The Not-So-Obvious Problem with Billing Back Utilities to Tenants

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So, I did one of my scopes on Periscope this week. I do those now because I saw Brandon do a few and thought they were cool. I also saw Cardone do a few from his Rolls and figured that while doing my scopes from my Tesla isn’t quite as sexy (or perhaps more so depending on who you talk to), my personality makes up for it.

So, on that scope I was talking to them about utility bill-backs, and Brandon, who was good to jump on, said I should write a post for BP.

This will be short and sweet ’cause I am busy. But I promise you will learn something today, so pay attention!

Here are some of the things you’ve heard here on BP:

  • It’s a good idea to buy multifamily — you heard this from a certain adorable nomad-looking, bearded dude by the name of Brandon.
  • If you’re going to buy multifamily, it’s a good idea to buy below intrinsic value (which means value add) — you heard this from me.
  • One of the techniques of value add in multifamily is utility bill-back — you heard this from Brandon, Serge, me, and everyone else.

All of the above is true; however, all of the above require finesse. Let’s discuss utility bill-back!

keller-williams

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Concept of DTI

DTI stands for Debt to Income Ratio. Debt to Income Ratio, in its purest form, describes the relationship of one’s income to one’s debt. You’ve likely heard of this term if you’ve ever applied for debt.

Related: The Surprising Truth Behind Tenant Turnover

This article is not about the DTI, but I need you to comprehend the concept. The idea that someone can only reasonably spend a percentage of their income to pay for things in their life is an important concept that often gets lost in this conversation around value add.

For Example

Let’s say you have a 24-unit building, where you the landlord have to pay for the water and sewer, and those two utilities combine to about $2,400/month. The 2-bedroom units in this building rent for $425. The rent is low, which is a reflection of the economic realities in Podunk, USA where you live.

One day, after listening to Podcast 14 with Ben Leybovich, in which he talks about passing the cost of water to the tenants, you sit down and strongly consider charging each one of your tenants $50/month for water and sewer. No, this wouldn’t underwrite all of your cost, but it would help! So, here’s what you need to consider:

RTI

RTI stands for Rent to Income. I just literally invented this term as I am writing this. I mean, Brandon invents terminology all the time, and he always sounds cold when he does (BRRRR), as he should — it’s cold and dreary in Podunk. (Brandon — applause please.)

Anyhow, Rent to Income is a play on words of Debt to Income and is meant to underscore the reality that what people can spend on living expenses is a function of how much they earn. And if you push them higher than this margin, bad things start to happen — more on that in a minute.

Well, your rents (in Podunk) are $425/month. Why not $1,300/month? Because there are 3 factories and a hospital in Podunk, and that’s the extent of the economic base. That, plus McDonalds, plus Starbucks. And in this setting, $1,300/month is what most people bring home on a monthly basis, which explains why the market for your 2-bedroom units is only $425. You know — 3 times the rent. Common sense!

What About Bill-Back?

So $425 rent represents 33% of $1,300 take-home pay. Add to that electric, which the tenants are already paying for, and your tenants are already spending 50% of their monthly income on rent-related costs. And now you want to add another $50 on those costs — because you can.

Tell me — what happens to people when you push them too far? People break, right? Maybe not right away; perhaps they try the best they can to make it work. But eventually they break, and what happens then?

lawsuit

Related: Tenant Turnover: The Biggest Killer of Your Rental Cash Flow

Physical and Economic Vacancy

People move out, forcing you to spend money on turning the unit. Or what’s more likely, they simply default — stop paying rent — forcing you to absorb months of no rent, pay eviction costs, and still have to turn the unit. Are you seeing the picture?

More Income or Less Cost?

That is the question. Understanding that destabilizing the tenant base will cost money, what you have to figure out is whether the additional bill-back revenue will create larger spreads than the potential losses. It’s a numbers game and a judgement call.

This is a discussion of the economic environment you operate in. How much people can spend on life is a function of how much they earn. And while a water bill-back something you can do, the question is should you?

