6 (More) Hidden Costs That Blindside Multifamily Investors

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Every investor has heard the saying “it’s all about the numbers” when investing in real estate. What about the numbers that you forget or underestimate? In my previous article, I highlighted 6 hidden costs that investors run into when investing in real estate. My instincts told me that there were countless other hidden costs, so I jumped on BiggerPockets and asked the members to send me additional hidden costs. This article will address these additional hidden costs. (Thanks, guys!)

Let me list the six additional hidden costs:

  1. Seasonal expenses
  2. Money held in reserve
  3. Property tax reassessment
  4. Poor lender connections
  5. Hiring wrong management company
  6. Government fees and regulations

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6 (More) Hidden Costs That Blindside Real Estate Investors

Seasonal Expenses

Every market has what we refer to as a seasonal expense. Up here in the Northeast, we have to budget for snow removal in the winter. Down in the South, landscaping fees are more prevalent throughout the year. Two winters ago, we experienced an unusually cold and bitter season. It seemed as if the snowplows were in constant motion for the entire month of February. Boston received over seven feet of snow in one month.

To add insult to injury, I had to pay to have the snow removed from the parking lot because there was nowhere else to push it. This past winter, snowfall was practically nonexistent. My recommendation is to assess the various types of seasonal expenses, such as heat in the Northern climates, irrigation in the South, or air conditioning in the warmer climates. Analyze the actual income/expenses of the property, and try to establish an estimate of the cost. Two years ago, the snowplow expense exceeded $7,000 on one property alone. Last year, the expense was one-third the cost. My remedy for these unexpected expenses is to leave more money in bank. The only problem with this strategy is that it leads to my second hidden cost…

multifamily-market

Opportunity Cost

Every investor would be wise to create a capital expenditure account for each property that they own. As buildings age, certain elements need to be replaced, such as hot water heaters, roofs, and driveways. A cap ex account is one way of setting up a rainy day account to address these issues. You run into two dilemmas when setting up a cap ex account. First of all, you may have to defer taking a draw from the property for a few months to build up the account (that stinks). But this is one of the strategies in real estate to limit your downside risk. If something needs to be replaced, the cash flow from the property will be used, and you will not have to come out of pocket.

Related: Investors: Think It’s OK to Skimp on CapEx? Here’s Why That Could Cost You BIG.

The second dilemma comes about if you own several properties, as I am sure many of the members on BiggerPockets do. Our portfolio is large, and we have a cap ex account set up for each property. We are talking thousands, and even hundreds of thousands of dollars, for operators who own a large portfolio. Unfortunately, that money is sitting idle in a bank account earning next to nothing.

What is the opportunity cost of money? It’s a tough pill to swallow if you just found a great deal, but you don’t have enough for the down payment. Most banks will require you to set up and fund a cap ex account, especially after you refinance the property. They will actually estimate cap ex and withhold a certain amount of the proceeds for the account. I have come to realize that it is just a cost incurred while doing business, even though it does stink!

Property Tax Reassessment

Beware of the taxman once you are about to acquire a property, especially if the property has maintained the same ownership for years. Every municipality has their own set of laws. Some cities reassess properties every year, some every three years, and others on the sale of a property. Check with the city, calculate what the increase is, and plug the new property tax expense into your analysis.

When I built my home years ago, the town paid me a visit six months into the construction and “reassessed” me during the build. My taxes skyrocketed, and I was still six months away from completion. When I eventually finished building, I was paid another visit and received my final assessment. Was it fair for the town to reassess me while I was building? My anger was due to the fact that I was unable to use any of the town’s services, yet they felt it appropriate to raise my taxes. Ironically, the town next door gave homeowners a break on the first year of their taxes, while my town felt it was just in charging me extra. Life isn’t fair, and it was my fault for not knowing the town’s rules.

Poor Lender Connections

We were ecstatic to land our first deal, but that enthusiasm came with a price. The terms on our financing were subpar, to say the least. The interest rate was about one and a half points higher than the market, the amortization was only 20 years, and the term was a mere five years. Luckily, our enthusiasm and sheer will propelled the property to success, and we were able to refinance two years later with much better terms. This lack of team building in the initial stages of real estate investing hurt our ability to cash flow — and ultimately led to a lower return.

Ironically, after extracting over $160,000 from the refinance, the payment was practically the same as our initial loan. We received a lower interest rate (4.25% versus almost 6%), a 25-year amortization and a 10-year term. I would expect all new investors to stumble upon this hidden cost. Experience is the best teacher, and once a newbie establishes his team, this hidden cost should dissipate. 

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Hiring the Wrong Management Company

The ability to hire the “right” management company is one of the biggest complaints when investors shun exploring new markets. Two websites that an investor can use to locate management companies are All Property Management and IREM. Try to hire a company that has the experience and the resources to manage the type of asset you are investing in. Get referrals from brokers and drive by properties that are under their management. Finally, don’t be afraid to change companies if yours is not performing. A terrible management company may blow up your entire investment.

