SS151: Understanding Vacancy and Make-Ready Costs

One of the easiest ways to increase the income from your rental property is to minimize turnover. By keeping tenants in your units for several years, landlords are able to minimize vacancy, and make-ready costs involved with the move-out of an old tenant and move-in of a new tenant. In this episode, Charles discusses vacancy and unit make-ready.

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Talking Points:

·        Turnover is one of the most expensive parts of owning multifamily real estate. Not only do you have an empty unit that is not producing any revenue but, you are spending money to make it ready for another tenant. Both of these things added together to show the true cost of vacancy.

·        Calculating the Actual Cost of Turnover

o   When you are reviewing the financials of an apartment complex; it should break down the actual vacancy, and in most cases, the make rent costs for units. Some properties might lump together the make-ready costs with repairs and maintenance but for the purpose of this episode, let’s assume you have a small multifamily property with 5 units.

o   Larger, stabilized complexes with 50+ units will normally use a 5% vacancy rate as their target vacancy rate. Much larger properties that are also stabilized might use a slightly lower number. The smaller the complex, the higher the vacancy number (in most cases).

o   For our example with a 5-unit property, let’s say that 4 of the units turnover every year, and the units are vacant for 45 days each turnover or 1.5 months. That is a 10% vacancy.

o   If only 3 tenants move per year, that is a 7.5% vacancy, which doesn’t sound bad for a 5-unit complex.

o   However, when you add in the make-ready costs and other expenses, it can become very expensive. What are the other expenses? For this example, let’s just assume you are cleaning, repairing small things, possibly painting, and re-renting, with no major renovations.

§  The total turnover expenses would include:

·        All of the make ready; the repairs, painting, and cleaning,

·        The utilities for the unit during vacancy; electric, possibly gas; this can get expensive during the winter in northern locations

·        The marketing expenses for the unit – larger complexes have consistent marketing but smaller complexes really just advertise as vacancies happen

·        The leasing expenses for the unit, if you are using an agent or have a management company, you will need to compensate them (usually a half to 1 month of rent)

·        It is not abnormal for make-ready to cost $500-$1,000 or more (depending on how long the tenants were there, and the condition it was left in)

·        A unit that is vacant for just 30 days, that normally rents for $1,000, might end up costing the landlord $1,000-$2,000 plus the cost of the lost month of rent.

§  Now, the silver lining; if the last tenant was paying say $850 or $900 a month, you are now getting a $100-$ 150-month rent increase. This helps to cover some of the turnover expenses.

§  Turnover has some benefits; you are able to now achieve full market rent since most landlords are behind on rent increases (known as loss to lease).

·        You are able to do a thorough review of the unit. Sometimes it is difficult to get into units and make repairs that otherwise might have been difficult with a tenant living there.

o   If you are performing renovations to the unit during the vacancy, and you plan to recoup your renovation costs in 3-4 years; this vacancy will be a great investment, and your property will increase in value but, you need to make sure the renovations make sense (that the neighborhood can support the renovations and the rent increase). Certain renovations I will perform on a unit depending on when the investment is returned, if the unit renovations will correct, any other issues.

o   For example, if you had a leaking roof at your property, and that since has been replaced but, it did damage to a kitchen, and the tenant is moving out. I might opt to renovate that unit, even if the payback is 5 or 6 years since you are going to pay to make repairs either way, you might as well get a return on the work being done, and the repairs alone, are not going to increase your income.

·        So How Do You Avoid Turnover Costs?

o   Be a tentative landlord – when there are issues or concerns, address them. Even if you are not going to make the upgrades they want, respond; and when there is a real issue; get it taken care of as soon as possible.

o   Be mindful of rent increases; double-digit rent increases on renewal leases, are not going to keep tenants in your units for years to come. They may resign once but, they probably won’t stick around.

o   When there are vacancies, prepare for them; start marketing the unit, right when tenants move out (don’t show the unit until it is 100% done). Get your handymen ready and scheduled before the tenants move out.

o   Once tenants are out, you want to be out and in within a week, 2 weeks tops, and be showing the unit right afterward.

o   Fully vet tenants; doing this upfront, will ensure you get great tenants.

o   The goal is to keep tenants in your units for 24-36 months. Your turnover costs could be divided by 2 or 3 or more, depending on how many years you keep your tenants.

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing vacancy and make ready costs.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Charles:
Turnover is one of the most expensive parts of owning multifamily real estate. Not only do you have an empty unit that is not producing any revenue, but you’re spending money to make it ready for another tenant. Both of these things added together show the true cost of vacancy. So when you’re reviewing the financials of apartment complex, it should break down the actual vacancy and in most cases, also the make ready costs for units. Some properties will lump together the make ready costs with the repairs and maintenance. But for the purpose of this episode, uh, we’re gonna say we have a small multifamily property with five units. Now, larger stabilized pro complexes with say 50 units or more, will normally use a 5% vacancy rate as their target vacancy rate. Much larger properties that are also stabilized might use a slightly lower number. The smaller the complex, the higher the vacancy number. In most cases, it depends on the class of the property as well and its location. For our example, with a five unit property, let’s say that four of the units turn over every year and the units are vacant for 45 days.

