Estimating expenses on apartment buildings

18 Replies

Hey everyone, I’m getting into small apartment investing, I’m looking for a 5-8 unit property at the moment, I’ve read people use the 50% rule, as a rule of thumb when making offers, does that generally include your vacancy expenses or do you add vacancy for your area on-top of that?

Also for anyone that buys apartment buildings, do you find the 50% rule is pretty accurate? If someone uses another method to assume expenses before doing their due diligence on the property to make offers I would love to hear it.

@Tyler Wisner

Get the historical financials for the past few years from the current owners and see what they have been running expense-wise. Then use your own judgement to create your own pro-forma. Oftentimes, the smaller properties have owners that do much of the work themselves, so bake in expenses to pay someone to do the work when you're underwriting. 

Vacancy, loss-to-lease, bad debt, and concessions would be added expenses in addition to using the 50% rule. 

50% is a good gut-check but it really comes down to how a property is operating.

@Mason Hickman

Hey Mason, appreciate the advice, when making initial offers though, on a property in an area with an 8% capitalization rate, would you use the 50% rule along with vacancy added on top to come up with an offer price to start with? (Assuming you did not have previous year expenses.)

@Tyler Wisner

Have you already asked for prior year financials?

50% can be very misleading and may not be enough if rents are far below market, if utilities are included and abused, or if there are abnormal expenses the current owners pay for, among other reasons. 

Based on my experience the 50% rule is pretty solid on single families and duplexes. I don't have experience with larger units, but looking at them and the rule seem to be good as well, at least in the area I am looking at. Depending on the area though, make sure th eproperty taxes are not a lot higher than you'd expect. Some areas have ridiculously high taxes. Build a 5-year projection for rents and expenses and see where you're at. 

@Tyler Wisner if you find a decent Excel spreadsheet analyzer, it will lay it out for you.

Total market rents (Research what market rents you should be getting pre and post renovation. Get the rent roll for current rents to check against)

- vacancy, bad debt, loss to lease, concessions

+ other income (pet rent, utilities bill back, laundry, etc)

- total expenses (50% quick rule of thumb, but ask for T-12, the trailing 12)

= NOI (divide this by the prevailing market cap for value)

- debt service for cash flow.

Hi @Tyler Wisner . I do think the 50% rule gets you in the ballpark on most deals and can help weed out the awful ones, but I would suggest really digging into the actual numbers at the property before making an offer. A variance in the expense ratio from 45%-55% could make or break a deal. You don't want to pass up a good one because you overestimated the expenses, but more importantly, you really don't want to buy one that turns out to be a cash-killer because you underestimated expenses.

1. not that you're asking, but I'd avoid 5 units. It's just over the threshold where you can no longer get residential financing, but not enough units to see the advantages of commercial financing. So you just get expensive commercial debt for what you're buying.

2. Rather than use 50% rule, consider picking up the phone, getting to know 2-3 prop mgrs in the area, and running your specific deals by them.  Your Q is "how much should this property cost me per year?" or "what should my expenses be on this property per year?"  They may say 'oh that property, with that vintage, in that neighborhood? That should cost you $4,000/unit/year' (or whatever number they say).  

ESPECIALLY if you have numbers from the seller, run those by your prop mgr, so they can verify if they're 'real' or 'fugazi' and trying to fluff up the deal.

 You'll soon get a take on the area, and the average expenses.  The reason that expense ratio can be deceiving on smaller multi's like that, is that a 6 unit that rents for $450/unit/month will have a different expense ratio than a 6 unit that rents for $850/unit/month in the same area. The more important number you may be looking for is 'how much will a property cost me per unit on average per year.'   THAT is a number that can make/break deals vs your expense ratio. 

Hope that helps. And great job getting out there and looking for properties!

@Tyler Wisner , my concern with the 50% rule, as others noted, is it is a rule of thumb.  An offer should be made once you review financials.  Now, if you are trying to ballpark whether asking is even remotely close to realistic, for a very surface level analysis it can work, but so can the 1% rule.

Before I make an offer, or if I am even remotely considering making an offer, you need to do a rough Capex budget (to be firmed up during due diligence) and financial review. Most properties in the areas I am interested in, can pencil based on the T12 (although make sure you adjust the taxes to your purchase price when analyzing) but are killed with deferred maintenance: roofs, furnaces, windows, exterior maintenance, unit remodels, etc are never remotely accounted for in sales packages or pricing.

I think the 50% rule is just a tool to make quick offers and weed out garbage deals.

You can also reverse engineer it to adjust the offer price so that the numbers work.

But it doesn't replace actual research and due diligence. Your inspection period should give you time to research and calculate the numbers.

You should use actual financials, as others have mentioned, for the final bit of analysis. It's doubtful you'll get rent rolls or financial history unless you are under contract, but it's possible you can get that information sooner (or without being under contract).

I'm no expert though

I would spend some time learning how to analyze multi fam properties like the pros.....  You can find a good commercial agent to help you  (which I think is really the only way to go) and you can pick up "What Every Investor Needs to Know about Cash Flow"

no simple "rule" is going to get you the knowledge you need....  you need to be educated so you can hopefully pick a good investment.  Good luck :) 

ETA I would never rely on a property manager for investment advice.  Also, if possible learn how to manage your own rentals.... 

@Rob Bassett  Great spreadsheet for larger deals but since Michael Blank is dealing in much larger properties, many of the assumptions don't ring true for a 5-8 unit building because the economies of scale just aren't there on the smaller deals. 

@Tyler Wisner @David A Lisowski Part of what will determine if actual financial information is readily available depends on who is brokering the transaction. If a commercial broker is selling the property, you are far more likely to get a T12 and a rent roll. With residential agents, you are far less likely to get this information.

I use the 50% rule for my large multifamily deals. It's a ridiculous estimation that misses a lot, so why even bother? It's easy and quick. Use this as the first tool to evaluate a deal. You will (should) be looking at many potential deals for that great one and the 50% rule helps you weed out the terrible ones. Most people interested in selling will tell you what they bring in annually in gross scheduled rents. Knock off 50% and you'll arrive at an estimated NOI, which you can use to calculate a value. If the seller's value is much higher than that, close the book and move on.

Once you've purchased it, your actual expenses should fall below 50%. Over time, you will have enough properties that you will know your typical expense ratio and you'll throw away the 50% rule and use your own.

The Expense Ratio is one of the quickest ways you can evaluate a deal, but don't just use it alone. Use it as the first of many tools in your evaluation. 

@Tyler Wisner , @Mason Hickman , great advice getting actual numbers and not basing your numbers on pro formas....6 units plus for commercial loans have the benefit of basing the financing on the performance of the property and not as much on your personal crediit.

Syndication involves sec rules and more investors to your properties. Nothing to be scared of, just educate yourself.

Your due diligence is key as you already know Tyler...You own properties. learn about emerging markets also.... just helpful tips.

I find no harm in learning more about larger properties and the deal analyzer only works based upon your numbers inserted. I paid for it. I own it. Michael is not out to sell you a bunch of stuff and 1000s of dollars invested unless you want his personal coaching.  One time fee of 129. I have no financial interest in his product.

Hope this is helpful,