Cap Rate Is Not Your Cash Yield

A 7% cap rate does not mean you earn 7% on your money. That number only tells you the ratio of Net Operating Income to purchase price. It says nothing about the capital expenditures sitting below the NOI line that eat into the cash you actually take home.

The number that matters for distributable cash is Property Before-Tax Cash Flow (PBTCF). PBTCF is what remains after you subtract debt service and capital expenditures from NOI. It is the money that hits your bank account.

Most investors underwrite cap rates and stop there. Institutional investors underwrite PBTCF. The gap between those two approaches is where expensive mistakes happen.

CapEx vs. OpEx: Where the Money Goes

Operating expenses (OpEx) sit above the NOI line. These are the recurring costs of running a property: property management, insurance, taxes, routine maintenance, utilities. They reduce Effective Gross Income to produce NOI.

Capital expenditures (CapEx) sit below the NOI line. These are the large, non-recurring investments that maintain or improve the physical asset: roof replacements, HVAC systems, parking lot resurfacing, unit renovations, elevator modernization. CapEx does not affect NOI. It reduces PBTCF.

This distinction matters because cap rate calculations use NOI. Two identical properties with the same NOI and the same purchase price will show the same cap rate, even if one needs $300,000 in deferred maintenance and the other was renovated last year.

The cap rate tells you nothing about the capital burden. PBTCF does.

The Above-the-Line Convention

There is a gray area between OpEx and CapEx that trips up newer investors. Repairs and maintenance (R&M) sits above the line as an operating expense. A $200 faucet replacement is R&M. A $15,000 full kitchen renovation is CapEx.

The general rule: if it extends the useful life of a building component or substantially improves it, it is CapEx. If it restores the component to its existing condition, it is R&M.

Why does this matter? Sellers and brokers present pro formas using NOI. If they classify a large capital item as an operating expense, it depresses the NOI and makes the cap rate look worse. If they exclude it entirely (common with "stabilized" pro formas), the NOI looks better than reality. You need to know what belongs where.

The 30% Problem: What NCREIF Data Shows

NCREIF (National Council of Real Estate Investment Fiduciaries) tracks actual performance data from institutional-grade properties. Their data shows that capital expenditures average 30% or more of NOI annually across institutional portfolios.

That 30% figure is not a one-year spike from a major renovation. It is the long-run average across thousands of properties, smoothed over hold periods. Some years it is 10%. Some years it is 60%. Over a 10-year hold, it converges around 30%.

The practical impact: a property with a 7% cap rate and CapEx running at 30% of NOI delivers a true cash-on-cash yield closer to 4.9% before debt service. Add leverage, and the gap between advertised return and actual return widens further.

This creates a 100 to 200 basis point gap between cap rate and true cash yield, depending on property type, age, and condition. Ignoring this gap means overestimating returns on every deal you underwrite.

Capital Reserves by Property Type

Multifamily

Multifamily is the property type most individual investors encounter first, and the capital reserve requirements are the most standardized.

Reserve benchmarks:

  • Replacement reserves: $250 to $350 per unit per year
  • Repairs and maintenance (above the line): $400 to $600 per unit per year

Common CapEx items and approximate costs:

  • Roof replacement: $5,000 to $8,000 per unit (allocated across roof area)
  • HVAC system replacement: $4,000 to $7,000 per unit
  • Parking lot resurfacing: $2 to $4 per SF
  • Unit turn/renovation: $5,000 to $15,000 per unit (depending on scope)
  • Exterior paint and siding: $1,500 to $3,000 per unit
  • Common area upgrades (lobbies, fitness centers): varies widely

The $250 to $350/unit/year reserve is the minimum for a well-maintained, post-1990 property. Older properties, especially pre-1980 with original mechanical systems, need $400 to $500/unit/year or more. Lenders often require $250/unit/year in escrow regardless of property condition.

Unit turns are the wildcard. A property running 40% annual turnover on 150 units means 60 unit turns per year. At $8,000 per turn, that is $480,000 annually, or $3,200 per unit. This single line item can exceed the entire annual reserve budget.

Office

Office properties carry the heaviest capital burden of any major property type, driven primarily by tenant improvement (TI) allowances and leasing commissions.

TI allowances:

  • Class A: $40 to $80+ per SF
  • Class B: $15 to $40 per SF
  • Build-to-suit: negotiated, often $100+ per SF

Leasing commissions:

  • New leases: 4% to 8% of total lease value
  • Renewals: 2% to 4% of total lease value

Recurring CapEx:

  • HVAC replacement cycles: 15 to 20 years, $15 to $25 per SF
  • Elevator modernization: $100,000 to $250,000 per cab
  • Lobby and common area renovations: $30 to $60 per SF

The TI and leasing commission burden is what separates office from other property types. When a 50,000 SF tenant's lease expires and they renew at a $50/SF TI allowance, that is $2.5 million in capital. If they leave and you need to re-tenant the space, add another $200,000 to $400,000 in leasing commissions.

This is why office lease rollover schedules are critical to underwriting. A property with 60% of leases expiring in years 2 and 3 of your hold period will require massive capital outlays regardless of how strong the NOI looks today.

Retail

Retail CapEx varies dramatically based on tenant mix and lease structure.

