What is the average expense ratio when underwriting multifamily?
Hi Guys, 

I recently got a job at a multifamily brokerage as an analyst 🎉

I have two questions (and I really appreciate any help in advance ❤️):

1) What is an average expense ratio to use when underwriting multifamily? Another analyst here said he usually uses a 35% expense ratio but I heard someone else say 45% is better. BUT, I was underwriting some apartments in NYC and owners/sellers are telling me their expense ratio is only 25%. So I am really confused. 

I am guessing that the older/worse condition a property the higher the expense ratio would be? And something brand new construction would be less? I am guessing it maybe changes on location to? 

How do you go about finding a market/fair average expense ratio to ballpark the NOI? 

2) Do I apply the average expense ratio to the rental income or the total income? Sometimes I see a P&amp;L where the total rental income is $900,000 but they have an extra $100,000 of "Other Income" which might include pet fee's, late fee's, and laundry income. Let's say I am using a 35% expense ratio, do I apply the 35% expense to the $900,000 of rental income or the $1,000,000 of total income? 

Thank you so much!
[{"id": "hl4khbw", "text": "Go off the actual P&amp;L T12 and the proforma your way to reasonable market rent, occupancy, and burn off loss to lease (typically in a n3m or n6m)\n\nRegardless buyers will ignore your proforma, do their own and request T12s and rent rolls, among many other things.\n\nThe answer to your first question is market, asset class, location, and property dependant... But, for a typical fully occupied and well managed class A property in a good location and market I would assume a 60-70% operating margin. \n\nBut I would much rather simply analyze a full P&amp;L and get to NOI and then use this to analyze the deal to come to my own proforma numbers knowing my operating structure as the buyer in my underwriting of the property.", "replies": [{"id": "hl4nrwu", "text": "Thanks so much for the quick reply. This is all helpful. \n\nSo if its a 30-40% expense ratio for a Class A property, how much higher would it be for Class B or Class C property? \n\nHow do you simply analyze a full P&amp;L? What I've been doing is confirming through bank statements that their income is actual income, and comparing it to nearby properties asking rates, and then simply applying an expense ratio to sort of guesstimate expenses. They may show a 30% expense ratio but I would underwrite it maybe using 35% to be on the more conservative side. How would you recommend I quickly try to find a properties realistic NOI given 10-20 minutes of underwriting? Think of this as a quick underwriting to see if deal passes \"sniff test\" as my boss says.", "replies": [{"id": "hl4p92k", "text": "I would not consider buying a property, especially a $50mm+ class A MF, or any other CRE, where the seller was not providing all of the financials and other relevant materials. \n\nAs far as buyer solicitation, use a trusted data source to create a market by market template/index and then modify to property specifics. But again, even then, before even getting to an LOI stage, I would expect disclosure from the seller or I would assume either problems with the property or unwillingness to sell/acting in bad faith.\n\nNow if all you are doing is driving around town looking at random properties and asking, \"what would that sell for?\"\n\nSure:\n\nNumber of units * market rate rent * occupancy rate * 12 * operating margin (60-65%, or better yet a trusted data sourced figure for the asset class, location, and market etc.) / appropriate cap rate\n\nBut that tells you nothing about the actual property in question, and accounts for nothing as far as actual DD is concerned.", "replies": [{"id": "hl5f3mn", "text": "Thanks so much. I usually have access to T12 but how do I know the owner is reporting all the actual expenses and that they are maintaining the property correctly? I was told that owners with lower expense ratios may be neglecting the property and it could cause deferred maintenance? So I guess assuming I have a T12, how do I verify if those numbers are \"market\" numbers vs them being super cheap? Calling brokers and asking them?", "replies": [{"id": "hl6od08", "text": "&gt;but how do I know the owner is reporting all the actual expenses and that they are maintaining the property correctly? \n\nYou don't.