Explain the impact of a capital reserve on a real estate pro forma.

• A. They are included only at sale.
• B. Capital reserves fund future capex and major repairs; reduce cash flow in year and plan for future events.
• C. They increase immediate cash flow.
• D. They are irrelevant to pro forma.

Answer: (B)

Capital reserves are funds set aside to cover future capital expenditures and major repairs. In a real estate pro forma, you budget these reserves as a cash outflow in each year, which reduces that year’s cash flow, even though they aren’t operating expenses. The purpose is to have money available when large items like a roof, HVAC system, elevators, or other major components need replacement or substantial upkeep. This approach smooths cash needs over time and reduces the risk of sudden, large draws on operating cash or debt when such projects come due. So reserves both fund future events and lower current-year cash flow, which is exactly captured by saying they fund future capex and major repairs and reduce cash flow in the year they’re funded. They are not irrelevant, nor do they increase immediate cash flow, and they aren’t only relevant at sale.