Not sure if you guys listened in on Ben Leybovich's webinar last night, but I have to say I agree with him.
He showed how 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, as Ben put it.
What do you typically use for your expense assumptions and why do you use them?
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
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.
I completely agree, but I still evaluate deals with the cost of PM factored in. For as long as I plan on self-managing that's money I'm just paying myself to do the job. When I get to a point where it makes sense to either employ a PM or shop it out, I'll still be getting the returns I want. I don't want a deal to only be a deal because I'm the one managing it, if that makes any sense.
Thanks Ben, I completely agree, tenants can move your turnover costs drastically along with the required fix of mechanicals. My last turnover with eviction was 1,700. So right in line with what your talking about.
Makes perfect sense and I do the same. Just wanted to put it out there for the others to be aware of.
Thanks Ben, I completely agree, tenants can move your turnover costs drastically along with the required fix of mechanicals. My last turnover with eviction was 1,700. So right in line with what your talking about.
Makes perfect sense and I do the same. Just wanted to put it out there for the others to be aware of.
Of course it was in line, Logan. What people don't understand is that people have been doing turns, evictions, rehabs for a very, very long time and over millions of units. On the average, this stuff costs what it cost - period. There just isn't any way to game that system on any kind of scale. The OpEx are not % of GOI - they are fixed $$ costs!
The value of experience.
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.
Logan, thanks for the example!
If your gas bill is for the water heater and/or furnace, that's a really great price you guys pay out in your part of the country. Also your taxes are awesomely low too.
So I ran your numbers through my Property Analysis Tool I created in Excel with my assumptions that I have been using to run my analysis up to this date. I ran your inputs, not your Capex/Maint. Reserve/Buildium Numbers. So we know your utility/insurance/taxes/water costs. Those are numbers that we KNOW are probably accurate (since you pulled them straight from your energy company/water company by calling them up). Now, the premise of this whole post, time to start ASSUMING things...
Here are the expenses that I have been assuming when running my analysis:
10% CapEx: $260/month
10% Repairs & Maintenance: $260/month
10% Future PM: $260/month
8% Vacancy: $208/month
So I'm calculating that per month your PITI ($1,092) and all of your expenses will total to $2,300/month. With your $2,600/month of rent, you will be cash flowing $300/month or $3,606/year on this building with those expense assumptions.
You will be seeing exactly a 10% Cash-on-Cash Return and your CAP Rate would be 7.35%
Now, if one were to assume the expenses were only 22% of gross rents (as opposed to the 38% I assumed above), then you'd be looking at these results:
Cash Flow: $716/month or $8,598/year..........ROI or Cash-on-Cash Return 24%............CAP Rate 10.28%...............
So as the theme of this forum continues, I guess we see it all depends on locality and what the history of expenses are (for a large quantity of similar properties).
The million dollar question again is, where does one get information on 10,000 similar units in your area..........? I'm thinking 10,000 was used by Ben as just a number he was throwing out there. Maybe it's more realistic to gather this data for 100 similar units in the area over the past 5-15 years as opposed to 10,000.
just a few things to look at .
1. Your annual assumption of vacancy is 2,500. However you have deposits right?
2. A stable 4plex is not going to run maintenance of 2,500+.
I believe Ben is referring to 10,000 units. You need to talk to big operators to get those figures. They are out there.
I cash flow 750/month and it will jump to 1200/month later this year once my reserve account hits 6k.
One important thing to remember when thinking about expenses as a percentage of rents is that everyone comes from a different market. When @Ben Leybovich and @Brandon Turner talk about 10% for CapX that is on relatively inexpensive properties in Lima, OH and Podunk, WA. A water heater costs about $800 whether the unit rents for $800/month like in their markets or $1600/month like in my market. A unit that rents for twice as much does not necessarily cost twice as much to maintain.
Taxes and Insurance and PM and other costs might track rents, but CapX and repairs are pretty stable throughout the country, so expect these expenses to be a lower percentage of rents in more expensive markets.
I personally added up all of the capital improvements to a "standard" unit in my area and divided by the life expectancy (conservative) and came up with 7% of rents for a "standard" unit in my area. But this number isn't very useful over time. If I have a property in a high demand area and rents increase by 50% my CapX isn't going to change.