Related: The Biggest Lie Investors Are Told About Property Management

Government Fees

As I alluded to earlier, every city has its own sets of laws, and some cities have different laws within the submarkets of a city. For instance, I visited Cleveland recently and discovered a new term: “point of sale.” It sounded innocuous enough until the broker described what it meant. Basically, the city comes in before a transfer and begins to highlight the deficiencies of a property. The buyer will receive a list of all repairs that are needed to bring the property back into compliance. I wonder why the city wasn’t busy keeping a record of the property before it was sold. In any event, you need to know the laws, fees, and regulations that every city imposes.

In certain submarkets of Cleveland, the landlord is required to receive a C.O. (certificate of occupancy) every time the apartment is turned. The broker told me it was $250, and if the apartment was turned twice in one year, you had to pay each time. That will put a serious dent in your cash flow. As a landlord, you can’t avoid performing these inspections because it is your duty to provide safe housing. If something tragic occurs on the property, such as a fire or an explosion, you will be held responsible if your property is not in compliance.

I want to thank all of the BiggerPockets members for these fantastic suggestions. Being able to understand these hidden costs will limit your risk and ultimately lead to a more profitable investment. Knowledge leads to a reduction of fear, and a reduction of fear will lead a person to taking action!

Any MORE items you’d add to this list?

Let me know — leave a comment below!

About Author

gino barbaro

Gino Barbaro is a father of six and the co-founder of Jake & Gino LLC, a real estate education company focused on multifamily investing. He has grown his portfolio to 674 units in three years and is the best-selling author of "Wheelbarrow Profits".

9 Comments

  1. I have multiple properties and I do NOT have a separate CAP EX account for each property. I keep a decent sum of money in my business bank account for hot water heaters, repairs, furnace, AC, roof, etc. My portfolio is not as large as yours, but with 674 units you can probably start to estimate how many roofs, furnaces, ACs etc you are going to have to replace each year. It will change from year to year, but a trend will soon emerge. I have found it can be cheaper to handle things like roofing at the end of the summer/fall when contractors are looking at winter and trying to bank some money. I would err on the high side, but there is no need to keep a half a million dollars in the bank at 0 percent interest.

    My contractor and I do not always agree, but when you buy a building, if the furnace and HW tank and AC unit look like crap and are 20 years old, you should probably replace as part of your rehab budget. It is less disruptive and will alleviate the need for emergency repairs in the middle of the night and the dead of winter. I always want to wait until something breaks, but he is slowly convincing me to fix the property correctly from the get go.

    Regarding government inspections and local regulations, in 2016 this should not be a surprise. Most towns have a code enforcement or building department and you can ask about transfer stamps, Certificate of Occupancy, annual landlord licenses and other profit suckers before you buy your property. Don’t forget “Crime Free Housing” , which is a municipal license to print money. There are some towns where the taxes, fees, and regulations are simply not worth it, and you should avoid buying there.

    Find a great local community bank that lends to landlords and investors and stick with them. Keep your business checking and your CAP EX accounts with them. Always be looking around, but loyalty works both ways.

    Regarding property taxes, that is a sad fact of life and it will only get worse as local governments grow out of control. ALWAYS protest your property tax assessment.

    I am still small enough to self manage my rentals, but I would interview multiple property management companies and talk to their landlord clients in detail. Visit the properties that they manage to see how it looks on the ground.

    Gino, sounds like you have quite the business and are really rocking. The problems you face are the same ones facing all of us. Good Luck!

  2. gino barbaro

    The cap ex account is annoying. When you go to refi, the bank expects to see a cap ex account. I know from experience you should never commingle accounts between various LLCs. Big no no in the eyes of the IRS. I think having a separate account allows for proper bookkeeping, proper controls and proper analysis of a property’s expenses and performance. I would consider setting up separate accounts when you are small so that when you do ramp up, you will have that system in place.
    Thanks for your feedback and suggestions. It was difficult to write about govt. expenses. The whole article could have been based on that alone. I was trying to convey to the new owner to try and learn every single law and fee instituted. My town just decided to institute a fire inspection yearly. I own a restaurant with 3 apartments upstairs. They decided to perform two different inspections and charge two separate fees. I am ll in favor of these inspections, but two separate inspections. The expenses start to add up.
    We love community banks also, so much easier to work with and they know the market, although there terms are usually not as good as regionals.

  3. Hi Gino,

    Since I am small, I do not keep separate properties in separate LLCs and my bank is fine with having one bank account ( as long as it is with them!). In Illinois, LLCs are very expensive and easily pierced. My attorney and CPA and bank is fine with me having a lot of insurance including an umbrella liability policy instead of LLCs. Maybe because I have SFRs and two units and they are considered residential.

    Thanks for the article.

  4. Brian Loper

    Great article, I didn’t know about keeping separate cap ex accounts either so something to keep on my list when I get my first place. Snow removal is a good call there also. I’ve been wondering about liabilities around that in nj.

    Gary, thanks for your comments as well.

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