Investors: Do you bill back utilities to your tenants? Why or why not?

Let me know your thoughts with a comment.

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

34 Comments

    • Pamela H. Kinzey

      Sonia, there’s not much of a way to do that. I only go up on rent between tenants. As mentioned, any increase in their cost is likely to drive off a tenant, whether you call it rent increase or hand them a power bill to split and pay.. But if you are having a problem, you might mention to tenants that being frugal with utilities helps keep down the possibility of rent increase. That’s with mo. to mo. contracts, or people staying long term. But with a lease, you can’t go up during its term.

    • Pamela H. Kinzey

      True, If you split the cost of water at a duplex where one side is a single person, and the other is a large family with a kiddie pool, you will rightfully hear about it, but have no way of knowing a fair division of the cost. If you pay for water, you are likely to have more leaky faucets left unreported and hoses left running.

      The cost of getting the water co. here to convert to a meter for each side was going to be $2,000 per house. But I got lucky. Underground pipes burst, on the power company’s side, and, for some reason, when they repaired those, they decided to put in individual meters for my two duplexes there for free.

  1. julie oldham

    I have discovered a company that installs a water meter in-line on the pipe where the water enters each unit. It’s relatively inexpensive, monitored wirelessly, and makes sure each unit is only billed for the water actually used. I’ve found that with a direct correlation between use and cost, people are more frugal with their use. But when it’s a group billing, this mindset doesn’t exist. It’s so cost-prohibitive to have the city install water meters, I think this is a great alternative and will be implementing it as soon as I can get it installed. I agree with Ben, but this is perhaps a work-around?

  2. Hi Ben,
    One of your fellow BP bloggers recently video blogged about a similar subject. Before adding utilities to the tenants reonsibilities, you are correct an understanding of the finances has to be considered, including the cost of the utilities. Asking a tenant to pay for heat in an old inefficient property could be fiscally devistating, as you pointed out. If each unit is not separately metered, this could cause problems between the tenants. For example, for heat, if all are build the same percentage of the total bill, there is no reason to conserve, but, if they are not paying already, no need to conserve either. We ran into this with one of my parents properties. Solution that worked ok in this situation was upgrading the furnace, which reduced the costs of the heat and then forgoing rent increase substituting the cost of heat. There was still the occassional, fair share discussion, but it worked out.

    As the landlord you should include utilities costs in your rent ratios.

    Enjoy the Tesla, I hope to check out the Lima Supercharger this summer while driving through.

  3. steve g.

    this was a great article , because it underlines why you need to do your due diligence, to know what people can afford in a certain area. if the median income is 25,000 and rents need to be 1000 a month to make this property work, then its not really a good by no matter what price its selling for. .. i also love what you said at the end ( And while a water bill-back something you can do, the question is should you? ) My son and I were having a discussion the other day(not about real estate) but still, I made the statement Just Because You Can, Does Not Mean You Should.. so It appears to come up here in Real Estate as well, we always need to look a this equation, just because we can, does it mean we should.

    thanks for the post, loved it.

  4. Mehran K.

    Awesome article Ben! These are some of the things I consider also while thinking about rent increases on long term tenants that are below market rent. I’m going to share this with some of my partners/investors.

  5. serge s.

    Two key metrics you forget to mention … the competitive landscape is probably the most important part of the decision process. Are your competitors billing back water? Where are your rents in comparison to everyone else. On my 32 unit project I initiated water sub metering in a city where nobody else did it. Surprisingly it had absolutely no effect. The tenants paid and I added $200k to my complex value overnight. My rents were still in an acceptable range and my new tenants simply overlooked the bill back and focused on “rent.” At a 56 unit project I tried to institute the same program and my tenants revolted. I still raised rents to cover the cost of water but not via RUBS. They were more concerned with the cost variability than the actual expense. Lesson is to listen to your customers.

