Rent and Expense Growth Assumptions

[Rob Beardsley]

Hi everyone,

I would like to survey the crowd as to what everyone is using for organic rent growth and expense growth assumptions. What are your baseline numbers and how do the idiosyncrasies of a given deal affect these numbers (if at all) and do you adjust these assumptions for different submarkets/markets? 

Additionally, I'm finding it difficult to reconcile the fact that when you project 3% rent growth and 2% expense growth for 5 or 10 years, your expenses as a percentage of EGI (which should be around 50-55%) get way out of wack (40% or less). Does this low of an expense ratio ever become a reality? If not, how does strong rent growth over a number of years play out in these numbers? 

[Omar Khan]

@Dan Handford Next time, I'm going to charge ;)

@Rob Beardsley Your ratios go out of whack because of compounding. 3% vs 2% compounding results in big gaps. This isn't as big of an issue in the deals I've done because our expense ratio (non-stabilized) was in the 55-58% range. Expense optimization was one of the reason why the asset was being acquired. 

All things being equal, in a value-add project, your expense ratio should be in the 55% range in the first 1-2 years because you will be going through a rehab (units will be down but fixed costs will continue). At this level, in 3-5 years, you should see your expense ratio fall to the 48-50% mark. 

From a purely modeling POV, if that is not the case, it could mean 2 things: 

• Incorrect modeling; OR
• You have an amazing property manager who's killing it!

Personally, I have not understood the expense growth rate of 2%. That doesn't really work in primary and/or secondary markets. E.g. payroll costs have shot through the roof, but a multiple of 2%, in Texas over the past 3 years.

Alternatively, you might also consider not being aggressive on rehab time frame, renovated rent premium and rent growth. Most markets are slowing down. The high growth rates that worked over the past 3-5 years might not work in the coming few years.

Great saying I heard which helps me: "It's better to be approximately right than precisely wrong."