The Costly Mistake Most Investors Make When Underwriting Apartment Expenses

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The formula for building wealth in the apartment space seems pretty straight forward:

  1. Buy an under-performing asset
  2. Increase the top-line revenue
  3. Decrease expenses as much as possible

Pushing the top-line and compressing the middle (expenses) increases the NOI, which capitalizes into higher value. That’s the theory, and if you execute correctly, the theory does work.

What’s Hard About it?

On the above list, there is one item that is harder than the rest, one item that is responsible for most failures in this enterprise. It’s item #3.

Indeed, while it takes effort and research to know what rents should be, once you do know, the business plan of driving rents is, at least on the surface, sort of obvious.

Caveat: To prevent the likes of Brian Burke and Serge Shukhat ripping into me regarding the statement above, let me just say that nothing is easy. Rent amount has an inverse relationship to a lot of the economic losses we sustain; therefore, driving rents is a balancing act that is anything but easy. However, for the purposes of this discussion, simply knowing that comparable units are renting for $75 more than the subject does make it easier to underscore the value-add proposition and strategy.

However, expenses—that’s really, really hard. Estimating what to expect in terms of expenses is a multi-step process, and some steps are just not easily accessible to all. Let’s talk about it…

This is What Most People Do

Most people look at the pro-forma provided to them by the seller or the broker—and stop there.

There are several issues with this. First of all, pro-formas can be either based on actual financials or on broker’s projections of financials. If based on actual financials, there is some value to the pro-forma in that we can perhaps glean why the property is being sold. The fact is that most of the time, the reason the property is being sold is because the owner is unhappy with it, meaning it loses money. If so, looking at the owner’s numbers can perhaps underscore where the owner has gone wrong and how we can do better.

Related: From Listing to Closing: The Step-by-Step Process I Used to Buy a 32-Unit Apartment

However, this requires us to assume that the owner did not lie, which is somewhat of a stretch. And as to broker’s pro-forma, this is always based on pie-in-the-sky assumptions and should be ignored for the most part, aside for this:

We can assume that broker’s numbers result in a suggested price for a reason. That reason is the seller’s expectations. So, by looking at broker’s pro-forma, we can establish a pretty good idea of where the seller’s thinking is, and from here, our job is to see if we can get close enough to be competitive.

This is where most people stop… not good!

Step Two

Understand, looking at pro-formas of any kind is looking at past performance. While the above paragraphs underscore some reasoning behind knowing past performance, what we really care about is future performance. In steps one and two, we isolated value-add proposition relative to revenue, but what will this thing cost to run—really?!

To underwrite these expenses, we must start with some sort of averages that are applicable across the industry. For example, I can’t tell you how many times I’ve seen a pro-forma that indicates a payroll expense of $19,000 for a 120-unit building. Immediately, if you’ve done any studying up on this, you should know that the industry average is one employee per 40 doors. This varies, of course, but this piece of knowledge on its own should tell you that there is no chance in hell you are employing three people at a cost of $19,000. This means that right off the bat that your NOI is going to be about $120,000 less than the pro-forma, and any chance at a deal hinges on you finding that money elsewhere.

Step Three

Now, let’s say that the pro-forma is more realistic and includes $950/door worth of payroll. Typically, it costs more than that in even very large buildings, but in a 120-unit I would want to be safe, and personally I’d underwrite $1,200–$1,250/door.

However, the pro-forma at least makes an attempt to be realistic here, and in my effort to get a deal I have to now ask myself, Is there any reason as to why payroll should cost less on this building, and can I bridge the gap of $250–$300?

Related: 8 Awesomely Simple Ways to Maximize Your Apartment Building Profits

If I can come up with a legitimate reason, then perhaps I can get closer to asking price. Perhaps the HVAC systems on this building include through-the-wall AC and baseboard heat. These are easy to work on, and on-site personnel can handle them. Furthermore, I neither need an HVAC certified mechanic on staff, which means I can pay less salary, nor will I be outsourcing that work to third party contractor, which means savings on contract services.

Thus, perhaps I can I can knock off my payroll by $100 and be comfortable around $1,150. And perhaps there is now rationale to justify contract services of $100/door less than I would typically use for forced air.

As such, I’ve mitigated $200 out of the $300 gap, which gets me closer to where I need to be. However…

THIS is the Problem

In order to complete this type of analysis, I must have good knowledge of industry standards of what things “should cost,” and I must have good working perspective on “WHY.” The problem with the “WHY” becomes evident via experience—there is just very little that can be substituted for experience.

And if we don’t know why things cost what they do, then we can’t make adjustments to the averages (even if we know what those averages are). And if not, we are just left looking at past performance and flat out guessing at the future.

Not the best way to buy multifamily.

How do you go about estimating expenses when evaluating multifamily investments?

Let’s talk in the comments section below.

About Author

Ben Leybovich

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the BiggerPockets Podcast. He was also featured on the cover of REI Wealth Monthly and is a public speaker at events across the country. Most recently, he invested $20 million along with a partner into 215 units spread over two apartment communities in Phoenix. Ben is the creator of Cash Flow Freedom University and the author of House Hacking. Learn more about him at


  1. Brian Gibbons

    Without being a good detective you just can’t get involved with apartment investing and turning them around
    Once you get good at turning apartment buildings around with a track record you can get involved with creative ideas like Master lease options
    Nice job Ben, I love this post 🙂

  2. Nick B.

    Good article, Ben, as usual.

    However, I’d like to add another dimension to it from the point of view of a passive investor.
    What about sponsor’s proforma? Is comparing it to the industry average good enough? If not (and I have a gut feeling that it is not) then how should a passive investor evaluate a sponsor’s proforma other than performing a full underwriting?


    • Ben Leybovich

      Nick – thanks so much!

