You're using the wrong expense assumptions...
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Gino BarbaroPro Member
Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votesHi max
I think it depends on the market as well as the asset type. I own C properties in Knoxville, TN. When I refinanced the property, the bank assumed a 3,600 per unit expense figure for 136 units. They were pretty close. We try to run between 3200-3800 per unit. We just purchased a B in the same market and the expenses may run a bit higher because of the amenities, higher taxes.
I use a 50% rule of thumb for expenses as a percentage of total income. If you see a property running above 60%, then you may have an expense play. Anything below 40%, then you are looking at self storage or a dishonest or disillusioned seller.
Gino
56 Replies
- Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes10y
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
- 10yGino BarbaroPro MemberRental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes
Hi max
I think it depends on the market as well as the asset type. I own C properties in Knoxville, TN. When I refinanced the property, the bank assumed a 3,600 per unit expense figure for 136 units. They were pretty close. We try to run between 3200-3800 per unit. We just purchased a B in the same market and the expenses may run a bit higher because of the amenities, higher taxes.
I use a 50% rule of thumb for expenses as a percentage of total income. If you see a property running above 60%, then you may have an expense play. Anything below 40%, then you are looking at self storage or a dishonest or disillusioned seller.
Gino
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Logan Hassinger:
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
So you're saying in a four family home, you put aside $8,000/year for the building. So in 10 years you have saved $80,000 to put towards a new roof, new water heater, furnace, windows, siding? Not sure that makes much sense to me.
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Gino Barbaro:
Hi max
I think it depends on the market as well as the asset type. I own C properties in Knoxville, TN. When I refinanced the property, the bank assumed a 3,600 per unit expense figure for 136 units. They were pretty close. We try to run between 3200-3800 per unit. We just purchased a B in the same market and the expenses may run a bit higher because of the amenities, higher taxes.
I use a 50% rule of thumb for expenses as a percentage of total income. If you see a property running above 60%, then you may have an expense play. Anything below 40%, then you are looking at self storage or a dishonest or disillusioned seller.
Gino
When you say $3800/unit of expenses, is this including taxes, insurance, utilities if you pay them, repairs & maintenance, capex? So you're saying that in a year on your 136 unit building, you set aside $516,800 per year for expenses? Doesn't seem right.
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
The expense assumptions I use are as follows:
10% CapEx, 10% Maintenance & Repairs, 10% future PM, 8% vacancy. This gives me a total of 38% of gross rents expense assumption.
I ALSO include the actual tax, insurance, water bill, and energy bill associated with the building. When I do this, it's very difficult to find a property that cash flows. I then thought I needed to bring down my expense assumptions to 22% since that mimicked more of how my properties are currently operating. The properties I invest in are in Class A areas.
Then when I watched Leybovich's webinar he basically uses 42%-45% of gross rent expense assumptions. So now I'm really racking my brain on the best way to assume my expenses.
I'm trying to determine the best assumptions to use for really the main 4:
CapEx
Maintenance
PM
Vacancy
- 10yGino BarbaroPro MemberRental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes
Hi Max
3800 comprises all operating expenses above the NOI number. We are around 3600, which is 490,000. Revenues are about 90,000 per month.
Cap ex falls below NOI. We use 250 per unit per year as a rule of thumb. 34000 per year, or about 3000 per month. We just refinanced the property and funded cap ex and used a good chunk to repair the driveways and paint the exterior of the buildings.
Hope that helps
Gino
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes10y
@Max James - thanks for hopping on the webinar. I'm glad to hear you found some value in it.
@Logan Hassinger - your statement that "you try to stay away from assumptions, and stick to actuals..." is dangerous. Why, because experienced players like @Gino Barbaro will tell you that all expenses are fixed, and very often what we know them to be is rather drastically different than what's being sold to us by the pro-forma.
