Fixed vs. Variable expenses - Property taxes

9 Replies

Hey folks. I current own in IL - 2nd highest property tax rates in the country. Like any business, in MF real estate, not all costs are the same. Meaning all else people equal, if you're looking at 2 deals, both 8% caps, in IL vs IN.  The IL property naturally has a higher portion of its costs dedicated to property taxes.  So, as I think about protecting on the downside, if vacancy increases, there's simply less levers to pull if my property taxes are fixed (Yes, i understand they can be contested, but even if successful, its not moving much).  The hypothetical IN property would likely have more variable costs to adjust, providing more downside protection.  I haven't seen much discussion about this and given my state and my neighboring state are so different, this can potentially change my strategy. 

I have clients that buy retail properties. IL does have very high taxes as I have clients there. They try to focus on good areas that are not too high on property taxes yet compared to rents.

With retail strip centers the tenants reimburse property taxes with the rent. It can still be an issue because if taxes go up to much then it can make CAM expenses to high for the tenants above the base rent. Multifamily 4 to 5 years ago was a good value. You have low property taxes, low rents, high cap rates to compress, utility expenses were manageable,etc.

These days cap rates are low for the good areas, most rent growth has already happened, counties and cities are out like crazy raising property taxes and even if you appeal and win they still go up some, and utility companies like water even with no leaks are raising the water and sewer per gallon usage rates because they kept flat in the down turn.

If you add all of these things up for the yield versus more passive commercial assets I do not like multifamily at this point in the cycle as much as I did 4 to 5 years ago. For what I have to do versus the yield I get with MF it does not excite me. 

Thanks for the insight Joel. Agreed on all fronts, the trouble is 4-5 years ago (the great recession) was, I believe a once-in-a-generation opportunity...one that I missed from a real estate perspective unfortunately (though I did invest heavily in the stock market at that time).  I'm starting to look at neighboring markets like Indiana in which I can find very similar characteristics to places I invest (central IL), but with a different cost composition.  Sort of starting anew with a fresh market, but it'll be fun.

@Masroor Ahmed I own 20 units in Michigan but have a goal of reaching 150 as I grow my business. My objective is to own in 3 different markets. Preferably those are also located in different states. This way my portfolio has economic risk mitigated(downturn), and political risk(property taxes, tenant rights, etc.). The states that make sense for me right now are Michigan, Wisconsin, and Indiana. Indiana has the lowest property taxes of all the states. Its amazing the difference this makes. One thing I love about low property taxes is you have the opportunity to increase the price of a property much higher when you do a value add. As you said this is due to a smaller percentage of your value add getting taken away from the fixed cost of taxes. 

But don't just run to other markets for that one reason. I have identified my target areas based on personal goals, economic, political, and geographical reasons. All must be considered. 

Good luck! 

@Joel Florek . Totally makes sense.  I'm earlier in my process (own a 7-unit building right now).  I plan to get to 20-40 nits with my own capital, then raising funds.  What you're saying makes a lot of sense, though I'm not sure how much hedging you get from being in such close proximity. Meaning, for some of these places, the economies are tied together due to overlapping industries or metro centers like chicago or detroit, etc. That said, I think it makes a ton of sense. thanks for the insight!

Hey there @Joel Owens and @Masroor Ahmed !

I could not agree more with your issues with Illinois property taxes! I recently purchase my first multi-family property in Lake County this past March, and since then the taxes had increased to $14,700 which is absolutely absurd! 

With this cruel reality awakening, I have certainly adjusted my REI plan and have shifted focus to the Milwaukee market and southern Wisconsin along the border. With annual tax hikes of 15%+ year over year in the DuPage, Lake and Cook County markets, it is only a matter of time until expenses far surpass a point which market rents can be raised too.

Best of luck!
Patrick

But don't just run to other markets for that one reason. I have identified my target areas based on personal goals, economic, political, and geographical reasons. All must be considered. 

Good luck! 

Joel, I absolutely love the fact that you state the above. Being new to the REI world and only have closed on one multi-family property thus far, I have suffered the confusion of jumping from "shiny object to shiny object" and not dialing down precisely what kind of investing I'm truly interested in being (MF, SFR, Rent to Own, Commercial). Do you have any suggestions on how to better come to this realization rather than "learning from experience" and trying multiple different avenues to see what interests me most?

Thanks much!
Patrick

Masroor,

Take a close look at Indiana. I live in the Northwest Part,( Hammond, Merrillville, Crown Point), about 40 minutes from Chicago and do business in both states. The taxes are far below Illinois. There are many opportunities out here for B&H's and Flips, and we have properties for $40k  up to $500k and everything in between. That was a "run on" sentence, wasn't it? lol. Good Luck!

@Patrick Roob Thanks! I started out my research before buying properties to think about what type of lifestyle I wanted. That included traveling, not fixing toilets(although in the beginning it is necessary sometimes), and building wealth of +$5m. I then turned to look at investors who were out in the world and looked at their lifestyles. The ones who were living the lifestyle I wanted for myself and achieving the financial goals that I want to achieve all owned multi family real estate. I also noted that they didn't own small duplexes, or triplexes. Typically they owned 8+ unit properties and the ones who I really idolized owned 20+ unit properties. 

Needless to say I took that as my lesson to focus on multi family real estate and scaling up to own larger properties. I started out with a 4 and then bought a 16 unit property. I am trying to find a 20+ unit property next and have a goal of 150 units to achieve the +$5m goal. As of now I am 13.3% of the way towards my goal from a unit standpoint and 17.5% of the way towards the goal for the value of my portfolio. 

Needless to say I am learning lots as I go still and you can never get away from learning by experience but I feel like I avoided potential 3 to 10 years of investing on the wrong path. 

Some perspective from someone who is completely unfamiliar with your market:  Taxes aren't fixed.  They also aren't variable... they just go up.  In my opinion, since we put taxes in our calculators as a fixed cost... when they do go up, the value of the property goes down.  The taxes are not to blame for the properties in your area not making money.... it's the government who's to blame for using taxation to eventually drive down property values which will hurt themselves in the end.  

From an investor's perspective, I wouldn't focus on the taxes so much as looking at the deal as a whole. When I calculate income from a MFR, I make sure there's a 30% margin between income and expense... this is where my comfort level is, regardless of weather the rents drop or the taxes go up. As far as taxes go, you probably have a better chance of them not going up more in an area where the tax hikes are already hurting property values, whereas if you buy property next door where taxes are low, you might getting in just before taxes get raised there.

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