One important thing to remember when thinking about expenses as a percentage of rents is that everyone comes from a different market. When @Ben Leybovich and @Brandon Turner talk about 10% for CapX that is on relatively inexpensive properties in Lima, OH and Podunk, WA. A water heater costs about $800 whether the unit rents for $800/month like in their markets or $1600/month like in my market. A unit that rents for twice as much does not necessarily cost twice as much to maintain.
Taxes and Insurance and PM and other costs might track rents, but CapX and repairs are pretty stable throughout the country, so expect these expenses to be a lower percentage of rents in more expensive markets.
I personally added up all of the capital improvements to a "standard" unit in my area and divided by the life expectancy (conservative) and came up with 7% of rents for a "standard" unit in my area. But this number isn't very useful over time. If I have a property in a high demand area and rents increase by 50% my CapX isn't going to change.
Jake - you are missing my point all together, and making it for me, all at once. What I am saying is that most of these OpEx and CapEx are fixed costs, and should be denominated in $$ not %. Precisely for the reason you indicated, underwriting these as % can be very misleading :)
Now - once you establish a dollar amount, then you can back out a %...
We're finally making some headway here.
I have to agree with you. When you have a sufficiently small portfolio of properties, you'll tear into your cash flow pretty quick if you include property management. However, always factor in PM costs so you can get out of the day-to-day management of said properties some day. And the property must CF with that PM cost on top, even if you're doing nothing more than cutting yourself a check every month for the "cost" of the PM. That's what I do. Now I don't spend that PM "check" I receive every month - I save it for the next purchase.
The real danger zone is between 10 and 50 doors. You can't afford to hire a FT person and yet you can't manage them while you're working FT. That's when a partner (or spouse) could be of big assistance. Split the responsibilities, time, etc.
Thanks Ben, I completely agree, tenants can move your turnover costs drastically along with the required fix of mechanicals. My last turnover with eviction was 1,700. So right in line with what your talking about.
Makes perfect sense and I do the same. Just wanted to put it out there for the others to be aware of.
Of course it was in line, Logan. What people don't understand is that people have been doing turns, evictions, rehabs for a very, very long time and over millions of units. On the average, this stuff costs what it cost - period. There just isn't any way to game that system on any kind of scale. The OpEx are not % of GOI - they are fixed $$ costs!
Exactly. I have a nine-unit building near several other apartment complexes. They charge about $125 less per month than me (because they are much smaller unit with one less bath). But if I replace the A/C, it's not based on the rent I get, it's based on the cost of an A/C unit. Those other owners are going to pay the same as me, too. Same with replacing a hot water tank, an heater, etc. The only variable is I have an extra bath and a much larger unit so turnover might cost more from a paint and carpet perspective.
But neither of those are priced according to the rents... they are what they are.
I seem to remember Ben having a spreadsheet which built in the cost of CapEX and was solely based on the components that made up the residence (maybe when you were talking about $30,000 pigs). That's the kind of analysis you need to do to determine what your "real" expenses will be.
With all due respect to Ben, let's keep in mind that ten years' experience includes a period with a huge housing bust which those of us purchasing now are not seeing those type of deals. Whether or not we are near a top in the market, or just a pause or continuance, the fact remains that there are far fewer (if any!) deals now of the type that were available in 2008/09/10. We need to be more conservative in our estimates because margins are going to be thinner right now. In my market there are basically no deals unless you have an inside track in some form. The other reality is that because there was a huge housing bust within the last decade there is also a lot of deferred maintenance out there. I can't imagine a lot of home owners in 2009 decided it was a good time to invest in a new roof or furnace or windows unless it was absolutely necessary to keep their home functioning or to sell. The end result is there is a bubble of sorts in capex working its way through many markets which is starting to come due now as we approach ten years from the major RE crash.
@Jason Slater, I'm not sure that it matters what environment we are in when it comes to finding opportunities. You may have to wait it out as a bad deal is worse than no deal. If you don't properly plan for these expenses, you'll be in trouble.
And it's like death by a thousand cuts.
Example - I just had a unit come available. The water heater is still functioning. But it was installed in 2003 (by the previous owner). There is no way I'm not changing that thing out during this turnover.
But I planned for it. Every month, I set aside money for these types of expenditures, and it doesn't matter if the unit rents for $1000/mo or $400/mo. In six years, I better have the $800 it's going to cost. I already know the roof needs to be replaced in the next five years. I've estimated what that's going to cost and am putting the money aside right now for that expense.