If you consider, for example, 10,000 C class units within a specific tri-state area, you will notice that pay roll averages x, R&M averages y, utilities average z, etc. That's our starting point - we underwrite to those averages, and we make adjustments for specific mechanical make-up and other issues relative to specific property.
Bottom line is that regardless of what the other guy says he's done in the last 3 years, we know that on the average things should cost xyz, and since this is a numbers game, all things equalize over time.
- 10yGino BarbaroPro MemberRental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes
Hi Max,
Keep listening to @Ben Leybovich, he knows his stuff
when you purchase as asset, we buy on the actual numbers the property is performing at. We hope the property is being run inefficiently. That is a value play. You use your assumptions to see if the expenses are high.
We know we run properties more efficiently, due to economies of scale. We get better pricing with vendors such as garbage, bookkeeping and landscaping and we self manage at a reasonable %. We also institute RUBS (ratio utility billing) to recoup a portion of the utility expense. I am surprised at how many operators leave this money on the table.
Bottom line: Know your market and what it will cost you to run the property and look to find properties that have higher expenses and fall short of revenue.
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Gino Barbaro:
Hi Max
3800 comprises all operating expenses above the NOI number. We are around 3600, which is 490,000. Revenues are about 90,000 per month.
Cap ex falls below NOI. We use 250 per unit per year as a rule of thumb. 34000 per year, or about 3000 per month. We just refinanced the property and funded cap ex and used a good chunk to repair the driveways and paint the exterior of the buildings.
Hope that helps
Gino
Gino, thanks for the information, definitely helps. Bottom line, in order to tell the story of how the building operates, it sounds like the pros don't just use the simple, "10% capex, 10% maint., 10% PM, 8% vacancy". You guys pull information from your current buildings/other investors buildings and use that as input into the analysis on the next building.
The million dollar question is, where does one find those averages for ~10,000 similar buildings in one specific area? Ask the local PM companies?
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Ben Leybovich:
@Max James - thanks for hopping on the webinar. I'm glad to hear you found some value in it.
@Logan Hassinger - your statement that "you try to stay away from assumptions, and stick to actuals..." is dangerous. Why, because experienced players like @Gino Barbaro will tell you that all expenses are fixed, and very often what we know them to be is rather drastically different than what's being sold to us by the pro-forma.
If you consider, for example, 10,000 C class units within a specific tri-state area, you will notice that pay roll averages x, R&M averages y, utilities average z, etc. That's our starting point - we underwrite to those averages, and we make adjustments for specific mechanical make-up and other issues relative to specific property.
Bottom line is that regardless of what the other guy says he's done in the last 3 years, we know that on the average things should cost xyz, and since this is a numbers game, all things equalize over time.
Yes, Ben thanks for putting on that webinar. I'm a huge backer in regards to your standpoint on "why are more people not asking about how to properly value a rental property?". I think there is a good amount that goes into coming up with the true value other than simple percentages. And like you showed in the webinar, you can clearly make huge mistakes when running your analysis on a property and think a $200,000 property is worth $300,000 all based on your assumptions!
One thing that is difficult on these small 2-4 unit MF's is that they are obviously not appraised the same as a commercial building. I'm guessing a lot of owners of small multi families don't have their heads wrapped around the analysis portion and also are banking on appreciation. Some of these 2-4 unit buildings are selling like hot cakes at numbers that make ZERO sense. They will be negative cash flowing in a heartbeat. So I think the 2-4 unit market is pretty skewed when it comes to what the appraisal will say it's worth and what a seasoned investor would say it's worth. I think it makes this space even more challenging to find a good deal than the commercial space. Alongside the fact the market is ridiculously hot right now.
I like your example on the 10,000 Class C units within a specific tri-state area. If I had access to that kind of data say for properties performing over the past 5-15 years even, that would make my Property Analysis Tool much more credible. The idea of tweaking the analysis for each property too, depending on the condition, is also a great tip. If the roof was just replaced, you probably don't need to set aside as much CapEx... Or do you still want to considering you're going to need to replace it some day anyways? In 20-30 years you're going to get hit with replacing all of the CapEx items anyways, so why not just just account for 10% of gross rent going to CapEx through the life of the property. As for the maintenance and repairs portion, I could see this being tweakable more so than CapEx. Say the place has all PVC plumbing vs cast iron. You're going to have less problems with PVC and therefore less of a maintenance burden for that property.
