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Lesson 13
Controlling Expenses
We have titled this lesson
"Controlling Expenses" rather than "Minimizing Expenses" for
good reason. That is that it is often being "penny wise and pound
foolish" to minimizing expenses because doing so does not necessarily
result in maximum profit.
Maintenance
The old adage of "an ounce of prevention worth a pound of cure" is
no more true then when it comes to maintenance. There are numerous
cases where immediate repair is important. Also, "controlling" expenses rather than "minimizing"
expenses is a particularly important differentiation when it comes to
maintenance because trying to minimizing them often actually results in lower net
operating income. This can occur for a number of reasons, including
the following:
- Bad repairs by low-cost vendors can result in the need to do the repair
over
- Cosmetic defects from bad repairs make the unit less attractive
- Failure to make repairs can result in inspections and citations and can
result in more serious damage
- Upgrades can result in higher rent and longer-term better tenants
- Tenants tend to take better care of well-maintained units
- Property in good condition at move-in minimizes or even eliminates argument at
move-out regarding what damage was done by the tenant.
Bad Repairs
Using the lowest price vendor is not always cost
effective in the long run. It is usually more costly to do a repair over
than to have done it right in the first place. Additionally, the need for
a vendor to return or to have a new vendor fix the previous vendor's mistake
wastes your time and/or that of office staff and irritates the tenant.
Cosmetic Defects
Rough drywall or plaster patches that don't match
existing texture, bad paint jobs with paint on switch and outlet plates and on
door knobs, and other unsightly repairs and maintenance are noticed by the type
of tenant that you would like to have in your unit. Tenants who don't care
about such "cosmetics" are more likely not care about how they treat
your property and even to cause damage to it. Paying a little more to have
drywall properly repaired by someone with such ability, having the switch plates
and door hardware removed before painting, and other issues of a cosmetic nature
will make it more likely that you will attract good tenants. The different in
cost of rehab after a good tenant leaves compared to after an average tenant
leaves can be hundreds of dollars, while the difference between a good tenant
and a bad tenant can be thousands.
Failure to Repair
Failure to repair in a timely manner can be most
costly of all. A slow leak from an under-sink supply valve can ultimately
result in the need for expensive cabinet repairs or even replacement of the
cabinet. Failure to take care of a roof leak can quickly result in the
need to re-build a ceiling.
Just as bad, failure to take care of repairs,
particularly those related to health and safety, can result in withholding of
rent, a government inspection, and/or citations with fines. You are
guaranteed that an inspection will result in a number of items needing attention
besides the one the tenant complained about.
Upgrades
Low-cost upgrades can sometimes pay for
themselves within a short time. The added cost of ceramic tile instead of
vinyl tile is relatively low, but can result in higher rent and attracts a
better class of tenants. Plus, the normal life of ceramic tile is many
times that of vinyl. Fencing the back yard can pay for itself over a
relatively few years because it improves security and privacy and provides a
better play area for young children and/or a place for the dog besides
inside the unit.
Tenant Care
Tenants, like most of us, will usually take
better care of something that is valued and it is human nature to value good
things more than junk. When it appears to the tenant that the landlord
doesn't care about the condition of the property, how can the landlord expect
that the tenant will care.
Utility Costs
Introduction
For many areas of the country, utility costs have
increased at a much faster rate than rents and, for those landlords paying for
water, electricity, and gas, the costs of utilities represent the largest
non-mortgage expense.
Predictions are for higher even rates and for
limits on consumption because of limited supplies and increased production
costs. These expectations should be of concern to income property owners,
managers, and those considering the purchase of rental property.
Accordingly,
reduction
of utility costs should an important concern.
What To Do?
There are basically two things that the
owner, manager, and buyer can do to solve the problem. They are:
Conservation
Conservation has long been an important concern
and this will only increase as resources are strained due to population growth,
more stringent water quality standards, a decrease in power source development.
Click here
for a detailed discussion of conservation.
Cost Transfer
Because of rising energy costs and the recent
attention to existing and potential energy shortages around the country,
transfer of costs to the tenants is an increasingly attractive practice at many
types of residential, commercial and industrial buildings. Click
here
for a detailed discussion of cost transfer.
Government Involvement
Various levels of government are also doing
things to encourage conservation. This includes offering tax benefits to
encourage sub-metering or a change in building codes to require sub-metering in
new construction as a means of encouraging conservation.
New York City
In July 2001, Mayor Giuliani signed a bill granting J-51 tax exemption to
co-ops, condominiums, and Housing Development Fund companies that convert
electricity metering systems. In signing the bill into law, the Mayor
said
"Currently, many co-ops and condos in the City use master metering
systems to measure the usage of electricity. With master metering, the
utility sends one master bill to the co-op or condo board. The board then
divides the bill equally among the tenants. Since an individual tenant is
not billed strictly according to his or her individual electrical use, there
is no direct incentive for a tenant to restrict his or her use in order to
save money and energy.
