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The graph on this page, Apartment expense budgets on sales, shows expense budgets have risen steadily since the beginning of 2000. But the trend also uncovers a problem investors need to come to grips with.
The average expense budget for 5-unit and larger apartment sales that closed in the past six months in the Tri-county market (King, Pierce, and Snohomish counties) area was $3,737 per unit per year, or $4.83 per net rentable square foot. Expenses consume about 32% of scheduled gross income. At least that's based on the expenses budgeted for these sales.
However, please note that the 2009 edition of our Apartment Expense Report found expenses in the Puget Sound region averaged $5,643 a unit in 2008 (operating and capital expenses). Operating costs alone averaged $4,565 a unit.
The bottom line is that there really shouldn't be much of a difference. The expense budget on sales excludes any major capital expense buyers planned initially, but it should include an annual replacement reserve for future capital needs.
It is possible that some of the difference between these two sets of expenses is justified, based on different characteristics of the properties in our expense research compared to the properties that sold in the past six or twelve months. But we suspect the difference is minimal. The expenses used on sales each year have always been lower than the actual costs we find in our annual audit of true operating costs, so this isn't a new problem. It has been with us for a long time.
Some investors tell us that they really do have lower expenses because they manage the property themselves, and in some cases do a lot of the maintenance and landscaping work too. Okay, we'll admit that if you took on the job of resident manager, professional property manager, and some of the maintenance work, your expenses could appear to be at least $1,000 a unit a year lower.
Note that we used the term "appear." That's because your expenses aren't lower, you just didn't pay yourself for doing the work. If you are good at it, and you don't care about getting paid, have I got some properties for you to work on. Even if you do the work yourself, you need to allocate a cost to the property for your time.
Another problem is investors do not budget enough for capital expenses. This is a major issue, which we discuss in detail in other articles.
As a result, many investors are significantly underestimating the actual capitalization rate on their acquisition, as well as over-estimating the cash-flow returns they expect to generate from their purchases.
This trend comes from our Weekly Apartment Investment Update, uploaded this morning for subscribers to our Apartment Advisor. If you subscribe to The Apartment Advisor, log into your account to download the complete 5-page update. We update our online database of 5-unit and larger apartment sales for our Apartment Investment Report subscribers every week, usually early on Friday mornings.
