your hold period. So like your cap rate could be incredibly high because you think you have a lot of capital spend upcoming (or TI for rollover, etc)", "replies": [], "depth": 3}], "depth": 2}, {"id": "fyh8sdu", "text": "I agree. I\u2019ve only seen replacement reserves taken out after NOI.", "replies": [], "depth": 2}, {"id": "fyhd2o8", "text": "Banks underwrite it above the line, as do appraisers", "replies": [{"id": "fyhma3w", "text": "This is the right answer", "replies": [], "depth": 3}], "depth": 2}, {"id": "fyhjagj", "text": "Agreed", "replies": [], "depth": 2}, {"id": "fyhm8o2", "text": "Not in multifamily or hotels", "replies": [], "depth": 2}], "depth": 1}, {"id": "fygvt6c", "text": "Replacement reserves are an operating expense, so NOI isn\u2019t NOI unless you first back out replacement reserves. Replacement reserves are calculated either on a per square foot, per unit, or as a percentage of income. What the course is intending is to teach you is how to calculate reserves as a percentage of income. \n\nThere are other forms of reserves taken after NOI, but that\u2019s usually in a niche or unique situation. \n\nNOI/Property Value= Cap Rate", "replies": [{"id": "fyh1vmq", "text": "That might be true for the lenders appraisal and I have often seen it as a lender requirement and had to factor it into my ANOI for DSCR and yield, but in terms of reporting or actual acquisitions it falls below the line.", "replies": [{"id": "fyh4wsj", "text": "what youre saying is that if two buildings are identical in every respect, but, say, the roof (building 1, just replaced, building 2, needs to be replaced asap), you would capitalize the indentical NOI's with the same cap rate? if no, then the answer to my question above is that you would use a different cap rate, and therefore the answer to part 1 of my question is that you bake replacement reserves into the cap rate in your market. can you let us know what market you work in?", "replies": [{"id": "fyheb04", "text": "West coast commercial appraiser here.  Capex is not an operating expense and is not included in the NOI calculation.  In your example the property would be valued using cap rate comps and then an adjustment for the cost of the roof would be a below the line adjustment that would alter the purchase by the costs of the roof replacement.  Say you are in a 5% cap market and the roof cost $50,000.  So even if you prorated that expense over 25 years that would be $2,000 that would be capitalized at 5% which would be $2000/5%=$40,000 less value for just one year of that expense that is only $50,000 to start.  See how it overstates the expense?", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fygz702", "text": "West Coast commercial appraiser here: replacement reserves are *always* above-the-line and baked in the NOI and going-in cap rate. This is typical of market underwriting for multifamily, office, retail, industrial in our area.\n\nDelving into the actual financials, though, most often, owners *do not* have a reserves category; instead the items we usually lump into reserves are below-the-line within capex.", "replies": [{"id": "fyh58lh", "text": "thanks, ive found in my market that smaller investors dont list replacement reserves on their income statements so you have to adjust the cap rate to make up for it. bigger investors usually have in house property tax people so i dont see those (unless i FOIA the assessors ofice for docs)", "replies": [], "depth": 2}], "depth": 1}, {"id": "fyh3ttq", "text": "Typically, its considered in the cap rate in my market.", "replies": [{"id": "fyh4z5x", "text": "what market? im trying to see where this is common", "replies": [{"id": "fyh52l6", "text": "I'm in Florida, specifically west coast.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fyh5i13", "text": "Commercial real estate appraiser here. Reserves are an above the line operating expense, typically derived from either a percentage of the EGI or as an expense per square foot.", "replies": [], "depth": 1}, {"id": "fyh8i95", "text": "Only time I see reserves above NOI and included in cap rate is with hotels. All other property types they are below NOI as a capital expense, and therefore not included in NOI. I don\u2019t think it\u2019s something that varies from market to market, but different investors will have different underwriting standards, so some may include it above the line.", "replies": [{"id": "fyhme1q", "text": "Apartments include replacement reserves above the line.", "replies": [{"id": "fyhqnzt", "text": "We\u2019ve always included it below the line for multi as well. Probably differs from shop to shop", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fyh99h7", "text": "Honestly I never understood why CRE obsesses over NOI instead of NCF. What is the point of valuing a property without including investments in the property (to maintain value)? Obviously the amount of CapEx required is not going to be equal across different properties, plus what really matters is how much cash is going to be returned to you, as the owner, at the end of day. I can understand metrics being prior to debt service - as financing is an external factor - but never understood the CapEx part.", "replies": [{"id": "fyhf0ef", "text": "You answered your own question.  NOI matters because cap rate is a market data point you can use to differentiate properties in different situations of the same or similar class and property type. NCF by itself is useless without using it to solve for something else. NCF is part of calculating the IRR, equity multiple, cash on cash return, etc. which every investor definitely looks at", "replies": [{"id": "fyhglzm", "text": "So what is wrong with a cap rate based on NCF? If one market let's say has a stronger preference for renovated multifamily than another one, would you not want the corresponding difference in CapEx reflected in each cap rate?", "replies": [{"id": "fyhhgbb", "text": "A renovated multi will have a lower cap rate than an apartment the same age but not renovated.  The only differences by market is how big (or small) the spread is between the two. There's also a relationship between the exit cap and the IRR's people are solving for, which takes that into account\n\nAnd in practice, that makes no sense.  Here's a thought exercise: There's two properties that are identical except building A needs roof replaced in year one and building B needs it replaced in year two.  