Analyzing Apartment Expenses for Investing
Analyzing apartment expenses for investing is a continuous activity that goes beyond the close of sale. This article focuses on common expense items to apartment investments. It’s important to know if costs are in line with what you estimated at initial underwriting. If expenses changed, you may need to make adjustments to your budget or look at ways to possibly offset costs.
Being familiar with the expenses of an apartment investment will improve your ability to spot abnormally high or low expenses. These are signs of something wrong or missing information. It’s not uncommon to see broker listings with missing information that should be obvious. These abnormalities may also produce an opportunity to increase the property’s value, if you’re able to reduce, control or eliminate the intended expense.
One of the complex and delicate things to forecast is the property tax assessment after the purchase. Always anticipate a property tax reassessment at the value purchased, unless it’s a severe distress situation. Some cities are more proactive at implementing increases than others. Investors buying in the southwest growth cities have felt the pinch on their property tax reassessments as city administrators aware of the growth and demand are proactively implementing increases. Property taxes are one of the highest costs; therefore, it deserves careful attention.
Figuring out what the new property taxes will be can take time. The information is typically at the county assessor’s website. Some assessor websites provide the formula for reassessment and even a calculator.
Assessor’s websites are not always user friendly. Some are not easy to navigate and difficult to get answers. Sometimes it’s easier to call the assessor’s office and talk to a representative. Explain your situation and that you want to know what the new assessment will be? They will give you an estimate of the reassessment amount based on your purchase price – and/or provide the formula to calculate the reassessment.
Some apartment expenses, like insurance tend to increase over time and it’s tricky to estimate the exact cost beforehand because all buildings are unique. With experience owning similar sized properties with the same insurer helps with estimating. Out of state investors get stunned by unexpected insurance requirements like flood, wind and hail policies. These are required by lenders in certain markets. Brokers will provide an estimate or tell you to use your best judgment. Brokers can give some guidance, but keep in mind that they have a financial incentive to close the deal. Unfortunately there’s no quick rule of thumb as different properties, built in different times, with different configurations and different locations have their unique qualities. Insurance agents are unable to provide estimates as its dependent on the different carriers they work with.
It’s best to start the conversation with your insurance agent as soon as the property is under contract. You can discuss beforehand (during the analysis phase) but they are typically unable to give an estimate or quote immediately. If they ask for a closing date, you may want to say an earlier date. Some agents have a tendency to wait until the closing date approaches, giving you little time to shop around.
Some policies may allow for savings if certain improvements or conditions are met. Improving safety or security along with controlled access can help with policy discounts. Changing your deductible amount by reducing it is one way to immediately affect savings on the insurance. You do need to make sure you have enough to cover the deductible in case of a claim.
If the maintenance costs is too high (above $600/unit per year), it could have capital expenses buried in the numbers. Sellers will spend for upgrades in preparation for the sale of the property. Costs for things such as exterior structure improvements; cabinets, appliances, major mechanical systems, etc. are long-term investments that are not routine apartment expenses. Verify if the maintenance costs include capital expense items that are one-time costs and compensate for them by adjusting expenses accordingly. Higher maintenance costs could be due to the age of the building and older mechanical systems reaching the end of their useful life. This happens with plumbing systems and heating/cooling systems with older properties that have not made upgrades. For older properties resist the urge to automatically reduce the maintenance costs. Instead ask questions about the integrity of the plumbing and major mechanical systems to make sure there’s not a recurring issue that may require major upgrades and investment of capital.
Some properties will have expenses for unit turn-over included with repairs and maintenance. There’s nothing wrong with this; however, keeping track of unit turn-over expenses helps to monitor if the turn-over rate is excessive. This can be a sign of mismanagement or bad tenant qualifying.
Using different methods or services providers could reduce costs. Properties relying too much on contractors for routine maintenance can be improved to run more efficient. On smaller properties that only support an onsite manager, we’ve been able to train the manager to handle small ticket repairs and even help with cleaning and trash outs (depending on the situation).
Work that can be done in-house with the right tools or equipment will save money in the long term. On larger apartment complexes it’s common to have a commercial plumbers snake to allow a maintenance guy to unclog drains. This saves money instead of calling a plumber. Upgrading to more competently skilled maintenance will reduce the need for contractors. Any improvement in reducing this expense goes a long way to increasing value.
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One of our most successful methods to reduce apartment expenses is to get services provided by existing 3rd party vendors, to get re-bid. After purchasing a property, get quotes for services like landscaping, pool care, trash removal, pest control, etc. Some properties have security services that will increase this expense. Markets with unregulated utilities allow competition for electric power and/or other utilities. Most of the time, we get better pricing than what’s currently being paid.
Be mindful of property management’s reluctance to get new bids. A previous property manager wanted to use their preferred landscaper. After reviewing financials we immediately knew it was too high, based on experience. We reached out to companies to quote the job. We found a company quoting half what we were paying. Later we fired the property management company as they were not a good fit.