Charles:
Each turnover or one and a half months. That is a 10% vacancy rate. Pulling three tenants move per month per year. That is a seven point a half percent vacancy rate, which doesn’t sound bad for a five unit complex. However, when you add in the make ready <inaudible> and other expenses, it can become very expensive. What are the other expenses with the turnover? Well, this example, let’s assume you’re just cleaning and repairing small things, possibly painting you’re doing. You’re, uh, gonna be cleaning with no major renovations. Now the total turnover expenses would include all the make ready, the repairs, the painting, the cleaning, the utilities for the unit during the vacancy, which is electricity, possibly gas, which can get expensive during the winter months in northern locations. Um, the marketing expense for the units. So larger complexes have consistent marketing, but smaller complexes really just advertise as vacancies occur.

Charles:
It’s really a start and stop type marketing. Now the leasing expenses for the unit, if you’re using an agent or have a management company, you’ll need to compensate them usually a half to one month rent. It’s not abnormal for make rate costs to range from 500 to a thousand or more depending on how long the tenants were in the unit for and the condition the unit was left. In a unit that’s vacant for just 30 days, that normally rents for a thousand dollars might end up costing the landlord 1000 to $2,000, plus the cost of the lost month rent. Now the silver lining is if the last tenant was paying say eight 50 or $900 a month, and you’re now getting a premium of a hundred to hundred $50, that is a great rent increase that’s gonna help you cover some of the turnover expenses when the new tenant moves in.

Charles:
Now, turnover has some other benefits as well. Now you’re able to achieve full market rent. Since most landlords are behind on rent increases known as lost lease. You’re able to do a thorough review of the unit and sometimes this is difficult to get into units and make repairs that otherwise might have been difficult with a tenant living there. If you’re performing renovations to the unit during the vacancy, you can plan a recuperate renovation cost in three to four years. And this or this vacancy will be a great investment for you and your property will increase in value, but you need to make the renovations make sense so that the neighborhood can support the renovations and the rent increases. So normally when we’re doing rent increases, we’re doing renovations. We work off a three to four x kind of, uh, payback on those renovations. If we’re putting money into a property, say we’re putting $5,000 into a property, we wanna see that we’re getting that money back in three to 40 years, and we can figure that out by what our rent increase is with the first new renter.

Charles:
Now, certain renovations I will perform on a unit depending on when the investment is returned, if the innovate renovations will correct any other issues. So I might go a little further. For example, if you had a leaking roof at your property and since then it has been replaced, but it did damage to a kitchen and the tenant is moving out, I might opt to renovate that unit. Even if the payback is in five or six years, not three to four, since you’re going to pay to make the repairs either way, you might as well get a return on the work being done and the repairs alone are not going to really increase your rent. If you’re going in there and just patching, patching issues that were done by water, you’re not really gonna get any increase in rent. If you go in there and actually renovate the unit, uh, renovate the kitchen that was damaged, then you’re now gonna be able to get some sort of increase in the rent.

Charles:
And even if the payback’s a little longer, it’s still a good return. So how do you avoid turnover costs? Well, number one is being a tentative landlord. Uh, when there are issues or concerns, address them. Even if you’re not going to make the upgrades they want respond. And when there is a real issue, get it taken care of as soon as possible. Be mindful of rent increases. I mean, double digit rent increases on renewal leases are not going to keep tenants in your units for years to come. They may resign, but once they probably won’t stick around after this lease term that they just sign for when there are vacancies, prepare for them. Start marketing the unit right when the tenants move out. Don’t show the unit until it’s a hundred percent done, but start the marketing and get your handyman lined up and scheduled before the tenants move out.

Charles:
Once the tenants are out, you want to be in and out within two weeks tops and be showing the unit right afterwards. Full event tenants in doing this upfront will ensure you get good tenants, and this is another good thing. You don’t wanna be having tenants that you put in there and they pay for a few months or they move out and break their lease. And so fully vetting tenants before they move in is going to also minimize your turnover expenses and your make ready. The goal is to keep tenants in your units for 24 to 36 months. Your turnover costs could be divided by two or three or more depending on how many years you keep your tenants in there. So for if it’s a cost $3,000 to renovate a unit with the loss of rent and everything else, uh, the total turnover cost is $3,000. If you can do that every two years, now you’ve got it down to 1500. And if you can do it every three years, now you get that down to only a thousand dollars a year or like $80 a month. So I hope you enjoy. Please remember to rate, review, subscribe, submit comments and potential show [email protected]. If you’re interested in actively investing in real estate, please check out our courses and mentoring [email protected]. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

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