The "rules" of 10% for maintenance and 5-10% for CapEX are back-of-the-napkin stuff. Used to help quickly analyze an opportunity to see if you want to explore further. During the due diligence period is where it needs to get real and you are writing down exactly what your expenses will be using hard numbers (as only you can best estimate based on your area).
Not sure if you guys listened in on Ben Leybovich's webinar last night, but I have to say I agree with him.
He showed how 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, as Ben put it.
What do you typically use for your expense assumptions and why do you use them?
I think forecasting expenses/CAPEX as a percentage of rent is nonsense.
Expenses/CAPEX depend on the physical characteristics of the property, not on how much rent someone is willing to pay.
Just my two cents.
just a few things to look at .
1. Your annual assumption of vacancy is 2,500. However you have deposits right?
2. A stable 4plex is not going to run maintenance of 2,500+.
I believe Ben is referring to 10,000 units. You need to talk to big operators to get those figures. They are out there.
I cash flow 750/month and it will jump to 1200/month later this year once my reserve account hits 6k.
That's awesome, definitely some favorable numbers. Once your reserve account hits 6K, you will put that extra $350/month in your pocket for now. However, in 15-20 years, unless you sell, you're going to have to unload probably close to $30,000 for new roof, new furnace(s), water heater(s), and other various capital expenditure items. I understand it'd be silly to keep a reserve account of $30,000, or in some cases even $15,000, and use it for the next investment. It's just still the fact that you cannot avoid having to come out of pocket one day for new, expensive, items. Bookkeeping rental properties is quite the art I'm learning.
I have to agree with you. When you have a sufficiently small portfolio of properties, you'll tear into your cash flow pretty quick if you include property management. However, always factor in PM costs so you can get out of the day-to-day management of said properties some day. And the property must CF with that PM cost on top, even if you're doing nothing more than cutting yourself a check every month for the "cost" of the PM. That's what I do. Now I don't spend that PM "check" I receive every month - I save it for the next purchase.
The real danger zone is between 10 and 50 doors. You can't afford to hire a FT person and yet you can't manage them while you're working FT. That's when a partner (or spouse) could be of big assistance. Split the responsibilities, time, etc.
Yes I concur, hiring a PM with a small portfolio kills your cash flow, if you are indeed investing for cash flow. Now, I think if you setup the proper systems and put the right team in place, managing your 10-50 units while you work, say 2-5 hours a week on average to manage your business, is doable. And I think it can be accomplished with an assumption of closer to 3% of gross income. If you have the right systems. I think this is definitely when your business accumen skills come into play heavily.
@Jason Slater, I'm not sure that it matters what environment we are in when it comes to finding opportunities. You may have to wait it out as a bad deal is worse than no deal. If you don't properly plan for these expenses, you'll be in trouble.
And it's like death by a thousand cuts.
Example - I just had a unit come available. The water heater is still functioning. But it was installed in 2003 (by the previous owner). There is no way I'm not changing that thing out during this turnover.
But I planned for it. Every month, I set aside money for these types of expenditures, and it doesn't matter if the unit rents for $1000/mo or $400/mo. In six years, I better have the $800 it's going to cost. I already know the roof needs to be replaced in the next five years. I've estimated what that's going to cost and am putting the money aside right now for that expense.
The "rules" of 10% for maintenance and 5-10% for CapEX are back-of-the-napkin stuff. Used to help quickly analyze an opportunity to see if you want to explore further. During the due diligence period is where it needs to get real and you are writing down exactly what your expenses will be using hard numbers (as only you can best estimate based on your area).
Ron, thanks for the input, what assumptions do you use for your small multi family buildings in regards to maintenance/repairs, vacancy and CapEx?
Not sure if you guys listened in on Ben Leybovich's webinar last night, but I have to say I agree with him.
He showed how 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, as Ben put it.
What do you typically use for your expense assumptions and why do you use them?
I think forecasting expenses/CAPEX as a percentage of rent is nonsense.
Expenses/CAPEX depend on the physical characteristics of the property, not on how much rent someone is willing to pay.
Just my two cents.
Concur! Out of curiously, and for the sake of providing more data on this thread, what expense assumptions do you use for your small multi family buildings and why?