So the million dollar question again is, where do you mine for all of that data on similar properties?
Thanks again for your input and participation, I find your standpoints to be very intriguing.
- Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes10y
For residential property (That means 1-4 units, not commercial apartment buildings) I never estimate repair or cap-ex expenditures. Over a large number of properties you can come up with numbers that will likely hold up...but over a sample size of 1...the numbers never hold true. They are better, they are worse...but they are never what you estimate.
District Invest Group546 Reviews - Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes10y
Originally posted by @Max James:
Originally posted by @Logan Hassinger:
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
So you're saying in a four family home, you put aside $8,000/year for the building. So in 10 years you have saved $80,000 to put towards a new roof, new water heater, furnace, windows, siding? Not sure that makes much sense to me.
No. But when those expenses come up, you MUST pay them, whether you've put money aside or not! Get it?...
- Investor · Coeur d'Alene, ID · Member since 2016 · 551 posts · 218 votes10y
In my area it's very hard to find a deal on a 2-4 unit property. And by deal I mean one that just cash flows. These units move fast but at prices that wont cash flow with market rents. It will be interesting to see how this effects the rental market, and if any of these properties will be back on the market any time soon.
- Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Russell Brazil:
For residential property (That means 1-4 units, not commercial apartment buildings) I never estimate repair or cap-ex expenditures. Over a large number of properties you can come up with numbers that will likely hold up...but over a sample size of 1...the numbers never hold true. They are better, they are worse...but they are never what you estimate.
Thanks for the input Russ!
So could I ask how you analyze a 2-4 unit building if you don't take into account cap ex and repairs?
- Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes10y
@Max James I will generally take the total rents, subtract the PITI, and then want my left over cash to be a certain percentage of my down payment. The percentage will vary by where the property is located, and the percentage is generally pretty high. So as long as that cash flow is sufficient, I know that after cap-ex and repairs takes a bite out of it I should hit a good return.
District Invest Group546 Reviews - Investor · Cincinnati, OH · Member since 2015 · 229 posts · 50 votes10y
Originally posted by @Brent Coombs:
Originally posted by @Max James:
Originally posted by @Logan Hassinger:
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
So you're saying in a four family home, you put aside $8,000/year for the building. So in 10 years you have saved $80,000 to put towards a new roof, new water heater, furnace, windows, siding? Not sure that makes much sense to me.
No. But when those expenses come up, you MUST pay them, whether you've put money aside or not! Get it?...
Let's look at these numbers when running an analysis on a 4 family building, with this $2000/unit/annum.
If one were to use $8,000/year as JUST their CapEx assumption on a 4 unit building, here is how it would pan out. In a month that would mean you're setting aside $665 in CapEx, setting aside more money for repairs and maintenance (say $250), paying a PM (say $250), and setting aside money for that vacancy (say $200) per month. That's $1,365 for just those items, not to mention your water bill, taxes, insurance, and energy bill. Then your principal and interest. Once you ran all those numbers, do you think you're going to ever find a positive cash flowing property? Does it make sense to use $8,000/year as just your CapEx assumption when you are analyzing your prospective property in your excel tool?
- Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes10y
@Max James, if $8k is too conservative, then use a more realistic number. Simple.
- Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes10y
Here is my most recent deal from August of last year that I purchased with 20% down at 170k:
4 units : $650/unit
$2,600 Gross Rents
Gas: $70
Water/Trash: $150
Taxes: $228
Insurance: $123
Buildium: $40
CapEx/Maint. Reserve: $500
Debt: $740
Once my reserve account hits 6k, I will no longer allocate cash to that account and will treat it as cash flow. I do not continue to build that account as you alluded to earlier.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes10y
Originally posted by @Max James:
Originally posted by @Brent Coombs:
Originally posted by @Max James:
Originally posted by @Logan Hassinger:
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
So you're saying in a four family home, you put aside $8,000/year for the building. So in 10 years you have saved $80,000 to put towards a new roof, new water heater, furnace, windows, siding? Not sure that makes much sense to me.
No. But when those expenses come up, you MUST pay them, whether you've put money aside or not! Get it?...
Let's look at these numbers when running an analysis on a 4 family building, with this $2000/unit/annum.
If one were to use $8,000/year as JUST their CapEx assumption on a 4 unit building, here is how it would pan out. In a month that would mean you're setting aside $665 in CapEx, setting aside more money for repairs and maintenance (say $250), paying a PM (say $250), and setting aside money for that vacancy (say $200) per month. That's $1,365 for just those items, not to mention your water bill, taxes, insurance, and energy bill. Then your principal and interest. Once you ran all those numbers, do you think you're going to ever find a positive cash flowing property? Does it make sense to use $8,000/year as just your CapEx assumption when you are analyzing your prospective property in your excel tool?
I think a lot of things need to be clarified here, which have no been as of yet. There will be a big difference between expenses as a % of rental income between a SFH, 4-plex, apartment building, and condo -- for obvious reasons. Ben's experience is in the apartment multifamily space. I can tell you that for my condos which rent for about $1800/month, have a fixed $450 maintenance fee, no "roof", no heater, no A/C, with just a fridge and washer/dryer. There is no way expenses can be 40% of rent. My experience has been the maintenance fee plus <<5% for repairs and CapEx, even if you want to do a 10 year study or multivariate regression analysis like Mr. Leybovitch suggested ;)
The type of asset, Class of tenant, location, age of building, etc. all matter and so do many more things. The expenses as a % of rental income will vary widely.
- Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes10y
Originally posted by @Andrey Y.:
Originally posted by @Max James:
Originally posted by @Brent Coombs:
Originally posted by @Max James:
Originally posted by @Logan Hassinger:
I steer away from assumptions and do my best to determine actuals. Be resourceful when obtaining them, talk to others in your market, and experience will add to better numbers when analyzing deals.
When it comes to CapEx @Ben Leybovich and @Serge S. have put together a great article that shows the math in regards to replacement costs and life span of each. I leveraged what they put together and determined for my market I like to assume 1.5k-2k/unit/annum. Simple percentages plugged in to a spreadsheet are just that, estimates. You need actuals or you maybe one surprised Multifamily owner with cash flow you didn't expect.
Good luck.
So you're saying in a four family home, you put aside $8,000/year for the building. So in 10 years you have saved $80,000 to put towards a new roof, new water heater, furnace, windows, siding? Not sure that makes much sense to me.
No. But when those expenses come up, you MUST pay them, whether you've put money aside or not! Get it?...
Let's look at these numbers when running an analysis on a 4 family building, with this $2000/unit/annum.
If one were to use $8,000/year as JUST their CapEx assumption on a 4 unit building, here is how it would pan out. In a month that would mean you're setting aside $665 in CapEx, setting aside more money for repairs and maintenance (say $250), paying a PM (say $250), and setting aside money for that vacancy (say $200) per month. That's $1,365 for just those items, not to mention your water bill, taxes, insurance, and energy bill. Then your principal and interest. Once you ran all those numbers, do you think you're going to ever find a positive cash flowing property? Does it make sense to use $8,000/year as just your CapEx assumption when you are analyzing your prospective property in your excel tool?