      I think you know the answer to your question. The reason SEC wants us to deal with accredited, or at the very least sophisticated investors is precisely because it is assumed that prior to jumping in you’ll know which questions to ask, and how to see through the bull.

      The best way to function, as a limited partner, is to indeed do a full underwriting for yourself. However, at the very least, you must know enough to be able to question all of the assumptions the sponsor makes in the underwriting – and there are a lot of assumptions indeed.

      I do my best to underwrite to IRR. Why – because it forces me to make assumptions for every step of the way down to disposition of the asset. Your job is to call me out, and when I answer your job is to agree or disagree with the moving parts as I see them. If we agree, we go forward…

      Incredible sophistication is requisite on your part. You, personally, have worked hard to develop it, but most passive investors would know about as much about tracing the IRR as flying to the moon. So, for them – God has created turn-key single family in Mid-West 🙂

  3. David Hays

    Hi Ben,
    Thanks for the article here, and I feel like you raise a valid point regarding not having a strong grasp (or failing to be realistic, ¨fudging the numbers¨, etc) on expenses. To be honest, however, I feel like you had a lot of buildup in this article with very little payoff. You present the problem in the initial paragraphs, but your solution is just…¨Well yeah, go get some experience, that´s about it.¨Really? I understand what you´re saying here – and there´s no real substitute for the experience – but if you´re going to write an article on the subject I would´ve expected a bit more actionable and constructive suggestions.

    • Ben Leybovich

      David – thanks indeed for your comment. Unfortunately, I have nothing more magical to advise here. It’s not so much a problem of, as you say “fudging numbers” – that would presume suspending logic and lying to yourself.

      This is not what happens most of the time. Most often people try to do the right thing, but you only know what you know, and you don’t know what you don’t know. Even while making the best effort to be realistic, without a “feel” for the dynamics behind the numbers it is very hard to be honest.

      And unfortunately, sad is it is, this only comes from experience. I am sorry if you are disappointed with the article, but this is the way I see it 🙂

      Thanks indeed for reading, David.

  4. Amy A.

    Very accurate article. In addition to experience, one needs data. I recently compiled 4 years of expense data, including vacancy, for my portfolio in one town I invest in. Now I’m using it to calculate what should be my actual expenses for a potential purchase. Of course, one can verify certain expenses for a given property, such as utility usage.
    Another piece of advice is to never take pro forma income at face value. I have found that these rents are often ridiculous. Yes, you can get any amount of rent if you don’t screen tenants, but their first month’s rent is the only time they’ll pay!

  5. Philip Bashaw

    Hi Ben,
    I’m looking into multifamily in the ‘Intown’ market of Atlanta and will be attending the webinar next week. One thing that made me laugh in your article was the comment about the property owner telling the truth. I was in an REO investing workshop at my local REIA a few months ago and the speaker told us an old saying in real estate: “buyers are liars and sellers are worse!” I think this applies to what you have gone through, hell, what all of us go through everyday!

    I believe in multifamily investing and about to make an offer on a 14 unit building that the owner has run into the ground. It’s a C property in an A neighborhood…hopefully they’ll be ready for a blind offer. The property is not for sale, but they obviously don’t give a crap about it

  6. Enrique Jevons

    Thanks so much for the great article Ben. Unfortunately, one of the bigger deals I purchased was based on a seller’s pro-forma of a 123 mobile home park without spending time talking to each of the tenants. Had I done so I would have found out a tremendous amount of covered up and deferred maintenance. The only thing that saved me was that I structured the deal as a 1 year option to purchase. After 6 months of misery I gave notice that I was not exercising the option. I thought that because I had known the seller for years that he wouldn’t try to mislead me so much. but, as Philip Bashaw said, “buyers are liars and sellers are worse.” Very true words that I need to always keep in mind.

  7. Tom Smith

    Newbie question: Is there a certain number of units in a building where a pro forma becomes part of the exchange of information in viewing/considering a property? I’m hoping to start with a duplex and wonder if a pro forma is something I should be asking about? That’s two units but perhaps pro formas don’t factor into this until, for example, five units (to follow the banking mortgage distinction between commercial and residential?

    • Ben Leybovich

      Tom – Pro Forma is just a packet of information. Larger properties usually come with a summary of all of the numbers. Duplex is no different from 200-unit in that you should take notice of what the current expenses are, but you should still underwrite to what you think your expenses will be 🙂

    • Ben Leybovich

      I’ve purchased 4 apartment houses. I’ve pulled money for all of them. Plus SFRs. They’ve all been under $500,000 – analyzing deals every day looking for the big one 🙂

      I am in the no man’s land in that smaller deals don’t make a significant enough impact any more to justify themselves, but bigger stuff – someone always wants to pay more. Their objectives are different from mine it seems 🙁

  8. Adam Stanton

    Large unit deals are a rarity these days. And that’s nation wide, I do not think apartment buildings can be analyzed locally due to giant asset houses like blackrock and others literally buying multiple portfolios site unseen for cash. My opinion, building up a decent stock of sfh that have decent cash flow is the way to go.

    Those who are syndicating are not doing so at the pace they’re use to. One team I know got out all together and moved over to the development side. Great money but takes forever and carries much more risk.

  9. Brian P.

    I am surprised at the large amount of buyers not requesting copies of the sellers tax returns for the property for the past few years (get directly from the IRS, seller signs request form) and watch a lot of fiction disappear. Seller says no, I politely say you mean these numbers don’t match what is on your tax return? I have yet to meet a landlord who overstated income and understated expenses on their tax return. Your not asking for the entire return, just the schedules applying to the property. Yes, doing real estate for 60 years has taught me that buyers are liers and sellers are worse is something to always keep in mind. Just like boxing it is always a good idea to keep your guard up, and not receive that sucker punch.

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