Anchor tenants (big box, grocery):

  • TI allowances: $20 to $50 per SF
  • Often negotiate landlord-funded build-outs as a lease condition
  • Longer lease terms (10 to 20 years) amortize the capital over more time

Inline tenants (small shop, restaurant):

  • TI allowances: $10 to $30 per SF
  • Higher turnover means more frequent capital cycles
  • Restaurant tenants require grease traps, exhaust systems, and upgraded electrical, adding $20 to $40 per SF

CAM reconciliation: Retail leases often include Common Area Maintenance (CAM) charges that pass certain capital costs through to tenants. But CAM caps, exclusions, and the difference between controllable and non-controllable expenses mean landlords still absorb a portion of capital costs. Underwrite the actual lease language, not the assumption that "NNN means the tenant pays everything."

Parking and exterior: Retail properties live and die by curb appeal. Parking lot maintenance ($2 to $4 per SF for resurfacing), facade updates, and signage are recurring capital items that directly affect tenant retention and lease rates.

Industrial

Industrial properties carry the lowest CapEx profile of any major property type, which is a key reason institutional capital has flooded the sector.

Why CapEx is lower:

  • Warehouse and distribution buildings are simple structures: concrete tilt-up walls, steel framing, flat roofs
  • NNN (triple net) lease structures shift most maintenance and capital costs to tenants
  • Fewer building systems to fail (no elevators, minimal HVAC in warehouse space, basic electrical)
  • Tenants often invest their own capital in racking, automation, and interior build-outs

Landlord-retained CapEx:

  • Roof replacement: $4 to $7 per SF (20 to 25 year cycle)
  • Parking and truck court resurfacing: $2 to $5 per SF
  • Structural repairs: rare but expensive when needed
  • Environmental remediation: property-specific, can be significant

TI allowances:

  • Warehouse/distribution: $2 to $10 per SF (minimal finish)
  • Light manufacturing: $10 to $25 per SF
  • R&D/flex: $25 to $50 per SF (approaching office-level finish)

The NNN lease structure is the primary driver of low landlord CapEx. But "NNN" is not a guarantee. Read the lease. Some industrial leases exclude roof and structure from tenant responsibility, leaving the landlord exposed to the two largest capital items. A 500,000 SF warehouse with a roof replacement at $5/SF is a $2.5 million hit.

Worked Example: 150-Unit Multifamily

Here is how CapEx changes the return profile on a real deal.

Property: 150-unit multifamily, Class B, built 1998

Acquisition:

  • Purchase price: $10,000,000
  • NOI: $700,000
  • Cap rate: 7.0%

Year 1 Capital Budget:

  • Replacement reserves: $300/unit x 150 units = $45,000
  • Scheduled roof replacement (3 buildings): $200,000
  • Total CapEx: $245,000

PBTCF Calculation (unleveraged):

Line Item Amount
NOI $700,000
Less: CapEx reserves ($45,000)
Less: Roof replacement ($200,000)
PBTCF $455,000

True cash yield: $455,000 / $10,000,000 = 4.55%

That 7.0% cap rate just became a 4.55% cash yield. The 245 basis point gap is entirely capital expenditures.

In a "normal" year without a major capital project, the picture improves:

Line Item Amount
NOI $700,000
Less: CapEx reserves ($45,000)
PBTCF $655,000

Normal-year cash yield: $655,000 / $10,000,000 = 6.55%

Still 45 basis points below the cap rate. And this assumes you never have a major capital event, which, over a 7 to 10 year hold period, is unrealistic.

The NCREIF 30% average applied to this deal: 30% of $700,000 NOI = $210,000 in average annual CapEx. That produces a long-run PBTCF of $490,000 and a true cash yield of 4.90%. Add debt service, and the cash-on-cash return to equity drops further.

How to Underwrite Capital Reserves

Step 1: Get the capital plan. Request the seller's capital expenditure history for the last 3 to 5 years and any property condition assessment (PCA) or engineering report. If the seller does not have one, commission your own. A PCA costs $3,000 to $8,000 and will identify every major building system, its remaining useful life, and estimated replacement cost.

Step 2: Build a reserve schedule. Map every major building component to its expected replacement year and cost. Spread the cost over the hold period. This converts lumpy capital events into an annualized reserve number you can underwrite against.

Step 3: Stress test the reserves. What if the HVAC fails two years earlier than expected? What if unit turn costs run 20% over budget? Run sensitivity analysis on your capital assumptions the same way you stress test rent growth and vacancy. Capital surprises are just as likely as revenue surprises.

Step 4: Compare to NCREIF benchmarks. If your underwritten CapEx is less than 20% of NOI over the hold period, challenge your assumptions. You may be underwriting to best-case conditions.

Step 5: Calculate PBTCF, not just NOI. Every deal model should show PBTCF as a primary return metric alongside NOI and cap rate. If you are only looking at cap rate, you are looking at half the picture.

The Mental Model

Cap rate measures income yield before capital costs. PBTCF measures the cash you actually receive. The difference between them is the capital burden of owning a physical asset.

Different property types carry different capital burdens. Industrial is the lightest. Office is the heaviest. Multifamily and retail fall in between, with wide variation based on age, condition, and tenant mix.

Every deal you underwrite should answer one question: after I pay for the capital this building needs, what is my actual cash yield?

Run the numbers on your next deal with the Quick Screen calculator and compare the cap rate to what PBTCF actually delivers.

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