25% Expense Ratio - How to I get it?

Question

I've seen several multi-family home listings suggest that a 25-33% expense ratio was not only possible, but commonplace. In my properties, I've been operating at about 50%. Is this something that comes with economies of scale - more properties = better discounts with insurance, etc?

Joel Owens · Answer

Don't drink the koolade.............. : )

Maybe if the property is brand new and they self manage you can get close to 30 or 35%. Over  a hold period as the asset gets older the operating costs usually start going up more.

A seller owning a brand new built asset years 1 to 10 and claiming XX costs might be true but you owning for the next years 11 to 20 etc. the cost profile of the property will be way different as many items will reach the end of their life expectancy and need replacement or multiple repairs to keep functioning optimally.

Even on larger multifamily 50% is common for total expenses and if landlord pays utility it can even be more like 60% operating costs. Most individual investors if they are buying 100 unit properties are doing value add or buying an older property in a B to C area for less cost per door.

The low maintenance properties that were built correctly brand new in good areas are usually 6 figures per door in cost. So cap rate purchase is generally low and you are hoping for increased rent growth to further yields unless you built the complex from the ground up to own then you might have a 10 cap rate to cost versus buying in the market for a 6 for class A apartments  with little operating expenses.

Watch out for (newly renovated) properties where some syndicators and sponsors do rehabs on the cheap but the expensive items are fixing to go out after you own it reducing yields heavily in future years.

Newly renovated to these sellers might mean carpet,paint, some lighting fixtures. My idea if cap rate is lower and recently filled up is all new mechanicals, roofing, windows, plumbing, electrical, no alligator cracking in the parking lot, newer siding,etc.

Oren K. · Answer

Just to underscore @Mike Dymski point; I recently met with a contractor in Ohio who took me to another site they were working on to show the quality of work. The other site was a 100+ bed nursing home that was being totally remodeled by a new out of state owner.

During the tour / discussion, he mentioned that his company did not do the windows so I asked who did. It turned out that the new owner brought in a company from NJ.  There could be more to the story but taken on its face; consider that the NJ company brought in their own  crew, housed and fed them for the time on site. The NJ company had to bare the extra costs but still bid low enough to get the contract. There are limits to economics of scale but it is a powerful force.

Regarding the question of expense ratios; I am also an NON-BELIEVER in any claim of 25-35% expenses except in extraordinary circumstances.  If you are NOT spending at least 45% or more on management, property taxes, utilities, insurance and maintenance, you are not doing enough to maintain the asset in good condition. Sooner or later it will catch up with you if you hold.

Oren

Timothy Murphy III · Answer

It's highly unlikely over an extended period of time. Use a more realistic budget for your projections (~50% expense ratio is a good rule of thumb) when analyzing a deal. Then if you can operate with a much lower expense ratio there's extra profit in your pocket, but you won't be stuck in a bad deal if you can't hit those ambitious targets.

David Faulkner · Answer

Most expenses do not scale linearly with rents (at least not directly), so if you buy an expensive property with really high rents (relative to the size of the unit) then your %rent needed for expenses typically goes down ... at some point it would get to 25%.

Joel Owens · Answer

The problem with 25 to 33% ratios is that one little thing goes wrong and poof there goes the returns.

Sellers of course want lenders to go along with it and the buyers because they can try to show more NOI and sell for a higher price.

An astute investor underwrites for the worst situation and hopes for the best. In this way if the worst happens they still hit acceptable numbers. If the best really does happen then you hit a grand slam. Either way in that situation you make your goal.

I had a lender one time tell me they underwrite 50% opex regardless of sellers numbers because if they take it back from the borrower because of default they will not be managing themselves and they also could not run it as efficiently as the previous owner who sold it to their borrower.

Underwrite conservatively for standard industry practices.

I don't buy anything on the if the (everything goes right) scenario because if it doesn't you are up the creek.

Jeff B. · Answer

Spot on!  Evaluate worst case and insist that there's still money to be made.

However, managing for myself, I did get ~35% expenses for over a decade and this is while I was catching-up from prior owner's deferred maintenance. It's doable with some care.

Christine Swaidan · Answer

This discussion is making me feel good about my numbers. I'm spending more than 50% but I am doing rehabs of 6-7K as each unit is vacated.

Mike Dymski · Answer

Hey Keeton.  The amount that many apartment owners pay for things like paint, flooring and HVAC equipment (among other items) is shockingly low.  It gets discussed as "efficiency" on many posts and that does not do justice to the savings for this scale.  Many of these apartment vendors have regional buying power, use professional communication, and manage the subcontractors; so, it's a completely different business model, pricing and service level.  That being said, expense ratios are still well above 25-33%.

Jeff B. · Answer

I Calculate my expense ratio every year.  With QB, you can always compare current year income & expenses to last year's.  These numbers will draw attention to not only What Changed, but areas that deserve your attention as an asset manager (not just a landlord).

I've run almost a full decade with a 32% expense ratio (yes, self-managed) and only in the four years did extraordinary circumstances arise that really had an impact; fire and adverse eviction with large damages.

Hopefully you ARE tracking GSI and NOI changes, so don't neglect Expense Ratio (yeah it's obvious that expenses are withing NOI, but the ratio will tell you why your GSI increase didn't achieve your expectations in the NOI)

Thomas S. · Answer

Expense ratios are a unknown till the day you sell a property. Anyone that tells you they have a certain ratio are basing that number on yesterday or today expenses not on the full life of the property. 40% would be good, depending on the type of property, 50% is the statistical average based on tens of thousands of properties over many decades of collecting data. If your expenses are lower you have not owned the property long enough to even guestimate.

If you want really low expenses buy a brand new property and sell in less than 5 years. If you are a buy and long term hold you will know the expense ratio when you sell in 30 years.

25% Expense Ratio - How to I get it?

Most Popular Reply