\n\nThat's part of the game that comes from experience. Without knowing what side of the business you're on it is hard for me to say how you would know, but regardless... You should have a) market research (if MF this would be Yardimatrix, realpage, and RCA etc.) B) comps,  and c) past deal flow you can reference.\n\nBut again, normally, as a buyer, I didn't care what you tell me your expense structure is because I know what mine will be. From there I can make my proforma based on my investment thesis for the property.", "replies": [], "depth": 5}, {"id": "hld2w3y", "text": "#deposit, GL, and utilities reconciliation. If you\u2019re going to Reddit for advice on this I can only imagine what bs your superiors are pitching to their \u201cclients\u201d", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "hl4pt17", "text": "For sniff test use 45% to start. \n\nThen, when you go back to fine tune, reduce it to 35%  in a subsequent version.", "replies": [], "depth": 3}, {"id": "hl4t1wk", "text": "Wouldn't you rather ask, what will they go down to?", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl4rhdw", "text": "So many variables can change that. I never look at percentages, but rather per unit controllable expenses.  Things like high / low rents, high / low RE taxes, franchise taxes, other income (parking?) and utility structure can greatly skew ratios.\n\nUnless it's new construction or not stabilized, you should have a T12 you can base expenses off of.", "replies": [{"id": "hl5c2pd", "text": "Thanks so much for the reply. How do you do that actually? Go line by line for every income and expense and compare it to market numbers? Im a total novice and I wont lie, this is confusing/overwhelming. How do I figure out their controllable expenses?", "replies": [{"id": "hl5cnqh", "text": "We compare general categories, not ever single line item. For controllable, it's marketing, turn, R&amp;M, G&amp;A, landscaping, contract services, etc. For uncontrollable, it's items like RET, insurance, utilities, management fee and other like ground lease, franchise taxes, etc. Then we compare with T12 + other comparable assets in the market.", "replies": [{"id": "hl5faam", "text": "Got it, thank you. How do you get access to the other comparable properties? Through CoStar or Brokers or some other method? Very helpful, I appreciate it. To be honest, it seems like a ton of work to underwrite a single property.", "replies": [{"id": "hl5fju8", "text": "&gt; How do you get access to the other comparable properties\n\nBy doing hundreds of deals over the years. Or sometimes I'll ask a client for their T12 of a competing asset\n\n&gt;To be honest, it seems like a ton of work to underwrite a single property.\n\nProbably why we are the best around and most brokers suck as they just forward shit around.", "replies": [{"id": "hl6p6w2", "text": "&gt;Probably why we are the best around and most brokers suck as they just forward shit around.\n\nLmao, don't know you from Jack, but can we do a deal together? I'm loving that attitude!", "replies": [], "depth": 6}, {"id": "hl6qsly", "text": "Who is \u201cwe\u201d?", "replies": [{"id": "hl6qzfp", "text": "Myself, my partners and the guys that work for us.", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl4tjp9", "text": "25-50%.\n\nIt depends mostly on how high income the property is.\n\nIf the property averages rents of $5,000/unit with minimal amenities then you might be in the 25% range.\n\nIf the property averages rents of $800/unit then you might be in the 50% range.", "replies": [{"id": "hl5bh4s", "text": "Thanks for the reply. How come the higher the average rents the less the operating expense would be and vice versa?", "replies": [{"id": "hl5f6ka", "text": "Generally speaking, the lower the rent - the more the tenants beat the crap out of the place. It's probably an older building so you have to account for increased maintenance. \n\nPlus fixed costs are what they are.  Water/electricity doesn't care what the average rent is - so the percentage will be lower on more expensive property.  If you have staff, you don't pay them 10x more just because the rent is 10x more - things like that.", "replies": [{"id": "hl5fix3", "text": "Haha, I love that quote about tenants beating the crap out of their place. That all makes a lot of sense though and is really helpful, I appreciate that.", "replies": [], "depth": 4}], "depth": 3}, {"id": "hl5jfnx", "text": "Say you charge an average of $5,000 a unit per month.