How can you accurately calculate operating cost for the ROI?

Question

Hello everyone. My name is Vincent. I'm 26 years old and am currently working in the medical field for the Navy but my future goal is to own multiple multi family apartment complexes along the East coast.   I've been reading a lot about how important the numbers are when it comes to finding the right property but how can you accurately calculate operating cost and up keep for the ROI if you haven't actually bought the property?

Jeff Copeland · Answer

Aside from looking at actual expenses for the property, many investors use a "50% rule" - meaning plan on 50% of your gross rents going to cover operating expenses. You should be able to do better, but this is usually close enough to analyze a deal (and conservative enough to keep you out of trouble on one).

If you see a property being advertised with expenses at 10% or 20% of gross rental income (which I see all the time), something is usually missing from the formula on the expenses side.

Jeff B. · Answer

Copeland has it right.  The '50% rule' is a conservative benchmark and ok for estimates, but when you make an offer and require the Approval of PnL & two years Sche-E you will get the truth.  This is when you tell if the property is falling down or well run.  We use the contingency to escape when necessary.

Personally, my 6-plex ran at a 35% expense rate for years.

Cherie Ganesh · Answer

First I'll disclose that I'm a commercial broker in Memphis who doesn't do apartments.  However I have had significant formal training on investment analysis during my career and by teaching it in the classes offered by the CCIM Institute to standardize methods of investment analysis and to provide a professional designation as a CCIM (Certified Commercial Institute Member).  I highly suggest that as a budding investor that you take some time to take at least the basic course in that curriculum which can be done online or in a classroom which is a four day commitment of your time. I have had many investors take the courses just so they develop a strong understanding of calculating alternative investment opportunities and learn how to analyze a market for forecasting rent increases or possible decreases.  I would also highly recommend that you pick a specific market area to focus on initially and find an experienced multi-family investment broker to help you look at various alternatives.  It can be very difficult to try to start out doing everything yourself.  I am always very conservative in any acquisition analysis I do which is usually retail and if there is more than 5  tenants, I build in a property management number even if I think I can do it myself.  At least I have given myself room for miscalculations I may have made instead of paring down the expenses too much.  As you add more properties your experience will assist you a lot in knowing how tight you can squeeze a projected budget and how to recognize when a seller has left items out of the budgets they initially provide you.  Once you're able to see either certified property records or tax filings, you'll see either the real expenses for the property or the fluffed expenses LL has included to get better tax treatment.  I love finding that stuff since he's now immediately lowered the value of his property and now I guess I have to use his higher expense number in my budget!!  Wow, looks like lower case flow on the property.....

Good luck in your endeavors.

Christopher Phillips · Answer

@Vincent Ames

You just ask for the trailing 12 month expenses. Not everyone will always have them, but organized owners usually do. If you see enough of them, they tend to be pretty close to each other for a given area. Utilities are pretty stable these days, so you're also looking to see if there are some inefficiencies somewhere that you can improve when you take over ownership.

Loyd Frazier · Answer

Hi everyone,  I know i am over simplifying (simple is best for me), just wrapping my head around the 50% rule.  For example, if the gross rent is $1000, i would guesstimate $500 in monthly expenses not counting P&I. If the mortgage is $600 it may be over priced, if $400 its a better deal. Also, if the rent is $1000 and the stated expenses are $200 a month, something is missing.

Sound about right?

Will Johnston · Answer

@Vincent Ames, you really have to pick a specific sub-market to figure this out.  Things like the 50% rule are helpful starting points, but the truth is analyzing deals using that as a guideline will cause you to miss out on some great deals.

For example, I invest in Washington DC, which is a pretty expensive area.  If I used the 50% number I'd never find a property that would work.  I'm at less than 40% expenses, and that 10%+ difference makes all the difference in the world.

Vincent Ames · Answer

Thank you James. This table is a great. I'll use it as my guide.

James Masotti · Answer

@Vincent Ames - Here is a good source for doing some bottoms up calculations on CapEx. You might need to tweak the numbers a bit for your local market though. For repairs you'll need to talk to property managers in your interested market to see what they run. The lower the rent the higher the percentage generally needed for repairs. Vacancies are also variable by market, but I generally try to crunch my numbers at an 8% vacancy. This means every unit is vacant for one month of the year for turnover. Obviously if you retain someone for a second year, have a waiting list,  or a unit takes longer rent out than a month all of these things can impact your vacancy. Anything less than 8% I treat as a bonus. Property management is going to depend on your local market but it's usually somewhere from 8-12%. Even if you are going to manage yourself you still need to consider this because at some point you'll have to stop managing yourself as you scale....or at the bare minimum you'll start paying yourself this fee. Then you need to add in utilities because things like water and electric aren't always sub-metered which means you'll have to pay for those things. Plus any additional services offered, such as WiFi, cable/satellite, snow removal, trash pickup, etc.

Start adding all these things up and that's why people say start with the 50% rule but then dig into the details during your due diligence phase.

Vincent Ames · Answer

Thank you everyone for the help. I never heard of the "50% rule" until now but I'll make sure to use that for now on when doing my calculations.

How can you accurately calculate operating cost for the ROI?

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