Few distinctions in real estate underwriting cause more confusion than the line between capital expenditures and maintenance expenses. The words themselves sound intuitive, but in practice they get blurred constantly, sometimes by accident and sometimes on purpose. The distinction matters because it affects cash flow, valuation, taxes, reserves, and lender requirements.
At a high level, maintenance expenses keep a property operating as it exists today. Capital expenditures change the property in a meaningful or lasting way, extend the life of major systems, or materially improve functionality or value.
Maintenance Expenses
Maintenance expenses are the ongoing costs required to keep a property functioning and habitable in its current state. These expenses recur every year, even if nothing goes wrong. They show up on the operating statement and directly reduce net operating income.
Typical maintenance expenses include routine plumbing fixes, minor electrical work, HVAC servicing, patching drywall, replacing a garbage disposal, fixing a leaking faucet, or addressing tenant work orders. Turnover costs such as paint, carpet cleaning, small appliance replacements, and minor repairs between tenants usually fall into this bucket as well.
The key feature of maintenance is that it does not meaningfully extend the useful life of the building or improve it beyond its prior condition. You are preserving, not upgrading. If you skip maintenance, the property deteriorates quickly. If you perform it consistently, the building stays roughly the same.
From an underwriting perspective, maintenance should be treated as a recurring, unavoidable expense. It should not be “smoothed out” with optimism or ignored because a seller happened to defer work. If a building is 40 years old and currently spending very little on repairs, that is not efficiency. It is a warning sign.
Capital Expenditures
Capital expenditures are investments into the physical asset itself. These are projects that either extend the useful life of major components, materially improve the property, or meaningfully change how it competes in the market.
Common capital expenditures include roof replacements, boiler or chiller replacements, electrical panel upgrades, window replacements, major plumbing replacements, exterior siding, parking lot resurfacing, elevator overhauls, and large-scale unit renovations. These are not annual expenses. They are lumpy, irregular, and often expensive.
Capital expenditures are not optional in the long run. Every property has a capital cycle. Roofs wear out. Mechanical systems fail. Parking lots crack. The timing may be uncertain, but the expense itself is inevitable.
Good underwriting does not assume that capital expenses disappear just because they are not immediate. Instead, it plans for them explicitly, either through upfront capital budgets, ongoing replacement reserves, or both.
Why The Distinction Matters in Underwriting
The most common underwriting mistake is allowing capital expenses to masquerade as maintenance or disappear entirely.
If a model assumes $500 per unit per year in repairs and maintenance but ignores the fact that the roof is 22 years old and the boiler is original, the projected cash flow is overstated. The problem does not show up immediately. It shows up three to five years later, right when the deal was supposed to be stabilizing.
This distinction also matters because lenders treat these costs differently. Maintenance expenses reduce NOI directly. Capital expenditures do not, at least not immediately. Instead, lenders typically require replacement reserves, often escrowed monthly, to ensure capital items can be funded without jeopardizing debt service. These reserves are a cash drag, even if they do not appear on the operating statement.
Replacement Reserves
Replacement reserves exist precisely because capital expenditures are irregular but inevitable. Instead of waiting for a roof to fail and scrambling for capital, lenders and prudent operators spread the cost over time.
In small multifamily, reserves might range from $200 to $450 per unit per year, depending on property age, construction type, and system quality. Older properties with original infrastructure should be on the higher end, if not higher than standard lender minimums.
Reserves are not a substitute for a detailed capital plan. They are a backstop. A property with a known $300,000 roof replacement in year three should not rely on generic annual reserves alone. That capital needs to be identified, budgeted, and timed explicitly.
Grey Areas That Cause Problems
Some costs live in the gray zone, and this is where underwriting discipline matters.
Replacing a failed water heater in one unit might be maintenance. Replacing all water heaters across the property because they are past useful life is capital. Patching a few sections of asphalt is maintenance. Milling and resurfacing the entire parking lot is capital.
Interior renovations are another common source of confusion. Replacing a broken appliance is maintenance. Renovating kitchens and baths to reposition rents is capital. Treating value-add renovations as operating expenses understates capital needs and inflates stabilized cash flow.
The rule of thumb is intent and scope. If the work is reactive and isolated, it is usually maintenance. If it is planned, broad, and intended to extend life or improve income potential, it is capital.
Conclusion
Capex and maintenance are real cash costs. The building does not care how they are labeled in a model, and it will require the money regardless of how clean the spreadsheet looks.
Maintenance shows up continuously through work orders, small repairs, and unit turns. Capital items arrive less often, but when they do, they arrive all at once and at scale. Replacement reserves help manage timing, but they do not eliminate the underlying obligation. When any of these are minimized or misclassified, cash flow is overstated and risk creeps into the deal quietly.
Properties that hold up over time tend to share one trait: costs were classified honestly, capital needs were acknowledged early, and the timing of those expenses was treated as inevitable rather than optional.