\n\nThat is $60,000 per year.  Even though it is an expensive unit you probably aren\u2019t spending much more than $15,000 to $20,000 per unit (25-33%) in operating expenses.\n\nAt $800 per unit that is $9,600.  50% of that is $4,800.  Maybe you cut costs a little bit from there but not by much.  There is just less money to work with.\n\nThese are obviously 2 extremes.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl4tpvy", "text": "The answer is it depends, mostly on how well the property is being managed and how old and well maintained it has be. A brand new well managed class A building may be 30-35% an old mismanaged project may be 40-45%+ which is where value-add opportunities may exist. Either way I always ask for current rent roll and 3 years of income statements to trend to where I believe my proforma should be.", "replies": [{"id": "hl5bsx4", "text": "I usually have access to T12 but how do I know the owner is reporting all the actual expenses and that they are maintaining the property correctly? I was told that owners with lower expense ratios may be neglecting the property and it could cause deferred maintenance? So I guess assuming I have a T12, how do I verify if those numbers are \"market\" numbers vs them being super cheap?", "replies": [{"id": "hl5fbsv", "text": "We always perform a property condition report and a walk thru to make sure that the on the ground property conditions match. You have to trust but verify that the numbers reported to you are accurate and in-line with other properties in the market. If they lie to a lender or you then they can get in real potential legal trouble if they misrepresented facts and or you can drop the project.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl4xi7r", "text": "I think this video really hits on several of your points. \n\nA) you need to generate your own P&amp;L and if you're getting paid, it cannot be based on \"rules of thumb\" but actual evidence and estimates based on facts.\n\nB) Other income is vastly important for reasons you mention. Is it recurring other income or one off? \n\nhttps://youtu.be/dxrIaxdxbEU", "replies": [{"id": "hl5bkjs", "text": "Thanks for sharing but it says \"This video is private\" and will not let me watch it. Do you have another link to the video? I really appreciate it.", "replies": [{"id": "hl92inr", "text": "How about now? Shows up for me", "replies": [{"id": "hl94rjx", "text": "Yes, it is working now. Thank you!", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl5h46g", "text": "I\u2019d say on average between 30-40% of EGR, but obviously varies in every situation.", "replies": [{"id": "hl5no9b", "text": "Thanks for the reply. So when you apply an expense ratio, is it just on the rent income or do you include ALL income? Meaning, the pet fees, laundry income, late fees, etc too?", "replies": [{"id": "hl5onj1", "text": "I would do your Potential Gross Revenue (which is all revs like pet fees, laundry, etc..) minus GV and credit loss to get your Effective Gross Revenue.\n\nThen take 30-40% of EGR as your expense ratio. Again, 30-40% is just a wide use case average and this ratio will always vary depending on the asset.", "replies": [{"id": "hl5peek", "text": "Got it, thank you so much! This is helpful.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl61qem", "text": "35%-45% expense is reasonable for larger multifamily properties. \nA lot of factors can have a huge swing in expense ratios. \nAge of property and maintenance have been mentioned above. High rent vs low rent market also impact the ratio. Many operating costs are fixed despite the different amount of rent you collect.\nHow utilities are accounted for. Some old properties still don't pass back utilities that raises expenses. Opposite is not having most utility expenses because they are paid directly by tenants.\nHigh or low tax assessment especially in CA with Prop 13. \nHow the operator is expensing Capital Expenditures. Some owners with low loan interest expenses will classify lots of Cap Ex as repairs and maintenance to minimize their taxes. \nAlternatively an apartment flipper will buy an old apartment building fix it up and classify everything as Cap Ex to have really low repairs and maintenance to drive up NOI and property value on a refinance.