Expenses: we may not like to dwell on them, but they’re a huge factor in every landlord’s business–and they just can’t be ignored. That’s why Dupre + Scott puts out an issue of Apartment Advisor each year that is solely dedicated to analyzing expenses. So batten down the hatches and cue the Jaws music–the issue just came out, and we’re here to break it down for you.
Profit or loss?
This post will be a two-parter. Today we’ll talk generally about budgets and expenses, and get into the specifics of vacancies; on Friday, we’ll pick up with the rest of the issue, which talks about utilities, office expenses, insurance…but also the fun part–income!
Total Yearly Expenses: What’s Typical?
Dupre + Scott begin by telling us the typical yearly expense per unit for 2011, which is $5,395. Note that this is the median cost, meaning that about half of properties spent more than that, while the other half spent less. Of course, there are always the extremes at each end of the spectrum–about one-quarter of surveyed properties spent less than $4,691/unit, while another quarter spent more than $6,291.
You may be wondering where Dupre + Scott get their numbers; in this case, they came from the 2011 operating statements for 910 properties, with a total of 97,200 units.
The Expense/Income Dance
They say it takes two to tango, and expenses are no exception. While operating costs rise steadily from year to year, income rises as well, so it’s vital to look at the relationship between these two if you want an accurate picture of the role expenses play in your business. In 1999, due to the late-nineties boom, costs only ate about 45% of a property’s income. By 2004, this had jumped to a 52% peak, but then it began to back off again. Recently, expenses have been dropping; they hit 49% in 2011, and are expected to continue dropping through 2012.
It’s important to note that when advisors say that expenses are just 1/3 of revenue, they are referring to scheduled revenue, not collected revenue–and the difference between, say, 35% and 40% can make a big difference to investors.
Are Buyers Budgeting Enough?
Dupre + Scott found that brokers and buyers of 20-unit or larger apartments budgeted a median $4,952 in 2011; that’s about 8% below actual $5,395 per-unit cost that the study found to be accurate. Investors have always tended to overestimate cash-flow–in fact, this 8% difference is “the closest these budgets have been to actual costs since the 1990s.”
Let’s Talk Vacancy.
Are you familiar with the difference between physical and financial vacancy? Dupre + Scott explain it as follows:
Physical vacancies report the vacancy rate in the market based on the number of vacant units found from the survey; financial vacancy is measured by comparing total rent collected, prior to deductions for credit loss and concessions, with the rent schedule.
The financial vacancy rate climbed from 3.7% to 4.6% between 1997 and 2001; by 2004 it had hit higher than 7%. It’s been dropping since then, and hit 5% in 2011; if it follows recent patterns, it should continue to drop throughout 2012. Meanwhile, physical vacancy mirrored the financial vacancy rates fairly closely, usually with a difference of less than 0.4%.
Occasionally, concerns are expressed over whether survey respondents accurately report vacancy information; however, over their 30 years in the business, Dupre + Scott have found that “as long as we respect the privacy of information people share with us…they will share information honestly.”
And Don’t Forget Economic Vacancy…
Of course, physical and financial vacancies are just two ways to lose money–there are plenty more. The economic vacancy rate takes concessions and credit loss into account as well. This rate increased steadily between 1998 and 2004, when it hit about 12%; it dropped to 5.2% in 2008, but jumped back up to 10.1% in 2009. It’s been dropping since then, hitting 8.7% in 2010 and 6.9% in 2011.
…And that’s all for today. Check in on Friday for The Expenses and Budgets Report: Part 2. Until then, see you in the comments or on Facebook!