On the other hand, with master/sub-metering,
each individual tenant is billed according to how much electricity he or she
uses. In addition, the master/sub-metering system allows the utility to bill
at a slightly higher rate in the summer, when people use more power, and at
a slightly lower rate in the winter, when power consumption tends to
decrease. This system gives tenants far more of an economic incentive to
reduce their electricity usage, especially in the summertime when power can
sometimes be scarce."
San Antonio, TX
A water shortage in San Antonio this past
summer had city officials discussing the idea of mandating water sub-meter
installation for all new multi-family housing.
Houston, TX
Apartment developers in Houston aren't waiting
around for any mandates.
Tax
Deductible
It should be remembered that the cost of
retrofitting for sub-metering and the costs of other conservation efforts will
be tax deductible.
Property taxes
Property
taxes are a significant portion of the operating expenses of
any real estate investment.
How determined
Property
tax assessments are usually a percentage of the value of the property.
The taxable value that a
local government assessor places on your
property determines your tax bill.
Investors should always monitor
a property's assessment as it
invariably increases from year-to-year. If you believe
it has become excessive or
unfair, you can and should challenge the value
assumptions, either with the assessor or a Board of
Review, and get your property tax reduced. However, if
you miss the deadline, you can never get the overcharge back, even if the review
board totally agrees with your position and agrees to reduce the amount in the
future.
The "true cash value" of any real estate is always a "best
guess". However, the law requires that tax assessors must
try to determine the actual fair market value of the real
property being assessed. Some jurisdictions assess property
taxes based on a percentage of that value, while others assess a tax
based on the average value of
similar properties in a neighborhood. Although statutes or court
decisions may define what "fair market value"
The
most often used method of valuing real estate is comparing the
subject property to recent sales of property with similar
characteristics. The sale of a
comparable property with approximately the same
square footage, location, condition and use is the
best indication of the "true
cash value" or "market value" of
a property. However, because all properties have
some differences, you have to do your best to consider
those differences when you use comps to establish fair market value.
Right
to notice of assessment
You
can't complain about the assessment if you don't know what it is. Some
jurisdictions mail out notice of the assessment. Others publish it in the paper.
Either way, the date the notice is given may trigger deadlines limiting your
ability to appeal. As a taxpayer you must be given the chance to question the
assessment, but the time and manner of your objection may be specified by state
or local regulations.
When your loan has an impound account
and the lender is paying the property taxes, the lender is usually also
receiving the notice of assessment. Since the lender cares little whether
you property is over-assessed, it is unlikely that the notices will be forwarded
to you.
If
you haven't received notices of assessment in the mail, you need to
find out when assessments are made and how notice is given so that you
can exercise your right to object.
The
bottom line is simple: Your property may be over-assessed. If it is, you
are paying taxes you should not have to pay. If you follow the proper
procedures for challenging the assessment, and do it in a
timely manner, you will likely be rewarded with
lower property taxes and a better return on your real estate
investment.
How to protest assessment
You should always
pay attention to the local taxing authority's assessment for your
property. If the assessment is excessive, you can challenge the
assessment and you should be able to get your property tax reduced.
If you are uncomfortable with doing it yourself, there are attorneys or
other agents that will help, or do it for you. In that case you must
have some idea of of how much you may gain and weigh the cost to the
likely benefit. If
your property taxes are unfairly high, the assessment may be challenged
with the assessor, a Tax Review Board, or in court. For more detailed discussion regarding property taxes,
see our Property
Tax Assessments page.
Insurance
We provided
discussion of some aspects of insurance in Lesson 5, titled
Health & Safety. The best ways to minimize insurance costs is
to provide only those coverages needed and to shop for the best premium
for those coverages. However, when deciding which coverages are
needed, it is important that you not delete any important ones just to
save a few dollars. Also, when shopping for the lowest premium, it
is important that all the desired coverages are included in the
quotes. You should also consider financial rating of the company
and its reputation for payment of claims.
One of the primary ways to reduce premium
for hazard coverage is to have a high deductible. You should
consider insurance as a safety net for catastrophic events rather as making
ownership risk free. The premium for a $1,000 deductible will be
significantly lower than for $250. You might even want to consider
much higher deductible, say even $5,000. Since an uninsured loss
will be tax deductible, a loss equal to or less than the deductible
amount will really cost you the difference between the loss amount and
the tax deduction resulting from that amount.
For additional discussion of insurance
issues visit our insurance page.
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