Utilities used to be a token cost. Natural heating gas was cheap. Electricity was cheap. And water was literally nothing. Today, all of these have inflated dramatically, to the point that in some markets they have outpaced rent growth by a significant clip.
With this in mind, as investment property owners we have to be very cognizant indeed of our utility costs, specifically in those buildings where we as owners have to cover the costs…but not only in that case…
Does the Landlord or Tenant Pay Utilities?
In most jurisdictions, whenever a utility is separately metered to a dwelling, and whenever the settings are controlled from inside of that dwelling, it is possible to simply require the tenant in this dwelling to put the utilities in their name. Typically, therefore, the utilities in single family rentals are passed along to the tenants.
When it comes to multi-family, you’ll find that while utilities are separately metered and controlled in late-year construction buildings, most everything from the 70s and earlier has at least some utilities master-metered. As I mentioned above, it may not have been a huge issue for the owner in pay for the water in 1968, in 2016 the costs have risen so much that landlords are forced to look for ways to pass the cost onto the tenants.
Let’s talk about some of the ways in which this can be done, and discuss some of the implications…
Sub-Metering of Utilities in Multi-Unit Rentals
The cleanest way of make the tenants pay for utilities in a master-metered situation is to sub-meter. What happens is that you hire a company specializing in this work, and they install meters at each apartment. This is most commonly done with water service. At times, the meters can go on the inside of the unit where the main water line enter. Other times, on the outside of the unit.
However, this tactic is limited by the design of the plumbing inside of the walls. Quite often, thinking that the owner will be paying for the utilities, the engineers designed the system in such a way whereby one main supplies more than one apartment, and it either is not clear where the split is inside the wall, or it is cost-prohibitive to do it since too many walls would need to be opened. In this case, submetering will not work, since the savings do not justify the cost of doing the work.
In this case, there is an easier way…
Ratio Utility Billing Systems RUBS
RUBS stands for Ratio Utility Billing System. Just like it sounds, this approach looks at total utility expense, in some way rations that expense, and bills the tenant for their portion of the total bill. There are regulations and guidelines as to how this is done, and there are companies who specialize in this.
Sometimes they ration based on number of occupants; sometimes based on square footage; and sometime a combination of both.And when they are done, the tenants receive the bill from them directly, and it looks very streamlined.
However, obviously there is a cost to the owner of the building, and some times this cost is prohibitive, which leaves the following option.
Many apartment owners, specifically those who are not interested in maximizing the utility revenue stream, chose to do a simple bill-back. In this case, the owner will simply charge a fixed amount every month to every unit, which is based on the number of bedrooms. While you can’t maximize the income this way, you also don’t have to pay a third party service provider, and this makes the simple bill-back viable in a lot of cases.
The Law and The Market Tell You What You Can Do
In our pursuit to maximize the top-line and off-set as many of the expenses as possible, I see a lot of investors (especially new investors) lose track of the reality that these decisions are very much driven by the marketplace. In other words, while the law may allow you to do something, the marketplace may or may not!
Debt to Income Ratio and Tenant Utilities
DTI stands for Debt to Income Ratio. Debt to Income Ratio, in its’ purest form, describes the relationship of one’s income to one’s debt. This is a metric used by lenders a lot to determine credit-worthiness.
The lenders understand that most expenses in life are fixed. You have to buy food. You have to buy cloths. You have to put gas in the car. You have to buy insurance, both auto and medical, science today both are mandated. Having to buy those things is not a choice, but basic necessities. And, what is important, while there may be certain amount of play in how much you spend, the banks know actuarially about how much it will be.
What this means is that your expenses, as far as the lender (and government) are concerned are fixed to a large extent.
Well, this idea that someone can only reasonably spend a certain % of their income to pay for things in their life is an important concept which often gets lost in this conversation around value add in real estate. The banks know it; the government knows it; and investors should wake up to the realities!
Rent to Income Ratio and Tenant Utilities
RTI stands for Rent to Income, which is my play on words Debt to Income, and is meant to underscore the reality that what people can spend on living expenses, including rent and utilities, is a function of how much they earn. And if you push them higher than this margin, bad things start to happen…
Well, let’s take a 6-unit in which the rents are $425.month. Why not $1,300/month? Because there are 2 factories and a hospital in your town, and that’s the extent of the economy. And in this setting, $1,300/month is what most people bring home on a monthly basis, which explains why the market for your 2-bedroom units is only $425.
What About Tenant Bill-back?
$425 rent represents 33% of $1,300 take-home pay. Add to that the bill for electricity, which the tenants are already paying, and your tenants are already spending 50% of their monthly income on rent related costs. What do you think will happen if now you add another $50 on those costs, because you can…
Physical and Economic Vacancy
What you are likely to experience is people moving-out, and forcing you to spend money on turning units. And, what’s even more likely, your tenants will simply default and stop paying rent, which means months of no rent, eviction costs, and still have to turn the unit. Are you seeing the picture?
Yes – passing the cost of utilities to the tenant base seems like an attractive proposition. But, please remember – it is the marketplace that dictates what you can and cannot get away with!