3 Areas That Investors Overlook

3 unseen costs overlooked by most investors

Hey, what’s up, folks? Chris Kennedy here with Mayfair Real Estate and Mayfair Property Management located in Fort Lauderdale, Florida. In this video, what I’m going to do is show you three line items that are commonly overlooked by investors when they are comparing deals. So three line items that eat into your profit on apartment buildings, multi-family investments, that a lot of investors overlook when they’re underwriting deals. We’re going to get right into it.

Behind me on the whiteboard here, just put a very simple operating statement. We got rent at the top, that’s your income, then you’ve got some typical expenses that would be expenses for either an apartment building, or a single family home. But you’ve got insurance, property taxes, property management, repairs, utilities, and landscape. Okay. Now, there may be more items that would be on this profit and loss statement, depending on the size of the deal that you’re looking at. There might be salaries, there might be a lot of administrative expenses, whatever, but for the purposes of illustration, we’re just going to keep it simple.

Now, what are the three areas that investors frequently miss or overlook? Now, it depends where you’re getting your information. I will tell you that if you’re getting information directly from a seller, it is usually a little less reliable in certain respects than from a broker. But it can vary. What happens with sellers is they will typically, not because they’re trying to deceive you, some of them might be, but most of them are … Most sellers are honest people, they just don’t necessarily think about how a new investor might be looking at the property, but a lot of sellers will leave off vacancy. So vacancy needs to go up here.

Now, why do sellers leave that off? Because it’s an expense that you don’t actually really see on a day-to-day basis, or week-to-week, month-to-month basis. Vacancy is something that actually happens. It doesn’t matter how well you are managing the building, if you are charging close to market rents, or market rents, you are absolutely going to have some level of vacancy. If you see a building that has zero vacancy whatsoever, and historically has had zero vacancy, you can almost guarantee the rents are extremely low. That’s the only way that vacancy goes way down to almost zero. People stay there just because it’s ridiculously cheap compared to the rest of the market. If you’re charging market rents, which you would be doing as an investor going in and purchasing a property for yourself, you’re going to probably bump those rents up, you’ve got to account for some vacancy.

Now, most listing brokers in the marketing packet will include a vacancy number. How do you know what a vacancy amount is? It’s going to depend on the market you’re in. Going to depend on what’s going on in the financial markets, what’s going on in the economy, all that good stuff. I can tell you right here, down in Fort Lauderdale, as of the recording of this video in 2021, typically people are using a 5% vacancy factor. Now, depending on the broker or on how high the seller is asking for the selling price, they may try and justify a lower vacancy rate. Nicer location, whatever, they may be able to justify a slightly lower vacancy. But it is impossible to totally eliminate vacancy, no matter how well a building is managed because for various reasons people have to move at some point which creates an empty apartment, which is not producing any revenue. So, that’s the first side of vacancy.

The second area that people often overlook when they’re looking at deals is property taxes. What happens is, a lot of times when you receive the information from the seller or the listing agent, the expenses here will reflect the property taxes that were most recently paid. So we’re in 2021. For example, if I got a marketing packet today from a seller or listing agent, it may show the 2020 tax bill. That’s not a lie. The owner of this building in 2020 paid the 2020 property taxes. But what happens is, if you’re purchasing a property, and we’re assuming here this is not a distressed sale, so you’re actually purchasing the property and the seller is making a profit, i.e., they’re selling it for more than they purchased it for, then the property taxes are going to get reassessed by the County and they’re going to be increased. So you got to be very careful because that can be a significant increase if the seller has owned the building for a significant amount of time.

So a lot of times you’ll have the seller who’s got a building owned free and clear. They’ve owned it for 40 years and they’re retiring so they sell the property. Well, back when they purchased it 40 years ago, the value of that building was a lot less. Now, it might have incrementally increased in value in the County tax records, but the chances are that it’s way undervalued by the County. When that sale happens, you’re going to show a significant increase in value and it’s going to get reassessed at a much higher value, therefore your property taxes are going to go up. So you must underwrite a deal as if you’ve got the new property taxes in place.

