In the previous article, we focused on general rules of thumb for property classifications. Rules of thumb can be defined as a guideline that provides simplified advice regarding a particular subject. It’s important for beginner investors to learn certain investing criteria and formulas in order to properly analyze investment properties. Using rules of thumb will give investors an idea if the property is worth consideration. In this article, let’s focus on property expenses and management fees.
The percent of expenses-to-income may fluctuate a bit in different markets, but we’ve found that expenses are typically 50% of total income in multifamily investing. The expenses for running a property vary from one investment to the next. For instance, in self-storage, expenses run around 35-40% of income. Our general guideline is 50% of income, so if we see expenses at either 35% or 75% of income, it’s a big red flag. At 35%, the landlord is either overstating the income or understating the expenses. If the expenses are at 75%, this is a sign that the property is being run inefficiently and it’s a possible value play. The property can also be experiencing an unusually high vacancy rate. In either case, it behooves you to take a closer look.
When refinancing your property, most banks estimate expenses at around $3,500 per unit. Landlords who are running their properties efficiently are getting penalized, but the banks have no remorse. If you can show the bank your expenses from prior years, they may factor that into account. When analyzing a property, use this figure as a quick estimate to see if the property is worth further investigation. To calculate expenses per unit, take total operating expenses and divide by the number of units.
Now let’s discuss management fees. Fees paid to a property management company or real estate broker go to manage the operations of the property. They should be charged as a percentage of total gross income that’s collected. Gross income can include pet fees, storage income fees, application fees, and late fees, to name a few. Some property management companies try to include security deposits as a percentage of income. Security deposits should put deposited in an escrow account and never included in calculating management fees. These deposits are technically the tenant’s money, and once the tenant vacates the property in satisfactory shape, the money has to be returned.
How do you know what to pay for managing a property? The rule of thumb is: 1-20 units = 10% of gross income. 20 to 50 units = 5 to 7% of income.
50-100 units= around 5% of income. 100 units and greater= 3% of income. As you can see, the larger the complex, the less expensive it is for management fees. Fees vary from market to market, so it is imperative to find the going rate in your market and pay that fee. Don’t try to pay less than the market rate, or else you will get stuck with what you paid for.
Keep in mind, management fees are usually incurred to manage the property and perform certain functions, such as rent collection, bookkeeping duties and screening new tenants. There are many jobs that management companies perform that are “extra”, such as maintenance calls, filling a vacant unit and staffing employees. Be sure to ask the management company what services are included in their monthly fee.
Let us know what management fees are in your market. If you have any questions dealing with management companies, leave us a comment below. – Jake & Gino