Reasonable Average Expense %s
I'm wondering what everyone's idea of average costs of doing business in landlording is. It seems like somewhere along the way I had heard that the average nationwide for everyone pros,apartments, people with one sfh is like 45% - and I'm talking about costs before paying mortgage....the things like tax, upkeep, insurance, vacancies, marketing and the like. Does this number sound about right?
I know some of this is variable and it is up to me to manage costs properly. I've got an offer in to purchase a property for ~ $57k that I believe I would need to spend $5k on to get it into rentable condition. I think I can rent it for $750/mo.
If I'm right on all these things (and suppose I paid cash) it seems I'd be able to get roughly an 8% return on my money cash on cash return.
Is this a reasonable return for landlording? Or am I still paying too much.? As it is, I am having to convince a bank to accept a short sale.
Is 45% a good ballpark figure?
Steve
Stevezilla wot does it mean.? do you have long arms and drag your knuckles as you walk?
The number you are looking for does not really exist. It is one of those items about which we all talk but alas there is no common constant.
At one time we ran 1800 units in one of the worlds most depressed areas. This was charming downtown Watts here in the wilds of Los Angeles.
You had to use so many gang signs it look'd like you were using sign languages for the hearing impaired. Hearing impaired, cultural impaired. Actualy I enjoyed it. reminded me of life in the British SAS or our own band of Brigands, Special www.Forces.or Lerds.
Our return on Dollar invested ranged from the ever present zero to as high as 58%. That was during the winter time when the incoming fire was at a minimum. I think you just have to find out for yourself what is your own comfort level.
True return that is increase in value and cash flowing in on a monthly or in my case weekly basis putting both figures together should be above 25%. But that is the kind of crap you get attending an MBA course at a Posh Eastern University taught by those who have never had to upend a tenant to shake the rent out of his pocket. Or sat thru long dumb poker games pulling a dollar out of each pot for the rent.
I have always felt if you enter the game of property with nothing in your pocket you will be satisfied with very small returns hoping for that great day (like right now) when the Value of Property is so high that it makes no sense at all. Then you sell. Of course how you handle the taxes is another little task which at the present I have no answer.
I always had a problem with this figure cause some of my properties I had no cash involved. People just gave them to me and took back second mortgages or promissary notes, anything just to get rid of the problem of hostile tenants, no money coming in. Resident managers newly graduated from the Joint who brought all their cell mates with them to rent. God the times I put tenants to work on the units cause they had no money for rent. The times I bought BBQ stuff so my friendly tenants could eat and at the same time sell to all the neighbors. Damn good BBQ. The Greens were great too. I think they were harvested from the lot next door. You had to be carefull cause they grew another crop in the middle of that lot that had to also be harvested, dried and cured and then chopped up and rolled in old newspaper. You could get a contact high just by turning onto the street.
Hard to put a hard currency figure on all those lovely times. The time the tenant flipped out and came running down the street with an ax in his hand. We talked him into letting go of his wife and took him over to a tree and started him on chopping that down. Should have seen the dumb look on his wifes face when we talked him into that little trip. Yes he brought the tree down and also the electric lines to the garages. Oh well at least he was so tired after that little doosey he gave up violence for about a week.
So pick your figure, it could be anything. If you add in these experiences which incidently you will carry with you forever. Something like scar tissue. You will have gained a deep understanding of your fellow man. This is good?
Cheers Lucius
8-) 8-)
Steve,
The problem with averages is that they are just that -- averages. I have a few properties and my total operating expense runs about 40% of my gross scheduled income. Another 30% for debt service and incidentials, gives me around 25% left over at the end of the year that I call my net cash flow before taxes.
Lufos gave you very good advice. If I can distill his wisdom into a simple statement, it would be: You can not depend upon average costs over a large population to predict specific costs for a particular property.
You have to calculate your own costs and do your own cash flow analysis. Each property has its own characteristics that affect overhead. My properties have a set of overhead costs that include professional management and homeowner's/condominium association fees. My replacement allowance may not be the same as yours either (if you even have one). My 40% number is really meaningless to you when you don't know the cost items behind the number.
In summary, my numbers are my numbers and your outcome may be completely different.
Thanks for the thoughts guys.
/do you have long arms and drag your knuckles as you walk? /
Quite the contrary. My arms are stubby but my legs are extraordinarily long. And my damn tail tends to knock over buildings. No rental properties though, strictly commercial stuff downtown.
Zilla
I gave up on figuring expenses long ago and apparently so did financial institutions. Just using the rents(realistic not hopeful) and the purchase price you can come up with a better idea of how the property will perform than anything I am aware of. If you simply use one of the common methods of using this data you will be fine unless you have some unbeliviably quirky property. One common method is to use rents divided by purchase price multiplied by 100 to get the gross rent multiplier. Banks want to see at least 1.25 to show at least a breakeven property. The higher the better. Personally, that's still too complex for me. I use the old, old method of purchase price divided by gross rents. You pick what number you want to see but most people agree that this number should be 6 or at most 7 to have a slightly positive cashflow. The lower the better. Don't forget to include all costs in the purchase price, including closing costs.