On a recent apartment acquisition the new property management company rebid the trash and landscaping. They saved tens of thousands of dollars for the operations. This expense is property specific but a range of $100-$200 per unit per year is reasonable. Refer to historical financials for accurate numbers.
Most properties have electric utilities that are sub-metered. Other properties that are on a master meter and operate as “all bills paid” are not ideal. Some tenants will not conserve energy, unless they pay it themselves. This is especially true in extreme climate cities. You can implement a utility bill back system to recoup some of the cost. Just keep in mind if the competition operates as “all bills paid”. Don’t just assume that if a broker says you can bill back utilities that the market will still want to rent from you. If all things are equal and your building is the only one in the area charging back utilities, prospective tenants will bypass your building for the competition.
Updating common area lighting with long lasting LED lights is a good way of reducing maintenance and electric costs.
Water and sewer are typically master metered. You can save on water by updating kitchen and bath water fixtures to low-flow versions that help reduce water utility costs. This is a common activity with older buildings that with old toilets.
Natural gas that’s used for heating will fluctuate. In colder areas of the country spikes in gas occur due to demand for heat in the winter time. Keep this in mind and budget accordingly. Some utility companies offer a type of budget billing. They calculate the average from the previous year and spread that payment out over the next 11 months. On the 12th month any balance due is paid by the owner or a credit is applied for overpayments. When deciding on a property to buy, make sure you have financials showing utilities for the whole year. If you’re working with only 6 months of financials you could become unaware of a huge utility bill during the winter.
Fees for professional services such as property management, accounting and legal fees are common in larger multifamily properties. Any legal work is usually related to evictions or other tenant issues. Improving tenant screenings helps bring better qualified tenants, thereby reducing legal fees.
Management fees will not fluctuate much. Be aware of any misc. fees from management, such as gas/trip fees, extra payroll charges, etc. Let your management team know you’re watching the operations. On bigger apartments the accounting will be done in-house or with preferred vendors. With smaller properties you may have an accountant do the bookkeeping. This charge will stay steady or not change much.
This expense is property specific. It’s recommended to reference the last 2 years financials. Expect similar results.
This expense may or may not apply depending on the size of the property. On larger apartment complexes with an office(s), this will apply. This is for supplies and services to run the office (paper, pens, office supplies, software, website subscriptions, computer equipment, etc). A fair range is $100-$200 per unit per year. A local property management company can provide more accurate guidance on this expense.
This expense covers advertising to market to prospective tenants (brochures, online ads; exterior banners/signs; print advertising, etc.). Smaller properties with less turn-over, spend on marketing on an as needed basis. Larger apartment complexes with more tenants have unfailing and unpredictable turn-over. You become familiar to “skips”. Skips are people leaving in the middle of the night to avoid paying rent due. On larger apartments, having a consistently running marketing campaign helps bring tenant prospects. More prospects help build waiting lists that help mitigate tenant skips.
This expense is property specific but general a range of $50-$100 per unit per year is reasonable. Properties in high traffic locations with high visibility generally get more walk-in prospects. This helps with saving marketing dollars.
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Capital reserves is money set aside for future investment into the property. These dollars are for high priced items to benefit the property’s long-term value. It’s not meant for regular maintenance items. Its equipment or materials designed for longer life use (appliances, water heaters; HVAC, roofs, floors, fixtures, asphalt, etc.). Deciding which costs to include for capital reserves can become a tax consideration with regards to depreciation.
With agency financing, lenders require this amount funded by operations with every mortgage payment. The funds are separate and accounted for by the lender in a reserve fund. You receive these funds back as reimbursement when you spend on an improvement first. This amount ranges from $250-$300 per unit per year. However, it’s dependent on the property’s condition. Amounts can vary depending on reports from engineers hired by the lender to provide professional opinions. If the property has severe deferred maintenance the engineer can recommend a higher reserve amount. After compiling all expense records, submit a request for reimbursement from the lender.
This line item is dependent on the property size. Smaller properties may not have payroll as the amount of income and size of operations don’t support the cost. Larger apartments require onsite staff, as rent collections; tenant issues and maintenance request are regular activities. Onsite support staff consisting of management personnel and maintenance are necessary for scheduling and coordination of tasks to keep operations running smoothly. Bigger complexes can have additional leasing people and even a manager’s assistant. These two activities can be be handled by the same person. Larger apartment complexes will require multiple maintenance personnel or a maintenance assistant. Depending on the area and circumstances costs range from $900 to $1200 per unit per year.
When analyzing apartment expenses you’ll notice fluctuations throughout the year, so make note of changes and budget accordingly. Reviewing expenses for your apartments is a continuous activity. I included expense ranges but these are for reference only. Use them as guides. Doing more deals in various locations will improve your experience with estimating costs and underwriting skills. The main idea is to be aware of the different expenses for an apartment investment and if something is out of the normal range understand why.
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