I think your still looking at it wrong be expecting every CapEx item to hit in one maybe two years of each other.
Let's say by September my CapEx account is at 6k. Then December rolls around and a furnace goes out. There's 1,750 pulled from my CapEx reserves. Now that units expectancy is 10-15 years. However, the other 3 units aren't all on that same time table. You're right in that over 20 years I'll probable shell out close 25k to keep the property running but it's not all happening in one year.
plus I'm always maintains a CapEx reserve balance of 6k so when the day comes that I have to withdrawal from that account, my cash flow steps up builds it right back up.
I'm protecting my minimum monthly COC of roughly 700.
It's all about cash management.
Hi Lane k, I would love to see cool cap ex spreadsheet !
I think your still looking at it wrong be expecting every CapEx item to hit in one maybe two years of each other.
Let's say by September my CapEx account is at 6k. Then December rolls around and a furnace goes out. There's 1,750 pulled from my CapEx reserves. Now that units expectancy is 10-15 years. However, the other 3 units aren't all on that same time table. You're right in that over 20 years I'll probable shell out close 25k to keep the property running but it's not all happening in one year.
@Logan Hassinger
I understand you line of reasoning, but also remember Murphy's law. This is a real example that got me very early in my investing career. Small SFH in Rural SC and one December we got 4" of snow. Unheard of for the area. The roof was 14 years old and in good shape, but aging. A 4" snow accumulation revealed several small leaks that had been present and missed prior and weak boards. Then with the combined heat running unusually hard for 5 straight days the heat pump took a dump.
Until this point I used similar numbers to you (I actually only kept $4,500 in reserves for repairs at the time). Over night I had a $3,500 roofing bill and a matching $3,000 HVAC bill. If I did not have the cash in my personal savings I would have bee in a bind, with a tenant in place who expected these to be repaired immediately. And if I couldn't have repaired them I could have been on the hook for alternative lodging costs to boot.
As my business has grown some I now keep larger liquid reserves and I use that hold back account as a fund for new property acquisition. My current floor on that account is nearly 10 multiples of what it used to be, but I have many more doors building it quickly. When it hits the magic number I allow it to grow unimpeded. And when it reaches the level to fund a new property (after the increased cushion the new property will dictate) I pull it and purchase.
At times I get frustrated because it doesnt allow my portfiolio grow as quick as I would like, but my style is essentially fool proof. I have rent reserves, minimal debt and repair reserves. I could lose my job tomorrow and have every tenant move out the same day and every unit need double normal rehab cost and I could repair them and service my business debt for 6 months without a penny of income. That is my standard. Same with my personal income.
There isnt a "right" or "wrong" answer here, per se. There is a risky approach that may or may not work and there is safe approach that will not fail. Which path you choose is a matter of personal taste.
Thanks for your input. Sounds like we have very similar strategys with conservatism being the top priority. I'm looking to add a Multifamily property every 1-2 years and build it slow and steady with more than sufficient reserves. I maybe sitting on more cash then necessary at times but like you said, use the excess cash to acquire additional property. Then compound the additional cash flow to quickly build the reserves.
I think your still looking at it wrong be expecting every CapEx item to hit in one maybe two years of each other.
Let's say by September my CapEx account is at 6k. Then December rolls around and a furnace goes out. There's 1,750 pulled from my CapEx reserves. Now that units expectancy is 10-15 years. However, the other 3 units aren't all on that same time table. You're right in that over 20 years I'll probable shell out close 25k to keep the property running but it's not all happening in one year.
Logan, I agree these expenses likely aren't going to hit all at one month or year or even decade for that matter. The point is, I think when we book keep an extra $350/month (or any amount for that matter) we're not actually gaining more cash flow. In the short term yes, that's an extra $350 to do whatever we want with it. Long term, assuming we hold the property forever, it ends up not being an extra $350/month and actually ends up being put towards replacements. Things like a fully updated kitchen and bath, in 20 years those will be outdated and need to be rehabbed.
I think when we save up a reserve account and hit a certain limit then stop feeding that account, we are just coloring money differently, when in reality it's still the color of capital expenditure.
I've only got a few years in this business with only 6 units so I'm definitely no expert, just my take on these aspects of REI from what I've learned along the way .. According to Malcolm Gladwell, it takes 10,000 hours to master many subjects!