Dirty Little Secret?

Question

I am trying to find a study with data on the operating expense ratio for residential real estate, and hopefully something that applies to my area. I want to use the data to prove this ratio to my real estate agent. He like a lot of other people seem to claim that operating expenses are far less than 50%.

The 50% rule is "The best available data show an average operating expense ratio in the US is 45-50%".  Although these data are referred to often, I have never seen a (viewable) link ro these data or a citation. It seems a former prominent member linked these data, but that link is now inaccessible.

I believe that these data are fom 2009 Income/Expense AnalysisÂ®: Conventional Apartments published by the Institue of Real Estate Management. However, these data have nothing to do with any building less than 12 units! These data are summarized by 4 building types in 150 cities.

1)ELEVATOR BUILDINGS  
2)LOW RISE 12-24 UNITS 
3)LOW RISE OVER 24 UNITS 
4)GARDEN TYPE BUILDINGS

Do these larger complexes/buildings have the same operating expense structure that SFH's and /or 2-5 family buildings? It may be a stretch to assume they do. Maybe my Real Estate Agent is right!

Can you provide another/better source of data for operating expense ratios?

source: http://www.irem.org/acb/stores/1/2009_Income_Expense_Analysis__P19312C1911.cfm

*If you look at the example data from Atlanta, don't be confused when you read OE=35%, their definition of OE doesn't include vacancy and other expenses so it is different from the normal definition here.

Account Closed · Answer

Mike,

I fear that many owners simply don't understand accounting and the implications of depreciating assets and that they are real.

Everyone grasps the idea of prepaid expenses, we pay our yearly insurance and each month we take off that portion that has been used, if we cancel the policy, then we get back that portion that is as yet unused.

But try and explain that about a roof. A new roof might cost say 12,000 for a building, but it occurs once every 12 years, but do most owners actually budget for the resulting 90 dollars a month in cost? Of course, no.

Therefore, getting most to understand that simply because the bill wasn't presented this year, doesn't mean it isn't there, is a bit of a problem. Add baths, kitchens, heating/cooling, etc, and it is no surprise that owners feel blind-sided by bad years and unusual expenses, I don't see them, therefore they aren't real.

If, in formulating a general rule, we say that depreciation is real and just, and that as a general rule of thumb, expenses must be related to that depreciation number as a MINIMUM,  then

1- This might help in actually creating a provable and accurate general expenses formulation, of course this would require actually holding property for the depreciation periods selected by the accountants and business managers.

2-
Now aswe add in the property taxes, insurance numbers, and their tax implications on the total true expenses, I think it will be clear that expenses are actually far greater then the 50% rule generally used.

Finally, anyone who believes a realtor's assessment over that of an accountant, well, lets just say, there is no Santa, regardless of the sales person who thinks there is, and the investor needs to be aware or they will learn that the hard way.

Michael Rossi · Answer

Kirk,

Taz's study is indeed gone - I just checked.  If you REALLY want to know, you can always plunk down your $199 and get the study - a small price to pay if you really want to see it.  Still much cheaper than the thousands of dollars that many people plunk down on guru nonsense that has no practical value.

I also saw in one of Taz's posts he says that he has over 20 SFHs and has more that 25 years in the rental property business and that his operating expenses including vacancy and capital expenses were about 50%.  Although that is too small a sample to be significant, it just adds one more data point the confirms the 50% Rule.

Mike

Kirk B · Answer

What I am trying to show the Agent is proof which supports the theory that operating expenses cost half of gross potential rents. This is nothing any accountant I know claims. My agent has his CCIM, 30 units of his own, and tends to think the 50% rule is too basic.

Personally, I think the 50% rule is the most compelling approach out there if you are running a real estate business  for cash flow.

Mike,

I found another study, but thats all 12+ unit again...

Kirk

Kirk B · Answer

Mike,

Thanks for your replies. You are probably right about my Agent. His primary approach is getting the properties far below market value.

I am fairly confident that I have identified Taz's study. I seem to recall looking at the same sample data pdf months ago.

I think that even though there is no perfect study out there, the 50% OER model is the best approach out there.

Kirk

Michael Rossi · Answer

Why not have the agent show you what his expenses are?  I'm betting even with 30 units, he doesn't have a CLUE what the operating expenses even are (as in can't even list the expenses), let alone tell you how much they are.  Ask him!!!  I think the answer with shock you.

In my experience, what happens is that people collect the rent and pay the bills.  When an irregular expense happens (new roof, new furnace, damage in excess of the security deposit, etc), they consider that a unique event (like a tornado or other act of God) and it's off budget.  Often, they'll have to borrow the money to pay these bills because they didn't have real cash flow that could have been saved to pay for these expenses.  Since they don't include these expenses in their budget, they think they're making money when they're actually losing money.

If you go back and read the posts in the landlording forum, you'll see this theme over and over!

Mike

Michael Rossi · Answer

I didn't have it Kirk.  If Taz took it off, it's gone unless you join his service or someone else saved a copy.

If you don't believe me that it showed the expenses were 45% to 50% in all categories, ask Will or Jon or some of the other long-time members.  I'm sure that some of them will remember.  That was a major thread at the time and quite contentious as I recall.

Mike

Kirk B · Answer

So, no luck on finding the a study?

Michael Rossi · Answer

Agreed, not to mention evictions, damage done by tenants in excess of the security deposit, lawsuits, utilities during vacancies, etc, etc, etc.  Unless you have a fairly large portfolio, you just don't get to see these things on a regular basis... and as they say - "out of sight, out of mind".

Mike

Michael Rossi · Answer

Taz might have taken the data down when he left.  His data covered about 30,000 rentals throughout the US in all practical rental ranges and using my definition of operating expenses (i.e. including vacancy and capital expenses).  ALL the different groups and types of rentals he listed had operating expense in the 45% to 50% range.

You could do your own study, but I'm afraid that looking at a "bunch" of 1-5 families isn't going to cut it - a bunch isn't going to be statistically significant.  Having said that, even if you only have one rental, you should be able to get in the ball park by taking your actual expenses and then taking an educated guess at the expenses you haven't incurred yet.

Unless I misunderstood, you already have at least one rental.  Why not post your income and expenses and let's see how it fits.

I just finished my taxes and took them to my tax preparer.  I'll try to look at the expenses this evening and see where my numbers fell (and then post them).  With several dozen rentals, I still don't have enough to be statistically significant, but we'll see where they fall.

Mike

Kirk B · Answer

Mike,

Thanks for your input. I did look in that thread and Taz's links are the links I refer to in my first post. His name now is "No Longer Member" and the links point to a site that charges $199 to view those data! Did I miss the correct link? I remember Taz was going to have an intern look at his personal data, but I never saw that either. Did you?

To me it doesn't matter where the study places vacancy rate. I can do the arithmetic to evaluate it based on the operating expense model used on this site (you are the one that created this method?).

My point is where is the proof? Where is a bunch of Income Statments from a bunch of 1-5 family properties? Someone at some point in time must have undertaken this study.

Have you ever seen such a study?

Kirk

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