I was discussing multifamily expenses via email with another BP member recently that was asking some good questions. I asked him if I could post the conversation on BP since there are frequently questions asked on BP about this topic.
There are some numbers in there that are specifically discussing the dallas ft worth market, so may not apply elsewhere.....
Its an email thread, so you'll have to start at the bottom; sorry its so messy, I didn't have time to re-type it!
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Now that is a good question! I just invested passively in two properties, and I did a TON of research on one of them, a lot less on the other. One was in Port Arthur, and I was nervous about the area, but had a great deal of faith in the sponsors. The other was in Irving, and the deal sponsor was very experienced at analyzing deals, so I felt comfortable with less due diligence. The short answer is that its up to you. I would say the deal sponsor is a HUGE part of the equation, but so is the area, and so is the specific property. Hows that for noncommittal? You may also run into deal sponsors that would get annoyed with too many questions. That is somewhat understandable, but it may be a signal of how they’ll respond to you later. On the other hand, as a deal sponsor myself, I’ve had people that just ask and ask up to the point that you just have to tell them there is a certain amount of risk in all investments and you don’t have a crystal ball.
I’ve seen people jump into an investment with absolutely no due diligence on the sponsor, the property, or the area. I’ve also seen people that do so much research that the deal closes before they make a decision. That has actually been ME on a few occasions!
I would at least want to know how the sponsor is coming up with their pro forma rents, their rehab budget, and the total economic vacancy. Are they so experienced that you just flat out trust them?, are they working with a good PM that they trust? Its just that you need to do enough due diligence that you’re comfortable with the risk.
Hopefully thats at least a little bit helpful?
Tom
On Apr 27, 2015, at 11:11 AM, xxxxxxxxxxxx> wrote:
Hi Tom,
Thank you very much for sharing. You largely confirmed what I thought this process was like. On the currents rents, I meant "rent rolls" when I mentioned it, not the consolidated number.
I look at the whole analysis process from a passive investor perspective though and I wonder how much verification do I need to do when a sponsor presents me a potential deal. More than once had I shown a proposed deal to another experienced investor only to receive less than flattering comments on the deal. One common area that everyone seems to disagree on is expenses. How much verification should be done to a sponsor's proforma?
Thank you
xxxxxx
On Mon, Apr 27, 2015 at 10:16 AM, Tom Lafferty < > wrote:
I do look at the brokers pro forma, but once you have an actual P&L, their numbers don't matter anymore. You really want to look at actual income numbers, then use "market expenses," meaning that you want to use what they actually should be, not necessarily what they are now. Sometimes they could be very accurate, but if it's being poorly managed, they might be too low (often the case when trying to sell because it looks better on paper), or too high. It's hard to give specific numbers for the different categories because they vary so much. A few items that ARE pretty easy to guesstimate are payroll -- should be around $900-1100/unit/year; insurance--$300-$400/unit/yr. But again, those can change. A bad loss history sticks with the building and can jack up your insurance rates, and a smaller property (60 units and under) can skew your payroll numbers because it's much harder to afford full time management.
The other categories can be all over the place! If the property is distressed or not on a main road, your advertising expense might be much higher than a nearby property that has NO advertising expense. R&M and contract services can be much higher on an old building vs a newer one. Or they can be really high for the first few years and drop as things get taken care of (I HOPE-- as that's the situation Im currently in!). They might have a very low makeready expense, but it could be because they're renting a crappy unit, and you want to make it decent. Same with repairs and maintenance-- does the property look well cared for? Or are they putting band-aids on everything?
One mistake you do NOT want to make is using taxes from the previous (or current) year. Get on the county appraisal district and confirm what the broker or P&L shows, then assume 80-100% of your purchase price X the tax rate for that county. I know TX is a non-disclosure state, but they WILL find out what you paid and jack up the appraisal. Then protest the appraisal EVERY YEAR.
On management fees, it's going to mostly depend on the size of the property and to some extent your relationship with them. Small properties can be 10%, 80-100 units and up can be 3-4%. I've found that companies who already have a presence in the area can do much better on their fees since they're able to share resources. Be careful though, as I've also been warned (by a management company that owns their own properties, as well as managing for others!) that you could run into a conflict of interest. Who wouldn't put their own interests first?
Basically, you can use pro formas and P&L's as you're initially getting into your research, but as you move through the process you're going to dig deeper and deeper.
You mentioned that the only info from the listing broker that was worth using was current rents-- Id argue that is definitely one NOT to use. Get a rent roll and confirm!! I can't tell you how many offerings I've seen that show a "market rent," but when you look at the RR there is ONE unit out of 160 at that rate, and the others are $150 less (seriously, looking at that exact thing right now). The RR is a whole separate can of worms-- lease terms, expiring leases, and about ten other things!
As for pro forma rents, talk to neighboring properties. Are they doing upgrades? How much are they getting?
I really didn't mean to go into all of that but you got me started! One thing that is a huge help is get a relationship going with a management company. Even if you're looking at smaller properties and will be self managing, there are companies that will be VERY good at estimating expenses. I'm not saying take advantage of their time and experience; as you may use them if they have a decent proposal. I'm self-managing a 32 right now, but have two companies ready to go that do "off-site" management which avoids payroll. They've been great about helping me with other properties I'm looking at and if things change for me, I'll be calling them first. I had bids from two companies before taking on the 32 unit, and looking back after the first year, it's amazing how close they got on some of the expense categories! As I mentioned before, they had a presence in the area, so knew it well, and even offered to manage ours for 5%. That's a GREAT deal for such a small property.
Sorry- I know you already know a lot of this, but figured I'd spew it all out anyway!
Good luck!
Tom
Sent from my iPhone
> On Apr 27, 2015, at 9:33 AMxxxxxx> wrote:
>
> Hi Tom,
>
> I've always tried to analyze properties based on the seller provided data until someone told me that this was a wrong approach and I should really discard all seller's numbers except maybe for current rents.
> Then I would need to find out what my future income & expenses would be and base my price calculations on these numbers.
>
> Do you follow the same or similar process? If so, how do you estimate future expenses? For example, where do you get data for contract services, maintenance, make-ready, labor?
>
> Thank you
> Nikolay
