Utility billing solution for Mult-Family units?

Question

I've been looking at a lot of multi family buildings here in NH, and since many of them are older homes that have been converted into apartments (2-4 units), many of which have common heating systems, so the rent includes heat.

With a background in (commercial) energy management and utility billing systems, these seem like they can be good opportunities for me to go in, lower rent and recover utility costs (subject to existing leases of course). NH is fairly lenient on sub metering and billing, so it should be fairly straightforward.

I see systems for larger apartment complexes, but I don't see a lot of low-cost systems in place to accurately measure and recover costs to heat a unit in a small multi-family dwelling. I know it can be done at a pretty reasonable price by modifying some commercial technologies to meet this need, but it seems like no one has done this. Am I re-inventing the wheel here, or is there really no cost-effective system to do this in these smaller properties?

Troy Zsofka · Answer

No idea @Sean OReilly. It has been our policy just to stay away from duplexes with common utilities (and we haven't invested in anything other than duplexes and SFRs). No incentive for the tenants to conserve. I do agree, however, that if you can remedy this, you could potentially add value to the property (lower expenses means higher NOI means higher value at same market CAP rate).

However, one thing to keep in mind: You can not expect to get the same rents once you transfer the utility expense to the tenants. You'll need to do some comp research to determine what the rents will become. For example, if transferring the utilities costs to the tenants saves you $10K/year, and the new arrangement calls for rents totaling $5K less per year, you have saved $5K. You then look at how much it costs to effect this change, and you can see how quickly your investment is capitalized (if it only costs $10K, you've recouped it after 2 years). You can also look at how it changes the value of the property overall (if, at the market CAP rates, it's effect on increasing NOI results in a value increase of $10K, then it's worth it in that regard as well).

Tough thing is, you'll probably be doing other renovations as well to increase rents, and/or existing rents may be low already when you purchase it; so you'll have to try to tease out the effects on rents from just the utilities transfer (and they will be lower than with the utilities included). You should be able to do this by finding good comps in the area with and without heat included. Given where you're looking to buy, however, you may have difficulty finding enough comps to determine this confidently.

Another simpler option that I know a lot of landlords employ is putting a max setting on the thermostats. Of course, that isn't very exiting is it?

Doug N. · Answer

My first impression is that this will be a break-even (- lower rent, + utility billings), and that you will not get paid for your development and implementation costs.

A friend of mine once said "When you are an Energy Analyst / Building Automation Programmer, all of your problems look like a nail."

Or something close to that.

Best of luck!

Troy Zsofka · Answer

Right, I don't think it will too tough of a sell to the tenants if you put it that way. The question is how long it will take to capitalize your investment based on your savings. It would have to be 5 years or less for me.

Sean OReilly · Answer

@John Newman,

There is no natural gas available in the area, but propane would be an option (provided I wanted to install lines and tanks). Electricity is split out by tenant, but domestic water is not. The main concern for me right now is the heat, although I could potentially meter the domestic water usage as well, but it would be more difficult due to the way the water lines are installed.

The heating system is relatively new, with the boiler being somewhere around 10 years old. It's been serviced recently, and the service tag shows it's a yearly occurance. I could add two boilers, additional fuel tanks and split things up that way, however the cost to implement that would be somewhere around $8,000, while metering the heating will cost me about $1,500 and a day of my time.

@Troy Zsofka I agree there's some balance to be had when it comes to utility costs, but I think people could view it as an opportunity to lower their costs. If I reduce rent by $75 a unit per month, while reducing costs by $100 per unit per month, human nature would be to do everything they can to keep their heating costs below that $75 that I just put back into their pocket. The other piece here is that I become less concerned with fuel costs when it comes to setting rent, so if fuel costs do increase, the tenant can elect to turn their thermostat down, take shorter showers, etc to defray the costs (much like when I tell my wife to go grab a sweatshirt in the middle of January, versus turning the heat up to 70).

John Newman · Answer

Hi @Sean OReilly,

Do these properties have other common utilities besides heat?

What is the age of the heating system?

Do you have any other heating choices besides fuel oil?

Troy Zsofka · Answer

@Doug M. -

Perhaps you're right, but I would bet that pushing the heating costs on the tenants will result in a rent decrease that is less than the fuel savings; so you will get a net-positive gain. One reason for this is because having the tenants bear the cost of utilities will tend to lower those costs, due to what I call the "Buffet Rule" (as in Chinese food, not Warren). It states that tenants (and people in general) will consume more of something that they don't have to pay for. In other words, when the tenants pay the bill, they will shut their lights off and turn their thermostats down. Therefore, a tenant can absorb the utility costs without an equal reduction in rent without affecting their budget, because the utilities will cost less than they did when the landlord was paying.

Besides, what @Sean OReilly is saying is that it will at least insulate him from volatile energy costs. I tentatively agree with that. Truth is, however, that increased heating fuel costs, even if borne by the tenants, will still affect the landlord to some extent. If the tenants' expenses go up dramatically, they will have a harder time paying rent. You may find that you need to drop rents a bit in order to retain the tenants, in which case you will effectively be subsidizing their fuel costs (because the underlying cause of the rent decrease was a fuel cost increase).

A lot of moving parts here that make it difficult to execute a completely objective analysis. My take is that if you can do it relatively cost-effectively, and the increased NOI capitalizes that expense in a relatively short amount of time while also boosting the value noticeably (by holding CAP Rate constant), it's worth doing. The fact is that if it does one it will do the other. For example, if it increases cash flow enough to pay for itself over 5 years, and the market CAP is 10%, it will, by definition, increase the value of the property (from a strictly income approach appraisal perspective) by double the cost of the improvement. I would argue that it would then be worthwhile. Conversely, if it takes 10 years to pay for itself through the increased cash flow, then it will increase the value by the cost of the improvement only, and it probably isn't worth doing.

Troy Zsofka · Answer

True that. So you just need to figure out the cost of doing so and add it to your renovation cost estimate. Then you still need to figure out what the rents will be with the heat on the tenants so you can properly calculate all of your pro-forma ratios upon stabilization.

Sean OReilly · Answer

@Troy Zsofka - My plan would be to lower the rents to compensate for the utilities no longer included. Limiting the thermostats (or installing fixed set point thermostats) is another option, but I really don't want to have to worry about the volatility of fuel costs. A building that has a $4,000 fuel bill with oil at $2.10 a gallon becomes a completely different animal when fuel jumps to $4.10 a gallon.

Utility billing solution for Mult-Family units?

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