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, 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.
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.