In our previous article we discussed sources of revenue; the money generated by an apartment community (interchangeably referred to as an apartment complex). If you haven’t read that yet you can check it out here.
An apartment community is a business at its core and like all businesses there are revenues (cash inflows) and expenses (cash outflows) generated during the operation of the apartment complex. These revenues and expenses make up the income statement (also called profit and loss statement) of the apartment complex. (Note that there are non-income statement related cash inflows and outflows related to capital activity such as debt and investor equity payments which are not mentioned in this article.)
As an active investor operating an apartment community your goal is to keep the expenses as low as appropriately possible to maximize net income and overall return for investors. The correct balance of expense management will help the property save money without jeopardizing the property’s ability to earn revenue.
As a passive investor that invests in apartment communities you will want to understand what the typical expenses are for an apartment community so you will make informed decisions while reviewing offering memorandums and on-going investor reports.
Apartment community expenses generally fall into two broad categories: Non-Controllable expenses and Controllable expenses. Non-controllable expenses are generally fixed expenses or items that are out of control of the apartment community owner to change. Controllable expenses, in contrast, tend to be variable in nature, based on fees directly impacted by the level of consumption of a product or service. These controllable expenses have a greater opportunity to be negotiated or controlled in such a manner that these expenses can be reduced (consequentially increasing the overall net income and profitability of the apartment community.)
Apartment community expenses generally fall into two broad categories: Non-Controllable expenses and Controllable expenses
The National Apartment Association publishes a survey each year of the typical percentages of each category of expense expected in an apartment community. Gross expense amounts may vary based on state, sub-market, building age and class and many other factors however the general categories of expenses remain consistent. While each of these expense categories may be more simplistically defined as controllable or non-controllable there may some aspects of each expense which are both controllable and non-controllable if you were to review the expenses at a more granular level.
Taxes – While property taxes may be contested and appealed the amount of taxes owed is generally out of control of the apartment community owner. The final decision on the tax bill for the apartment complex will come from the local governing bodies.
Insurance – Insurance helps provide financial support for apartment owners in case there are any issues such as a major repair that is needed, damage from a storm or similar issues. Insurance premiums may be negotiated up-front however they remain fixed until the term of the policy expires.
Utilities – Utilities include things such as electricity, cooking gas, heat, water, trash. Apartment owners may not be able to directly control the cost per unit for consumption of these utilities however they may be able to make energy efficient updates (such as low water consumption bathroom fixtures, motion activated lights and LED light bulbs) that help to reduce the overall consumption.
Management Fees – This expense represents compensation paid to a property management company for on-going management of the apartment community. While management fees tend to vary based on property management company and market, the rate charged by management companies typically fall in line with a standard for the specific market and apartment size. For smaller apartments (5-20 units) management fees may range from 7-10%. For apartments 20-70 units you may see fees between 5-7%. For large apartments (70+ units) you can expect 3-5% in management fees. As the unit count increases the management fee decreases.
Salaries and Personnel – Salaries and Personnel cover all expenses related to staff that help with the on-site operations of the property such as onboarding, ongoing training, payroll, employment taxes, workers compensation and more. Depending on the property management company that you use there may be some flexibility with the salaries paid and the way a property is staffed.
Economic and Physical Vacancy – As mentioned in our previous article economic and physical vacancy are somewhat of a hidden expense to operating an apartment complex. These expenses arise from having occupied apartments with non-paying tenants or having unoccupied apartments with no rental income coming in. Proper property management can help to reduce the costs of economic vacancy through methods such as better tenant screening and physical vacancy through better marketing or analysis of the unit leasing process. Economic and Physical Vacancy are related to another cost that usually shows up when an occupant leaves an apartment – Turnover.
Turnover – Depending on who you ask the definition of turnover cost may differ. The general definition of turn over costs relates to the repair and maintenance that needs to be done after a tenant moves out so that an apartment can be prepared to be leased again. The true cost of turnover may be much higher. If you look at the bigger picture of vacancy and repair expenses however there may be even more costs and lost revenue that occur during this turn over process.
Contract Services – Contract Services can vary widely depending on the property. These may include landscaping, pest control, security, pool cleaning and other services. As these services tend to have more variability in the market there may be room for more negotiation in these costs or making changes to consumption in a manner that doesn’t negatively impact revenue (i.e. doing landscaping weekly instead of every other day.)
Marketing – Marketing relates to costs used to advertise and lease apartment units. As there are many vendors and modes of marketing apartment owners can find cost effective marketing tools (or eliminate non-effective marketing channels) to help control this cost.
Administrative and General Expenses – Administrative and general expenses are miscellaneous expenses that are incurred during the operation of the business which do not directly help in generating revenue such as accounting software, phone services, office supplies and legal costs. A deep analysis of these expenses may provide insights into potential areas where unnecessary expenses are being incurred.
Repair and Maintenance (R&M) – Repair and maintenance relates to on-going and recurring repairs that are needed for an apartment community to function properly. An older building would be expected to have higher repair and maintenance costs than a brand-new construction building. Preventative maintenance and repairs that are cost efficient in the long term (i.e. replacing grass with a lower maintenance alternative) may help reduce the R&M expense.
Capital Expenditures (CapEx) – CapEx relates to major repair and maintenance expenses that are expected to be non-recurring or which should not occur frequently (i.e. once every 5-20+ years). Some examples of CapEx includes replacing a roof or an entire HVAC system.
As you can see there are many different sources of expenses for an apartment complex. We have just skimmed the surface here. Are there any other expense sources you have seen before?