Why I Would Not Use % of Gross Alone to Figure Expenses

General Real Estate Investing
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Reference Book: IREM Income/Expense Analysis for Conventional Apartments -----(order online)

I spent about 20 years buying and managing apartment buildings in the past and did not ever really figure them out. I never really made cash flow and only made any profit through sales. One of biggest problems was trying to come up with the estimate of expenses for apartments.

Yesterday I saw some of your posts on trying to figure out what an apartment building in Indiana was worth and it got my interest. I dug out some old year end income/expense summaries and came up with the following summaries:

In Phoenix for a combined 62 apartment units the yearly expense was 70.2% of the gross scheduled income. No wonder I lost money. IREM says I could use 41.8%. What is wrong with this picture? Was Phoenix rents very low and expenses normal so it made the % of expenses higher?

At the same time I was managing 83 apartment units in Southern California and the yearly expense was 47.3%. IREM says I could use 42%. The two numbers are closer why?

I had the same age buildings in two different states (about 35 years old), same utilities (individual metered), same styles, same property manager but the expense % is not even close, why?

I basically quit the apartment business then but thought what could I have done different if I did it again in the same area at the same time (early to mid nineties). One thing I tried was to come up with a cost per unit per year.

$2000 per unit for one bedrooms garden style…10 = $20,000
$2250 per unit for mixed garden style…10 = $22,500
$2500 per unit for two bedrooms garden style….10 = $25,000

How would I have done financially instead of using the 35% & 40% of GSI the brokers were projecting at that time?

Actual expenses averaged in Phoenix: …………………$36000
Projection of expenses using cost per unit:……………….$34000
Broker projection of expenses (40%) of GSI: …………….$21000

If I had used the new formula in Phoenix I would have been pretty close to the actual expense figure although a little low but not $15000 low by using Broker projections.

In Southern California it looked like this:
Actual expenses averaged in S. CA………………………$61,000
Projection of expenses using cost per unit…………………$64,000
Broker projection of expenses (35%) of GSI:…………….$45,362

Better here as I would of figured high for the expenses.

Conclusion:

  1. IREM: Numbers below based on averages.
    Age makes a difference: older than 40 years…… Use 46% Expenes
    10 years or less……Use 38% Expenses
    Location makes a difference: Cold Regions;……Use 46% Expenses
    Southern Regions………Use 42% Expenses
    Okla, TX……………….Use 49% Expenses
    CA, AZ…………………Use 37% Expenses

  2. I would try the % in #1 above and see how it comes out and then I would use the cost per unit as above, check my location, and make a guess but I would not figure any lower than my cost per unit guide.

Bottom Line: I still have no clue and my recommendation is to buy mobile home parks.

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Very well could be a factor that you were below market rent. But no way to tell unless you were actively keeping tabs on what others were charging and charging accordingly. Far enough below market to be a 30% difference, hard to say. If you were off on your rent prices your PM should have known and fixed that, that’s why you pay him the big bucks right?

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I think there are other issues with the AZ property. Was there significant deferred maintenance? If
if so was the maintance issue effecting your vacancy? Were your rents diminished by the deferred maintence. Did you have a bunch of capital expenditures? Are you using the mortgage as an expense, because it is not considered an expense…ie NOI - Debt service- cash reserves = BTCF (cash on cash) Using a published number can be tricky because it is an average and there is alot of data outside the average.

Sean

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Maybe you should buy office buildings. :beer

Interesting breakdown per unit. However, you would run into the some of the same problems here as the idea of “$100 per unit cashflow”. It would need to be a constantly adjusted number, adjusted frequently for variables like inflation, materials cost and so forth.

A percentage expresses a relationship, and it doesn’t really fluctuate with inflation(although it could with spiking materials cost), the reason being that multi-family is an almost perfect inflation hedge compared with, for example, a net leased retail with increases based on something other than CPI.

I’ve never seen over 70% expense for a commercial multi with anything near market vacancy. What percent of GRI was the PM charging? As Sean stated, there must have been some other issues at play such as cap. expenditures, rent delinquency?

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Rich, Sean, Kelly–thanks for responding. Let me add some more to the above.
I was the off-site property manager and the rents were at the market. There was really no difference between the properties in Phoenix and S. CA. although S.CA properties were in worse locations than Phoenix. All were the same even the deferred maintenance and that was not that much in either location and I did not use the mortgage in figuring expenses.

I think my point is to not focus on the GSI to figure expenses alone. But to also focus on the building, the size of the untis, the number of unts, the location, the age, utilities.

The expenses for the Phoenix units were just normal expenses for those units but the rents for Phoenix at that time were just what they were too low and would not fit into the model of taking 41.8% of the GSI.

Kelly, great post on the Indiana deal, but you used 60% & 65% of gross to figure expenses for the deal? Your post says do not use more than 50%. I used $2250 per unit per year and came to 45.8% of gross and a 11 cap price of $256.222. I’ve been following other forums and people asking for what to pay for apartments and using my formula I’ve been getting within 5% of what the experts are figuring for prices to pay.

Thanks you all for your posts.
Mike