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.
Percent of Expenses-to-Income
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, the banks in our market were estimating 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, we 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.
Expenses in our market fluctuate from one submarket to the next. In the city, property taxes and insurance tend to be higher than the outlying markets, an this pushes up the expenses to run the properties in the city. The flip side is that we may be able to generate a bit more in revenue if the property is located in the more desirable location.
Always use the seller’s expenses to analyze a deal, and buy the property based on actual figures. We get very excited on a deal when we notice that we can cut the expenses, yet purchase the property with the seller’s inflated expenses. This is a quick way to force the appreciation on your property.
Now let’s discuss management fees: Fees paid to a property management company or real estate broker 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 =8 to 10% of income.
50-100 units= around 5-7% of income. 100 units and greater= 3-5% 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.
I have included a list of questions to ask management companies if you decide to hire one:
- How Long Have you been in business
- Do you have a website
- How do you utilize social media?
- How many units do you manage?
- What are the types of properties that you manage? Single Family, Multifamily?
- Do you manage any units in the vicinity of my property?
- What is your fee to manage properties?
- What services are included in the fees to manage the property?
- Will you employ an onsite manager, and what are the costs associated?
- How much do you charge to renew leases?
- How do you advertise your rentals?
- What are your tenant screening policies?
- What is the cost of your staff: leasing agents, maintenance crew?
- What are the hours for the office?
- What type of property management software do you use?
- What is the cost of your average apartment turn?
- What is the timeframe for your average turn?
- How long does it take for maintenance requests?
- How do you document maintenance requests?
- Do you employ your own maintenance staff, or hire outside contractors?
- Will you inspect all work performed on the property?
- Will you hold my account in a separate bank account?
- Do you perform tenant surveys?
- What is the average rent in the market for my apartment?
- Do you charge security deposits?
- What type of fees do you charge tenants?
- What is your strategy on increasing rents to market?
- Do you handle Section 8 tenants?
- How long is the contract for?
- Do you handle eviction, and if so, what is your process?
- Do you have an after hour call center?
- Do you belong to any Property Management Organizations?
- Has your firm been sued in the last five years?
- Do you employ an employee handbook?
- What type of training do you offer to your employees?
- Do you have a tenant referral policy?
- Can you provide me with a list of a couple of properties that you manage in the area?
Task: Be sure to visit IREM and contact management companies in your market to compare pricing, services and experience. The management company is one of the most important team members, and will greatly affect the value of your asset.
What do you prefer? Self-managing or hiring a management company so you can continue to grow the portfolio.