Standing aplause for Lufos! That my favorite post from you yet.
Davmille is a bit confused on his numbers. I'll take the liberty to straighten out a few things:
"One common method is to use rents divided by purchase price multiplied by 100 to get the gross rent multiplier. "
---GRM is Price/Gross (scheduled) Rents. You can multiply or divide by 12 (not 10) depending on how you like to see the figure reflected (in yearly or monthly terms)."
"Banks want to see at least 1.25 to show at least a breakeven property. The higher the better. "
---This is the "Debt Service Coverage Ratio" which is found by NOI / Yearly Debt Service, and 1.25 is the base number. You want to go up from there.
"Personally, that's still too complex for me. I use the old, old method of purchase price divided by gross rents."
---This is the Gross Rents Multiplier
As for your questions....I'd say 25-50% is the ballpark area for your expenses.
I realize that that is a huge range, but there are many differnt ways to run your property. Do you live 1000 miles away and never see it and have a property mgmt company that buys only the best and most expensive products, or do you mow the lawn yourself with a mower you borrow from the neighbors?
Additionally, it varies from area to area for labor, insurance, taxes, parts, etc. Talk to landlords and lenders in your own area and get a feel from those that manage as you will. They'll give you the best opinions.
Hey Hibby76,
You're right. I was a little confused. I shouldn't have tried posting after we stayed up past my bed time watching some silly romantic comedy . Oh well, although I got the terminology wrong, the numbers were correct for what I was referring to. One of the numbers that I have found most useful is the Rent -Value ratio. This is the one were I mention above that the ratio should be 1.25 or higher, and it does work great. It does use the same base number of 1.25 like the Debt Service Coverage Ratio which I've been told that many banks go by. For some reason though, I have never had a bank ask me about NOI which makes sense to me because it's hard to determine. They have always asked, what rents were, and what my mortgage payment was. Now they may have thrown in their own guess at expenses but they have never asked me. I've tried the DCR and many others to evaluate properties in the past and I have found that simply using the GRM has been just as effective in determining how well a property cashflows. I guess the only point that I was trying to make though, is that I've found expenses to be difficult to get good estimates on, ranging as you mention from 25% to 50%. Some how though, if you buy at the right price, with the right rent, it always works out fine.
Gosh, there are a lot of smart people here. I have a vague understanding of your numbers here, actually, if I sat down and did the calculations, I suppose i could figure out mine... Thank goodness I have an accountant. I also suppose i ran these numbers when I bought a property or small group of properties. All I know, is 5 years after I began, I am constantly amazed when my wife (property bookeeper and love of my life), says, Shawn we have x amout of dollars in the rental account. Sometimes most pleasantly surprised, other times not so pleasant.
Lufos, if you ever get the urge to travel, I'd like to invite you to my home in Coshocton, Ohio. I bet you'd be a blast to party with. I'd also like to probe your mind. Thank you for sharing. We don't have any rough areas. Well, some of them think they're rough and tough, but I still do all my own collections without a piece, and my cars are all unlocked with the keys in them during the day.
Good Luck,
Shawn(OH)
Quote:Oh well, although I got the terminology wrong, the numbers were correct for what I was referring to. One of the numbers that I have found most useful is the Rent -Value ratio. This is the one were I mention above that the ratio should be 1.25 or higherdavmille,
Perhaps you could give us an example of the Rent-Value Ratio with hypothetical numbers. I tried to apply your 1.25 ratio criteria to an $80K property. The arithmetic says that I get a 1.25 ratio when I generate $100K in annual rents.
No way this will happen in my area. Typical monthly rent for an $80K property in my area would be $750 to $850. Use an average of $800 per month ($9600 per year) and divide by the property value gives me a ratio of 0.12 which is nowhere near 1.25.
Now, if you are really looking at a Price to Rent ratio, isn't that the Gross Rent Multiplier? The Gross Rent Multiplier is the Purchase Price divided by Gross Rent. The lower the GRM the better. The GRM is a very simple comparison number that is really insufficient for anything but general screening -- analogous to the stock market's P/E ratio.
Some would argue that the GRM does have another use. Just as in stocks, a high price to rent ratio is justified in regions where rents can be expected to increase substantially in the future. But in regional markets where the price to rent ratios are trending higher in spite of projections for a weak rental market for some time to come, you are in a "bubble" market. Keep in mind a housing bubble doesn’t burst, but instead, only slowly deflates. [ Edited by DaveT on Date 03/27/2004 ]
Hi Dave,
The 1.25 might not work for everyone depending on their niche. An example would be a property that I rent for $525,and which I have 35k invested in. If you divide 525 by 35000 and multiply by 100 you get 1.5 which is well above the 1.25 I mentioned. Again, this is not even my most common method of determining value. I would generally divide the price by gross annual rents which in this case would give a number of 5.55. Although that number would be considered good by almost any measure, I still would not have purchased the house for this price. The 35k includes 4k of unexpected repairs that is a whole story in itself.