    • Ben Leybovich

      Well, here’s the thing, Serge. It’s one thing to create instant value – it’s something else to create sustainable value. I venture to say that while in the first 3 months after you instituted RUBS at that 32 unit it wasn’t immediately obvious how much it was stretching the tenants, it has since become more evident. Though, of course, it’s not your problem anymore…

      My point is – if they don’t earn enough to support the extra expense, it may not manifest itself in the economic losses on day 2, but it eventually will.

  6. John C. Carlson

    Good timing with the post of this article Ben. I had just this discussion with a landlord who owned the 8-units I appraised a week and a half ago. I would like to ask you to be able to copy this article so I have ammunition when I talk to the next landlord who is raising rents beyond his/her tenants ability to pay.

    This landlord was thrilled that the buildings that were competing with his had been able to increase rent and switched their tenants to pay utilities & he was joyfully raising his rents & setting his tenants up to pay for utilities. My rent survey showed his rents were only slightly below market.

    I asked him what the average income was of his tenants & after a few minutes looking at his Contracts, he said the average income was $2,000/mo. I tried to point out to him that by making his tenants pay utilities, it was going to have them paying at least 50% of their mo. income in rent + utilities; in one tenants case, 60% of their income in rent + utilities. My research thru many appraisals shows that 50% of tenant income is the breaking point of affordability.

    I pointed out that every landlord in this market was rapidly pricing themselves out of the tenant base ability to pay & all it would take would be for a hiccup to take place & tenants would leave for cheaper rent areas.

    The on-line info-magazine Curbed LA has had many articles like: “What/where $1400 per month in rent can get you”. Landlords are fat & sassy because they think people would have to go to Barstow to get cheaper rent & so they have to pay to live in L.A.

    But I’ve seen other cycles before in which job losses & a descending economy = a huge increase in vacancies. In my opinion, based upon my research conducted during my appraisals, landlords all over are pricing themselves out of their market areas & are going to pay for in vacancies when thus current up-cycle goes down

  7. Dave D.

    Bill-back doesn’t work for me. I have a property management company who handles my rentals and if we try to get reimbursement for a bill I paid the tenants simply do not pay it. Anyone else have this problem? If I can get the utility company or city to bill the tenants directly then they will pay. They will pay the rent and bills sent directly to them in their name but getting reimbursement for bills I pay doesn’t happen. I don’t do bill-back for this reason. If I can’t get bills sent directly to them I just put the cost in their rent. By the way this is my first time posting on here. BiggerPockets is very informative.

    • Ben Leybovich

      Thanks so much for jumping in, Dave!

      Yes, I think unless the utilities are separately metered, or submetered, or you go through a 3rd party RUBS company which bills the tenants directly, including this as part of the rent is the best strategy. It’s hard to collect otherwise, as you’ve discovered…

      • Brendan Morin

        Sounds like there are a lot of proponents of submetering here, but I’ve been a fan of the flat monthly rate. Dave, if you’re having issues getting tenants to pay, try a flat rate and make it due to you (or your PM) with the rent.

        A good rule of thumb: Making it as easy as possible for your customer to transact makes the customer much more likely to transact. That applies to a lot of things, but in this case, they’re already used to paying a set amount to you on a certain day every month, so structuring the utility payment to coincide with that in the same fashion makes it easyet for them to wrap your new bill into their routine.

        Lastly, I think it’s important to note that you don’t actually have to bill full utility costs if you don’t think your market can support it. Try billing half utility cost on a few tenants. Their response to that will tell you if it’s the fact that you’re billing or the price that you’re asking that makes the tenants noncompliant.

  8. Jerome Kaidor

    I wonder how RUBS plays in rent controlled jurisdictions? I may have to check into this. I have a building in Hayward, CA. The area rents have gone up so fast that the 5% per year I am allowed will take a decade to catch up. Also, California is in a bit of a drought, and the water bills are getting REALLY high. I have had
    reports of certain people running their showers for HOURS.

  9. Brendan Morin

    Great points here, Ben. The way I look at it, utility bill back is effectively a clever marketing strategy to get above market rents from your units without it feeling like above market rent to the tenant. One of my favorite ways to increase NOI with (usually) minimal effect on vacancy.