Since they both have similar capital needs (just slightly off in timing), you use a rate like a cap rate on NCF.  One is going to have a massively higher return based on that pricing, which doesn't make sense", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fyhdl06", "text": "The cap rate is only snapshot of a building and a way to compare the investment across different asset classes and markets.  It does not take into account rent growth, repairs, term, vacancy, etc.  Therefore future capital improvements are not directly factored into a cap rate through the NOI.  The future required capital is factored into purchase price which in turn affects the cap.  In my opinion it should not be the sole or even significant evaluation methodology used when purchasing a property.  If you are strictly using it as an valuation/appraisal technique that is a different story.  \n\nIf you have two buildings with all other things being equal except one requires a roof repair and the other does not then this is how you calculate the cap rate assuming you don\u2019t receive a credit from the seller for the repair.  \n\nBuilding Initial Value: 1,000,000\nNOI: 100,000\nBLD 2 Roof repair: 50,000\nBLD 1 Cap rate: 10% (100,000/1,000,000)\nBLD 2 Cap Rate: 9.52% (100,000/[1,000,000+50,000])\n\n\nMy background: I currently invest (acq. &amp; dev) in medical office nationally, with a significant presence in the SE and previously did acquisitions at an institutional shop that invested across all commercial asset classes.", "replies": [{"id": "fyhj5mv", "text": "&gt; this is how you calculate the cap rate assuming you don\u2019t receive a credit from the seller for the repair.\n\nWho and why is this cap rate being calculated?", "replies": [{"id": "fyhl2ur", "text": "It is a cap rate on your effective purchase price and again it doesn\u2019t mean anything.  Going in cap rates don\u2019t matter as it is a way to quickly estimate a property\u2019s value but not an actual value.  Cap rates are effectively a measure of risk not value (think of an inverted PE Ratio). You purchase based on your required returns and not what the initial cap rate is.  \n\nI can look at two properties with the same NOI and have one valued at a 6% cap and the other at a 7% cap. The seven cap is not automatically a better deal because the rent could be flat, the term could be shorter, the rents could be over market, there could be short term capital, or it could be fully occupied while the 6% cap building could lease up opportunity.", "replies": [{"id": "fyhtexl", "text": "That did not answer my question.", "replies": [], "depth": 4}, {"id": "fyhudbc", "text": "&gt;  Cap rates are effectively a measure of risk not value (think of an inverted PE Ratio).\n\nActually direct capitalization is exactly a measure of value.  In a 10% cap rate market investors HAVE paid $10 per possible dollar of NOI.  In a 5% cap rate market investors HAVE paid $20 for that same dollar of NOI.  \nAlthough cap rates can reflect risk they do not measure it.  A 5% cap rate can be more risky than a 10% cap rate.", "replies": [{"id": "fyhxjdj", "text": "Jesus this is pedantic. To answer your question you wouldn\u2019t use my previous calc as a cap rate.  I was explaining that capital reserves are not above the line and if you wanted to factor it into a cap it would come in the form or a purchase price adjustment.  \n\nI also understand that a cap shows what someone HAS paid for a property but again it is simply a snapshot and not an actual assessment of the investment I was speaking in generalities.   For comparable buildings with comparable tenancy you would expect that the building with the lower cap rate to be a lower risk and therefore higher returns.  Yes a 5% cap can be riskier than a 10% cap. This only proves my point that cap rates are a marker used by appraisers, brokers, and novices.  They are not a signal of the actual value of the investment.  If someone buys a building because they are getting it for a 7% cap where the market is a 6% cap and they believe that alone makes it a \u201cgood deal\u201d that is just incorrect.", "replies": [{"id": "fyi32ke", "text": "That still does not answer my original question.", "replies": [], "depth": 6}, {"id": "fyi43dr", "text": "&gt;   For comparable buildings with comparable tenancy you would expect that the building with the lower cap rate to be a lower risk and therefore higher returns.\n\nIf the market cap rate is 10% and you bought at 9% how would that be lower risk with higher returns since you overpaid?\n\nOr are you saying market cap rate is 9% and you bought at 10%?   $100,000 NOI at 9% is $1,111,111.  At 10% it is $1,000,000.   Who is giving you a $1,111,111 discount on market price?  Grandma?  Seems like the higher cap rate would be lower risk.", "replies": [{"id": "fyi4xrp", "text": "Correct that is a typo lower cap lower returns", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "fyi3edt", "text": "&gt;it is a way to quickly estimate a property\u2019s value but not an actual value.\n\nWhat is the difference?  Did you mean to say that a cap rate estimates the market value but does not measure profitability or return?  That I agree with but I don't know what \"actual value\" is.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fyhi3f7", "text": "Two different return metrics: yield on cash flow (NOI less reserves) versus yield on income (NOI) \n\nYield on cash flow matters more. It\u2019s your true yield you should expect over the hold period. NOI for 3 year old property and 20 year old property could be the same but the latter will need significantly more capex and therefore lower your overall returns.", "replies": [], "depth": 1}, {"id": "fyhmvua", "text": "Apartments and hotels include replacement reserves and FF&amp;E reserves, respectively, above the line. Office, industrial and retail do not include reserves above the line. Other speciality products types (data centers, student housing, seniors housing, self storage) will depend, but generally follow their \u201ctraditional\u201d food group.\n\nWhat is confusing everyone in this thread is that there is ALSO typically a more generic capital reserve (eg 1% of EGR) included below the line. I\u2019ve seen some appraisers exclude this in their multifamily reports.\n\nSource: I\u2019ve done $3B of transaction volume in several different shops and this has always been the standard approach.", "replies": [], "depth": 1}, {"id": "fyiflyz", "text": "Buying, put it in NOI. Selling, put it below NOI.", "replies": [], "depth": 1}]