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. We also like to calculate a per unit expense, which is a simple calculation. You take the total operating expenses and divide by the number of units.
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.
For instance, let’s say operating expenses are $50,000, and the property is 15 units. $50,000/15 = $3,333 per unit in expenses. Is that high or low? That depends on what expenses per unit are in a specific market. It may be high in Tennessee, but it may be low in New York City. One way to find out expenses per unit is to talk to brokers and property managers in the market and ask them what they are experiencing in the market.
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, and 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.
Our motto is Buy on the future, but pay on the past.
That is, buy on future potential, but only pay for what the property is actually performing on. This has been challenging the past couple of years, but, as we transition to a buyer’s market, you will be able to start buying deals based on actuals.
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. The flip side is that you may be paying for payroll on the larger properties. Fees vary from market to market, so it is imperative to find the going rate in your market and pay that fee.
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?
Understanding the expenses of a property and hiring a qualified property management company are two critical components of our Three Step Framework: Buy Right & Manage Right.
Task: Call property management companies in your market to find out how much it costs to run a property in the market.