So what I do is I use a very quick rule of thumb. You can do the more detailed way. Once you get into due diligence, you go onto the County assessor’s office website. You figure out the millage rate, et cetera. But just for a quick underwriting, a rule of thumb, I use 2% of the purchase price. It works pretty well. It’s a conservative measure. Realistically, it usually falls at about 1.8% of the purchase price. It’s approximate, but use 2% for quick underwriting. In other words, if the deal is being listed at a million dollars, and you’re going to pay list price a million dollars, then you can assume that your property taxes in year one are going to go up to $20,000 a year. They may show as much less than that on that marketing packet, so be careful.

All right, last area that almost 100% of listing agents and sellers do not include on their expense line items is leasing. Why does this happen? Well, I’ll tell you, when you’re looking at a marketing package from a broker, it happens because it’s an extra expense that they don’t want to put on there because it makes the numbers look worse. None of the listing brokers ever put this on here, so the one guy who’s putting it on there is making his deal look worse than everyone else’s, even though all of them have leasing costs associated with them. So just keep in mind, it’s okay as long as you’re comparing apples with apples. So if all the deals you’re looking at do not have a leasing line item on them, you’re still comparing apples with apples, but you got to figure out your leasing costs on that property. If it’s a property with a lot of turnover, your leasing costs are going to be higher. If it’s a property with low turnover, good area, the leasing costs will be lower.

What will happen is you’ll ask a broker about this, and they’ll say, “Oh, well, we’ve included leasing. We assume that it’s included in the property management fees.” Or they’ll say, “Well, leasing’s part of the vacancy.” In reality, the vacancy factor is probably made as low as realistically possible and should be treated entirely separately from leasing. Leasing is a cost. Now, for property management purposes, most brokers down here will put on the expense statements a 5% property management fee. You can shop around with various management companies here locally. I can tell you, virtually none of them will manage property if it’s just one or two properties for a 5% fee. If you have a lot of units, that’s a different story, you can get a volume discount. But if you ask brokers about that, what they’ll tell you is, “Well, we put 5% in there to account for you self managing or having your own team in-house that’s going to manage it.” They’re assuming that you’re a big enough investor to be able to get a 5% fee.

Again, the reason I’m saying that is not to give brokers a hard time. They’re doing their job. Again, all of them pretty much across the board use 5%, so you’re comparing apples with apples. But the point here is not to talk about the management fee, it’s to talk about the fact that leasing is missing. Because you really cannot assume that 5% would be enough to both manage a property and lease up vacant units.

You’re saying, “Well, what do I use to account for leasing?” I’m just going to be straightforward with you guys. When I’m looking at a deal for myself personally, when I’m looking to invest, I’m going to take property management, I’m going to take leasing, and I’m going to put them together, and I’m going to assume it’s 10%. So property management plus leasing equals 10%, approximately, of the total rent collected. Now, I probably lost some of you there. You’re like, “That’s way too high.” But in reality, there are costs associated with leasing, no matter what you do. Some of you might say, “Well, I leased it myself. I’ll manage property myself.” There are still costs for your own time. There are still costs for advertising. If you’re paying a cooperating tenants broker to fill a space, you got to pay them a commission.

So again, I use 10% to be conservative. If you do that, you’re going to be conservative on your numbers and you can add that 5% for leasing across all your deals that you’re looking at, and just know, “Okay, that’s a more realistic number for where I’m going to be.” So again, I’m not trying to discourage you from … to make the numbers look worse on these deals you’re looking at, but I want you to go in eyes open, understand what you’re getting into. And again, you’re comparing apples to apples. So either add the leasing fees in and use that, or don’t. Just as long as you’re comparing one to another.

Now, things to look for with leasing. Obviously you want to look at a property and say, “Okay, why would leasing costs be higher on this property versus another one?” It’s pretty straightforward, common sense. I mean, if a property is ugly, it’s not well-maintained, and it just doesn’t look very good curb appeal wise, the management is not taking care of the residents, then absolutely, you’re going to have more turnover. People are going to move in, they’re not going to like it, they’re going to move out and you’re going to have more leasing costs. So if property is well-managed, it’s been upgraded, renovated, the units are nice, comfortable, tenants feel safe, they feel like it’s their home, it’s going to greatly reduce your leasing costs. Just a couple of pointers there on how to look at leasing. You’ve got to use some of your own judgment. But hopefully that helps. I’ll see you on the next one. Thanks for watching.
Christopher Kennedy

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