Expenses in Multifamily are easy

Multifamily Expenses are Easy

I will not buy small property – period!

Why you may ask.

Because it’s too risky!

Two Basic Due Diligence Tasks

When buying an apartment building we have two basic tasks relative to the due diligence. One – we have to underwrite the rents very precisely. Two – we have to underwrite expenses very precisely.

Rents

This is the first and most important step. The value of multifamily is teed-up by its’ income, more specifically the NOI. The formula for the NOI is:

NOI = Income – Expenses

Therefore, in order to back into the value of what we are buying, we need to establish the NOI, which requires us to know both the income and the expenses. Understand – if you get the income wrong, everything else you do will be wrong, since the income is the starting point.

You have to price those rent to the cent, and that’s hard to do. More on that in a future article.

Expenses

Let me put it to you this way:

When you go to a doctor, they tell you that your cholesterol needs to be in the range of x – y. If you fall in that range, you’re healthy. Otherwise, you have to look at it further.

Question – How does your doctor know what the “x and y” are in the x – y range?

Answer – Because scientists studied this issue and identified a range.

Multifamily Expenses are Easy

I should have clarified in the title that the expenses are easy IN LARGE MULTIFAMILY, and for the same reason it’s easy to know whether your cholesterol is normal. Statisticians study thousands of buildings and hundreds of thousands of units comparing each and every line-item of expenses in every major city and arrive at a range for each class and type of asset.

For instance, they know what the expenses should average in a master-metered community, and they know what those numbers should be in individually metered communities. They’ve cataloged expenses in high-rise verses low-rise buildings. They’ve identified the difference in costs of Class A versus Class B versus Class C buildings, etc.

All of this has been studied and cataloged so an apartment buyer like me has a very clear baseline. Naturally, there are variables with every asset, but we don’ typically see very much movement in either direction.

Why I Won’t Buy Small Buildings

Simple, the above information is n available for small assets, and therefore when it comes o underwriting OpEx it’s a bit of a crapshoot. I just don’t go there…

Hope this helps. Feel free to comment or reach out.

 

6 Comments

  • Marek Javorek Reply

    Hello, is there any reference material I can see to see expenses for a 6unit Multifamily in Chicago? What should be the range on expenses ?

    • Ben Reply

      No, Marek. At least not at any kind of institutional level. It’s too small. This is something you just kind of have to figure out and hope for the best.

  • Mario Alexandrou Reply

    Hi Ben, thanks for the article. I believe in the passed you have bought small multi family or single dwellings. The majority of us here on BiggerPockets are probably in this category. So for those who are unable to play in the apartment block arena, what advice do you have for us in the underwriting of expense and rents.

    • Ben Reply

      Mario, thanks for reaching out. That’s the thing, the reason I no longer buy those is that the small stuff is too inefficient. What you are asking, I couldn’t even answer for myself. SO I am done with that.

      In addition, I don’t want to manage tenants anymore.

      The only advice I can offer is follow in my footsteps and either syndicate your own deals or join mine.

  • Calvin Tory Reply

    Hello Ben I have been having trouble getting P and L statements and rent roll to underwrite from brokers and most self managed properties well you know. So I usually use the MAO formula.How do you go about it?

    • Ben Reply

      Calvin, I am not familiar with the acronym MAO – what is it?

      You are precisely describing the inefficiency in the small multi space. Most of these are self-managed, and the financials are, well you know. Secondly, due to self managing the financials are not shown because they are terrible.

      I actually don’t have this problem. I always get the financials. Now, my issue is on the other end of the spectrum because as you know numbers are just that, numbers, and they can be stacked any way you want. So, the question is not what are the financials, it’s more like how honest are the financials versus how much financial engineering has been applied…?

      At the end of the day, though, you are not (or should not) be buying an in-place TK asset. You are buying value-add. Therefore, how much do you really care about the in-place financials…

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