\nReally start by getting three years of operating history and start questioning year to year variance.", "replies": [{"id": "hl64592", "text": "Thanks so much! This is very helpful. I really appreciate it, especially the idea of comparing financials year to year for variances.", "replies": [{"id": "hl66w09", "text": "For a typical refinance in Freddie for Fannie, we are required to have 6 columns for analyzing NOI. 3 years operating history, trailing 12 month statement, Appraisal NOI, and underwritten NOI.\nIf you don't catch a borrower over classifying Cap Ex and repair expenses to reduce taxes initially, often an appraisal will screw up and assume that is how the property is operating.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl68emg", "text": "I've seen 35% used in every proforma I've ever looked at.\n\nI use 45% in anything I purchase.\n\nFrom NYC news reports, I wouldn't be at all surprised they are at 25%\n\nI prefer to see 5 years of actual expenses.\n\n*\"Let's say I am using a 35% expense ratio, do I apply the 35% expense to the $900,000 of rental income or the $1,000,000 of total income?\"*\n\nReminds me of a pastor who was asked by a parishioner \"*Father, I don't know if God wants me to tithe on my gross income, or my net?*\" and the Pastor responded, \"*Well....do you want to be blessed grossly, or netly*?", "replies": [{"id": "hl953rx", "text": "Haha, thank you so much!", "replies": [], "depth": 2}], "depth": 1}, {"id": "hl7drd2", "text": "Varies wildly. High and mid rises are typically around 28-32%. Garden apartments are closer to 40", "replies": [], "depth": 1}, {"id": "hl7gwtt", "text": "following", "replies": [], "depth": 1}, {"id": "hl7ikr3", "text": "10 years experience. 35% and low 40s in FL and other states with higher re tax", "replies": [{"id": "hl955rf", "text": "Thanks for the reply. For brand new construction is it usually a lot lower? 25-30%?", "replies": [{"id": "hl9cwz1", "text": "Generally not. In fact smaller older properties are the ones where I see lower costs. You have more Capex but those owners tend to have more time to find deals on upkeep. \n\nI would not underwrite a new property below 35% expense load, 33% maybe", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl7rizm", "text": "SE US - 32% for rough work. Conventional Larger Property say 150 units +\n\nLIHTC 72 units and less much higher \"say\" 45-50%\n\nBe cautious around Property Taxes (varies widely) and insurance (much more expensive close to the coast)", "replies": [{"id": "hl957fs", "text": "This is helpful, thank you so much!", "replies": [], "depth": 2}], "depth": 1}, {"id": "hl80g6g", "text": "Depends on where you are. Texas for example is closer to 50%. In California, closer to 35%.", "replies": [{"id": "hl958mi", "text": "Wow. Why is Texas closer to 50%? What is so much more expensive there?", "replies": [{"id": "hlc2syb", "text": "RE Taxes. And they are aggressively marking assessments up to fill their budget holes.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hl95qj5", "text": "30% expense ratio is too light. Yes you see them but if you need it to make the deal work that\u2019s no good.\n\nEdit: Use somewhere in the 40-45% range.", "replies": [{"id": "hl9c3ik", "text": "Thanks so much! Do you think this is true even for brand new construction? I.e. looking at a deal where someones almost done building a Class A 250\\~ unit apartment and they're projecting a 28% expense ratio.", "replies": [{"id": "hlagu9f", "text": "That seems low. New construction perhaps ~35% expense ratio. $250/unit in replacement reserves.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "hld0rqp", "text": "Definitely UW expense ratio off your net rental income + other income (EGI). If your doing NY deals inflating the T12 expenses  isn\u2019t a bad place to start since your rent controlled and have virtually no business plan other than managing for occupancy I.e your not going to seriously grow payroll, R&amp;m, and marketing expenses if your not getting paid for it in rent growth (assuming it\u2019s a stable, well maintained property). We don\u2019t go near the northeast and for institutional grade deals typically see high 30s to mid 40s% for total expenses including reserves.", "replies": [{"id": "hld1ui1", "text": "To add if you\u2019re at a brokerage shop go learn how tax reassessments actually work by state and that made up forward cap rate compression is not a real way to value a deal", "replies": [], "depth": 2}], "depth": 1}]