I think a lot of things need to be clarified here, which have no been as of yet. There will be a big difference between expenses as a % of rental income between a SFH, 4-plex, apartment building, and condo -- for obvious reasons. Ben's experience is in the apartment multifamily space. I can tell you that for my condos which rent for about $1800/month, have a fixed $450 maintenance fee, no "roof", no heater, no A/C, with just a fridge and washer/dryer. There is no way expenses can be 40% of rent. My experience has been the maintenance fee plus <<5% for repairs and CapEx, even if you want to do a 10 year study or multivariate regression analysis like Mr. Leybovitch suggested ;)
The type of asset, Class of tenant, location, age of building, etc. all matter and so do many more things. The expenses as a % of rental income will vary widely.
What's your point? Max already laid out all that in his original post: "you can drastically come up with a different valuation of a property ALL based on your assumptions. The expense assumptions are more than just simple percentage, it begins with the story of the property"...
(Although how he concludes that we're all using wrong assumptions - blowed if I know)!...
- Investor · Rochester, NY · Member since 2016 · 477 posts · 426 votes10y
Originally posted by @Max James:
The expense assumptions I use are as follows:
10% CapEx, 10% Maintenance & Repairs, 10% future PM, 8% vacancy. This gives me a total of 38% of gross rents expense assumption.
The month-to-month PM fee may only be 10% of gross, but in reality it will run more like 12%-14% due to lease-up fees, service call surcharges and all the other little things you'll get charged for.
All of my other assumptions are the same as yours when I'm penciling deals, and I have found very few properties that meet my requirements at these expenses. I'm closing on one in a month, and have been actively looking for the next one since before offering on the first.
From listening to people much smarter than me talk about it, and from what I have seen myself, it seems like we're near the top of the small multifamily market right now. In some areas this may very well be driven by a lot of out-of-state investors, especially from the big markets that prices have gone crazy in. I think this makes it especially tough to find deals on the MLS, but they are still out there.
So I keep scouring the MLS, I'm looking at starting to do some targeted mailings, and sometimes I just wonder if it woulnd't be a decent idea to just pile money up and wait for the market to come back down a little.
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes10y
Interesting conversation. Remember guys - my point of view come out of 10 years of property ownership. If you happen to disagree with my assertions, but you haven't owned property for more than 2 or 3 years, perhaps you will come around closer to my thinking in a few years.
Condos have been mentioned for their more stable OpEx. Wait - one day you may get a letter from the association which informs you that the decision has been made to make upgrades to the roof/windows/parking lot surface/etc. and ask you to write a check... no miracles in this world - things get old and have to be upgraded in physical property, and this will be your version of CapEx. And if you are not setting moneys aside, it's a mistake :)
- Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes10y
Sorry guys but the margins just aren't there for property management in this small Multifamily space. Now if you want to factor in that expense when your running deals so that your valuation comes in lower, fine, but I just don't see PM in the picture until you hit a significant number of units to support it. That maybe hiring your own part timer to field calls and other minor tasks, but the real PM costs of 12-14% when its all said in done is much to high. I work a 45-50 hours a week and self manage my little four-plex and will soon be adding another.
The reason I can do this is becuse the type of property I buy attracts the type of tenant I want. Low maintence, predictable, and therefore, income stream is reliable.
- Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes10y
Do you have a threshold on the CapEx Reserve account as I mentioned earlier that I'll look to stop funding that account once it hits $6,000?
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes10y
Originally posted by @Logan Hassinger:
Do you have a threshold on the CapEx Reserve account as I mentioned earlier that I'll look to stop funding that account once it hits $6,000?
Sure, but it depends on the newness of the mechanicals, the tenant class, the rate at which you can re-capitalize, and other things. Simply put, a decent turn of 1 unit, which involves replacement of flooring materials (and this is based on @Serge S. and mine combined ownership of over 100 units), is easily $3,000. A turn with an upgrade of other finishing textures, water heater, HVAC can run $6,000 - $7,000 easily. And, of course, who you get in your units will have a lot of impact on how long stuff lasts...
So, as you look things over in your building, just ask yourself realistic questions. In the end, it's better to be over-capitalized than under-capitalized! You can show-string the operation if there's no other choice, but not forever...
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