    Of course, I prefer to do it at turnover, primarily because of the reasons you mentioned – adding an extra monthly bill in addition to the annual rent increase can both strain the tenant financially and is likely to end up with you getting the middle finger and an unexpected vacancy.

  10. Joel Owens

    Utilities are an absolute killer to your cash flow. Most investors are not buying brand new product at 100k plus a door. Instead they are buying at 30k to 70k a door. These types of properties tend to be 20,30,40,50 years old or more.

    Back then water was cheap so most developers didn’t think anything about not separating it out and just including in the rent projections. Today water is called “liquid gold”. Tenants on average use about 30 to 35% more water when they do not pay the bill directly to the utility company. They do not report leaks and let friends and external family wash cars, do the laundry, take showers etc.

    Old plumbing and sewer in a building and the landlord paying for water can absolutely take a huge chunk of your cash flow. If it is not common for the area all things beings equal with rents etc. the tenants will not pay for water. You can try the RUBS and other things but tenants will fight back.

    I would rather buy a building where tenants pay all utility separate at a 7 cap then utilities included for a 9 cap. I am never buying a property with seller paid utility on multifamily. I would rather increase cap yield through saving on property insurance, fighting for a property tax reduction, adding amenities to increase income, etc.

    If you split the bill evenly among the units tenants fight and say that they did not use that much water for the tow of them and the people next door used triple the water. If you put separate meters from an external company the tenants sometimes do not trust your meters are accurate from the landlord. They tend to only trust a direct connection from the water company that bills them directly. Even if you use a water payback system the landlord still has to pay the whole complex bill. I have a friend with a 140 unit that automatically writes off 20% of the water bill knowing some tenants will not pay even when you sick collections on them. It was part of his underwriting when he bought the place about 5 years ago.

  11. lee Jackson

    I have been thinking about seeing if my tenants a willing to have a reduction in the rent, and take over the utilities. I have always paid the utilities, as the sfr has been rented as a duplex. Now I have a blended family living in the entire house, so no need to worry about splitting the utilities unfairly to 2 separate tenants. I guess I’ll need to have a chat…. great article!

  12. Mark Spidell

    Good topic. Very timely as we are coming to a point in the economic cycle where the sustainability of rent and housing related expenses for tenants is becoming an issue as rents go up but incomes are barely moving. Staying occupied will be key if we move into a recession. Hopefully we start seeing some income growth to help support higher rents, but it will pay to be prudent if that doesn’t happen.

    There is a bit of an art to being a landlord and understanding the economic reality of the tenants is a big part of that.

  13. Joe Splitrock

    I am glad this post was written, because when I have heard expert investors on BP suggest the brilliant concept of just billing utilities to tenants to unlock additional revenue, I always question the strategy. It really depends on the type of property. I found when I owned lower-rent multi-family that the class of tenant would have trouble paying too many bills. They may be attracted by a low rent, but then when faced with the reality of paying water, electric and gas, the total rent would be a burden. My total cost was higher than other properties and they would struggle to pay the bills. The utilities recognize this problem and often require large deposits to connect utilities. Yes, in my city there is a deposit to connect water on multi-family! Why, because of the high default rates. I finally determined that the best way to keep tenants and avoid disconnected utilities was to pay gas, water and garbage on all my multi-family. That left the tenant only responsible for rent and electric. That was the best way to competitively market my properties.

    Tenants fall into two categories. Some are smart enough to recognize that if rent is $425 and water is $30, their total expense is $455. If the neighboring building is $440 with water included, it is a better deal. The other category doesn’t understand total cost. They are less financially stable and struggle paying bills. They are more likely to get water or gas turned off, which can ultimately just become a problem for the landlord.

    In summary, I don’t see billing people for utilities as a brilliant way to unlock value. I would hardly call it creative. Worst case it can backfire on you and create more problems. Smart tenants will recognize the total cost is what matters.

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