structural reserve on apartment

[MNRural]

Anyone know where to get market support for a structural reserve expense on my appraisers projected income? I am using 3% of adjusted or effective gross income. Broker thinks that is too high.

Also, he thinks 5% management is too high for a 20 unit, due to the small size of the apartment project. I am not seeing managers work for free.

Any thoughts. I dont think IREM data has structural or replacement reserves.

 

[Michael S]

I'm working on a 40 unit apartment complex and most of the comparables have management of 7-10% of EGI. Management fees go up the smaller the property. For large professionally managed complexes I typically see management fees of 3-5%. A 20 unit property would probably be between 6-8%. Your market may be different though.

As far as reserves I think $200 - 300 per unit per year is a decent number. However that's what I've seen for larger professionally manager apartment complexes. Frankly I can count on one hand the number of properties, of any type, that have a specific line item in their actual operating expenses for reserves.

The best source for that information is comparable properties. With smaller multi-family properties the listing broker will often include a operating statement. Some times it's accurate, other times it's a proforma that they made up. If the OER is less than 40% for a smaller properties that's a sure sign that the numbers aren't accurate. Either it doesn't include a management fee, the owner has been skimping on repairs and maintenance or there's some other problem. Find some similar properties that are listed for sale and call the broker or owner and pick their brain.

 

[CANative]

4%-9% and I've done dozens over the last year and a half.

Today's is a 157 unit in Ventura County. 4.8% ($72,038 on $1,490,396 rental revenue.) The laundry income was higher than the management fee.

 

[Lost Cause]

Reserves Projection Support

If you need support for a reserves projection, you can do a cost-style calculation. The theoretical annual reserves are for the eventual replacement of certain items; in a multifamily these would primarily be the appliances (ref/stove) in each unit, the roof, and perhaps the boiler. You can get the replacement cost for all these items, apply the typical life of each and voila, you have an estimate of the theoretical annual contributions necessary to cover replacement of these items.

I say "theoretical" as few owners actually set up a sinking fund for such items. Some appraisers prefer to include reserves after NOI, leaving "cash flow", as reserves are not necessarily considered "operating expenses". It is important to know if the cap rates one is deriving are applicable to NOI before or after reserves are deducted.

This is a simple technique and provides strong support if anyone questions your reserves projection.

 

[Pittsburgh Pete]

Realtyrates has data for reserve requirements for various property types. A place to start. Lost Cause gives good advice--consistency is the key.

 

[Michael S]

I say "theoretical" as few owners actually set up a sinking fund for such items. Some appraisers prefer to include reserves after NOI, leaving "cash flow", as reserves are not necessarily considered "operating expenses". It is important to know if the cap rates one is deriving are applicable to NOI before or after reserves are deducted.

This is a simple technique and provides strong support if anyone questions your reserves projection.

Definitely theoretical. I imagine if you actually looked at all the short lived items in an apartment (appliances, carpet, paint) plus things like roof, mechanicals, exterior paint, etc. You would probably end up with a number for reserves far higher than anyone actual uses. I spoke with an apartment broker recently who handles a lot of the larger deals in our market. He says for a good property he uses about $200 per unit, for one that's not in as good of condition, $300 per month.

But make sure your cap rates are apples to apples. $250-300/month in extra expenses can change a cap rate by 100 basis points.

 

[Lost Cause]

There's nothing theoretical about the method. I see it used all the time in my review work. I've never seen anyone include decorating items such as paint and carpet in the calculation, however.

 

[CANative]

Just a question from a novice. Would you expect to see a line item for replacements in an operating statement?

 

[Stephen J. Vertin MAI]

Just a question from a novice. Would you expect to see a line item for replacements in an operating statement?

I think you are too humble. It is actually the best question. Further did your comparables used as cap comps deduct the amount?

One way, to answer the OP's original question, is to take the depreciated cost divided by the remaining economic-life and translate the amount to a percentage. Or you could do current cost (of the structure only) divided by estimated economic life.

 

[Lost Cause]

Just a question from a novice. Would you expect to see a line item for replacements in an operating statement?

I've never seen a property owner or manager include such a line item in an operating statement. The only ones I've ever seen do that are appraisers. Not all appraisers, though - some neglect it altogether and others include it after NOI along with other capital costs.