Capital expenditures (CapEx) are funds used to acquire, upgrade, and maintain physical assets such as property, buildings, technology, and equipment. One of the pros of using lender CapEx is, when you have a large CapEx budget, lender capital typically has a lower interest rate. When you raise all the CapEx dollars with equity, interest rates tend to be higher, which can lower investor returns.
Over the past two years, we’ve utilized lender funds (also known as additional debt proceeds) to future fund CapEx at two properties. Lender funded CapEx is not right for every property but works well with specific investment strategies and scenarios. When we close on a property, the lender sets aside a fixed amount of capital in a so-called “line of credit” that the borrower can use to renovate and improve the property. Prior to closing the borrower submits detailed budgets and plans that outline where the money will be used and how it will improve the value of the asset (most commonly, the increase of the monthly rental rate per unit).
Future funded CapEx is not right for every deal because while there are pros, there are also cons. For example, the overall loan to value ratio may be higher, requiring the property to have a greater breakeven point compared to not using lender CapEx dollars. The most important piece to remember is that using lender funded CapEx can be beneficial for the right investment opportunity.
The key is to identify the breakeven point—the occupancy rate (based on occupied tenants paying) required to pay all property expenses plus debt service. This ratio is an excellent test to see how well a property can pay the bills if economic times are tough and residents move out or can’t pay their monthly rent.