Something else that I thought of that goes along with the concept of ignoring expenses is a study that was mentioned in the book "What works on Wall Street" which came out something like 10 years ago. In the book they mention that the P/E or price/earnings ratio that is so well known did not turn out to be near as effective as the P/S or price/sales ratio in predicting the stock price and presumably value, of a business. Now intuitively it would seem that earnings would be more important than gross sales, but as John Adams said, "facts are stuborn things". So, this seems to support the limited observation I have made that a rental property can be evaluated very accurately simply using the rents and purchase price in most instances.
Of course, I'm referring to normal situations here. The dilapidated, 4500 sq/ft, mother of all money pits house that your great, great, grandmother left you clearly deviates from the mean and will do nothing to increase your bank account.
OK, I see now that you are talking about a variation of Carleton Sheets' 1% rule. He says that, as a general screening rule of thumb, a property should generate monthly rents at least as high as 1% of the purchase price. You are just modifying the rule to set your criteria at 1.25%.
Rules of thumb as initial screening devices are OK, but should never replace a detailed cash flow analysis.
Well, I guess we will just have to agree to disagree on this one. I actually think that simple ratios tend to work out better in evaluating a property. Although it would be nice to get an accurate detailed analysis, that gets us back to the crux of the question. What should expenses be? A range of 20% to 50% that I often hear leaves a lot to be desired and repair expenses are notoriously unpredictable. If you buy a house for 5 GRM or less though, you have a lot of wiggle room, as long as you screen out the properties that are obvious moneypits.
Just a source, though it may not help much with SFH guys. The institute for Real Estate management publishes every year (or at least they used to) a guide to apartment expenses. Based on an extensive survey of their members it breaks operating expenses down into categories and gives averages as a percentage of rent and as a cost per square foot. In addition it does this for many cities. so you can compare your costs to those of professional managers in your town, not some national average or compare Miami and Chicago. It also gives breakdowns for different types of buldings based on number of units or something. Although I havent used it in years I used to use it all the time as the basis to check whether sellers represenations of their expenses looked reasonable.
davmille. I must admit that I've been intrigued by your calculation. A ratio is a ratio, and can be manipulated any way so that it is useful to you. It seems that your method is a variation of other better known methods. There's no right way, as long as it is consistant.
You mentioned above "I have 35k invested..." Is that your Down Payment or you Purchase price/Value?
If it is your down payment, your equasion is most similar to ROI, but you use gross rents rather than net income and multiply it by 10 (so that it's easier to keep track of) rather than 12 (which would make a yearly reflection)
If you use the purchase price/value as your denominator then your equasion is simply an inverse of the GRM equasion. The normal GRM equasion is as follows:
GRM = Price / Rent
In your equasion you reverse the numerator and the denominator so that Your Number = Rent / Price
In other words GRM -1 = Rent / Price
(that is to the negative 1 power, hence the inverse)
So if you use your equasion Rent/Price (but don't multipy it by 100) and then divide it into one, your result is a gross rents multiplier based on the monthly rents
In other words 525/35000 = .015
and then:
1/.015 = 66.66 (which is the monthly gross rents multiplier)
OR
66.66/12 = 5.55 (which is the yearly gross rents multiplier).
Bottom line is this. Good for you that you found a method to crunch numbers quickly that works well for you. You know what the results should look like in your market. You can use it forever, make up a name for it, call yourself a guru, and sell it on infomercials, or whatever you want. There's no absolute right way to do it. What matters is that it's consistant, quick, and helpful. Numbers need to reflect information that is useful, and your equasion does just that for you. [ Edited by hibby76 on Date 04/10/2004 ]
hibby76,
That was an excellent anaylisis above.
The $35k is actually the total purchase price plus repairs plus closing costs. In other words, it represents the whole ball of wax. I know that decent houses can not be purchased for this in many parts of the country but it is relatively easy to do in a rental neighborhood where I live. Oddly enough, even though I minored in math in college, I use the least math I can get by with now. It seems like the simpler equations work as well or better and there is less opportunity for error. About all I can say is it works for me.
I prefer to work with the cash method which negates the need for an arbitrary % to find a % which tells me I am making money. The only way to truely know the expense of a property is to read the balance sheet(p&l). Each property and locale is unique local property tax,insurance rates,vacancy rates,and marketing rates vary,along with the market price to rent in certain areas. The % of expenses is an arbitrary number which can carry an expense ratio of up to 100%. As a landlord you can control to some extent your expense ratio.
Hi MichaelChandler,
I am loath to disagree more than once on the same thread, but I must disagree! The major problem with the cash method is that sellers will almost always (and I'm sure you are aware of this) understate expenses, and overstate revenue. Of course, once you own the property you will get a very good idea of how the property performs. Unfortunately, this is the type of situation that probably gave rise to the saying " I've got a tiger by the tail and I can't let him loose!".
not to mention defered maintenance so that when you pick up the property it all breaks loose
With property values increasing at an amazing rate, and rents soft, is there some point when the numbers tell you to just sell your rental properties and wait for things to change?