Apartment: Typical Operating Expense Ratios

[barcelona]

The firm where I work appraises large, Class A apartment buildings that are typically 250 units or larger.

Looking over past reports an "Operating Expense Raito" of approximately 35% to 40% appears to be the norm.

Operating Expense Ratio = Total Operating Expenses divided by Effective Gross Income.

So taxes are included in the Operating Expenses.

Does anyone have experience with large Class A buildings that is different, similar...??

I assume for smaller, older buildings the range would be quite higher...perhaps 45% to 55%????

Thanks.

 

[Michael S]

Just looked at a new class A apartment complex we appraised a few months ago, it was around 33%. Comparables were higher, around 40-45% but they also had EGI's that were quite a bit lower. The subject expenses was about 25-30% higher per unit than the expense comparable but they were commanding pretty good rents so it balanced out. The expense comps weren't all from newer class A properties because there's only a handful in our market and some were still in lease up or wouldn't share the information.

 

[CBBoston]

Also depends on who pays for heat/AC and hot water. That can make a big difference. The trend is for tenants to pay these expenses but there are still many large older complexs where it is included in the rent. Look closely at the items included as expenses. Many LLs include what should be a capital expense that should show up in reserves as operating expenses. That lowers taxable income. Something else I see too often paticularily in non-institutional owned properties are expense payments to relatives and lovers as bogus operating costs.

Don't forget there is IREM data. Samples sizes can be small but its better than a poke in the eye with a sharp stick.

 

[barcelona]

Thanks for the input.

CBBoston: Follow up questions/clarifications
1. With regards to who pays for heat/ac/hot water, you mean in comparing one complex to another you should factor this in to make an apples to apples comparison, right?

2. Aren't there many who would argue that replacement reserves should be considered an operating expense?? And should therefore be included in the calculation??

 

[tmh1982]

Hello,

I have appraised quite a few apartment buildings over the last couple years. Class A apartment buildings tend to command a premium and offer substantially higher quality interior finishes. I should point out that the Class A apartment buildings I have knowledge of are located in/on a college campus with parents dishing out the credit cards to pay the students rent. Although the rents do seem high here, when compared to where the students are coming from (Boston, NYC) these prices seem cheap. Rents range from $1,200 to $1,800 and have two bedrooms where they pack in 4 students.......unless Mom and Dad love you so much they buy your own room! Keep in mind my experience with Class A apartment buildings is limited to college students, because if you can afford $1,500+ rent you can afford to buy a nice home in the area.

Anyways, I am always intrigued with the historical operating statements and the projections. I have yet to see one projection be dead on for these proformas, usually it is to high in income and to low on expenses. The days of 3-5% rent bumps every year I am afraid are over. Imagine rent of $1,000 your freshman year ending up being $1,215 your senior year and nothing has changed, other than your roommates have urinated in the hallway several times, the bathroom has flooded several times from drunken stupidity, holes in the drywall from awesome drunken parties, etc etc. As these units get lived in, they get lived in heavily and the owner typically has to pay more than the security deposit for such repairs. The expenses might be accurate for the first few years, but double check the following:

1) Is there a line item for reserves?
2) Do expenses increase over the years 3-5%?
3) Are the projections for real estate tax accurate?

You will see more 5-7 year old properties on the market than you will see 1-5 year old properties of the same character. A main reason for this......the original developer wants the good years of depreciation and expenses before they have to dump megabucks into new carpet, walls, paint, cleaning, etc etc.

I find it hard to get any apartment building realistically operating under 40% expense ratio if properly accounting for future expenses and realistic incomes.

 

[PL1957]

Hello,

I have appraised quite a few apartment buildings over the last couple years. Class A apartment buildings tend to command a premium and offer substantially higher quality interior finishes. I should point out that the Class A apartment buildings I have knowledge of are located in/on a college campus with parents dishing out the credit cards to pay the students rent. Although the rents do seem high here, when compared to where the students are coming from (Boston, NYC) these prices seem cheap. Rents range from $1,200 to $1,800 and have two bedrooms where they pack in 4 students.......unless Mom and Dad love you so much they buy your own room! Keep in mind my experience with Class A apartment buildings is limited to college students, because if you can afford $1,500+ rent you can afford to buy a nice home in the area.

Anyways, I am always intrigued with the historical operating statements and the projections. I have yet to see one projection be dead on for these proformas, usually it is to high in income and to low on expenses. The days of 3-5% rent bumps every year I am afraid are over. Imagine rent of $1,000 your freshman year ending up being $1,215 your senior year and nothing has changed, other than your roommates have urinated in the hallway several times, the bathroom has flooded several times from drunken stupidity, holes in the drywall from awesome drunken parties, etc etc. As these units get lived in, they get lived in heavily and the owner typically has to pay more than the security deposit for such repairs. The expenses might be accurate for the first few years, but double check the following:

1) Is there a line item for reserves?
2) Do expenses increase over the years 3-5%?
3) Are the projections for real estate tax accurate?

You will see more 5-7 year old properties on the market than you will see 1-5 year old properties of the same character. A main reason for this......the original developer wants the good years of depreciation and expenses before they have to dump megabucks into new carpet, walls, paint, cleaning, etc etc.

I find it hard to get any apartment building realistically operating under 40% expense ratio if properly accounting for future expenses and realistic incomes.

You may be confusing student housing with conventional apartments. Student housing has an entirely different set of economics that traditional apartments. Design is different, services are different and investor expectations are different.

 

[CBBoston]

barcelona
1--You should first try to find comps that include heat/hot water expenses if the thats what the subject includes. It you can't then yes you need to adjust the income.

2--yes there is diagreement. But too many owners want to include capital expenditures (long-lifed items) as operating expenses. You can do it that way but if you're only doing a direct cap it might be very misleading. Roofs and heating systems last a long time but do wear out. Replacement of these items can lead to abnormally high expenses when they occur. Think of them as lumpy expenses as opposed to recurring item like taxes, repainting and cleaning units between ocuupants. This isn't so much a problem if using a dcf to value the property. Also many leander have wanted to see reserves for high cost items so that there is money there to do it. And let's face it most of us will dance to their tune unless the request is truely outragous. Sellers and borrowers what to maximize either price or loan amount so they don't like these expenses showing up. Ask youself would you buy a property that needed new roofs and not factor that into your offering price? I hope not.

From my POV I don't really care what owners or the bank want to call them as long as the method of income valuation reflects these costs somewhere. Now the irs might take a whole different view on this issue but for the most appraissers live in a land where tax impacts don't exist.