SS252: Property Expenses Increase as Properties Get Older

SS252: Property Expenses Increase as Properties Get Older

One mistake many real estate underwriters often make is failing to adjust property expenses for older properties. In this episode, Charles discusses property expenses and how to adjust them as properties age.

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Talking Points:

  • When reviewing comparable properties, whether to figure out sale or rent comps, the vintage of the subject and comparable properties is extremely important. Many investors will simply look for properties and units with similar square footage and the same number of bedrooms/bathrooms, while overlooking the age of the property or marketing that metric as less important, which couldn’t be further from the truth.
  • There are several reasons why the age of a property matters, especially with rental properties.
    • 1. Older properties rent for less than newer properties. This is true for both small properties with 5-49 units and large properties with 50+ units in the U.S. multifamily market.
    • 2. Broadly speaking, rent collections decrease as properties age. If you have ever wondered why large private equity firms prefer newer properties, this is a significant contributing factor.
    • 3. As properties age, their expenses increase, which is what we will be discussing today. Before we get started, my goal is not to dissuade investors from buying older properties, but rather to ensure they are aware of the differences in expenses compared to newer-built properties.
  • The main reason that properties experience an increase in property expenses as they get older mainly revolves around the natural wear and tear on the building, the systems, and the materials used. Let’s break down why this happens and what expenses an investor can expect to increase.
    • 1. Maintenance and Repairs: Older systems, including HVAC, electrical, plumbing, and roofing, will require more frequent repairs. Deferred maintenance is very common in older properties, where previous owners often patch up repairs instead of addressing the underlying issues. It is common for older materials to be of lower quality or to have additional issues, such as environmental concerns, that are often not realized for decades after installation.
    • 2. Capital Expenditures (CapEx): Building on the last point of maintenance and repairs, and deferred maintenance. CapEX investment is typically required to correctly address issues that have been continually patched over the years, which is capital-intensive. A roof with leaks that requires a roofer or handyman to patch it every two months might cost an owner $20,000 to replace it correctly. Boilers that repeatedly experience issues throughout the winter, especially if they are 10 years old or older, most likely require full replacement. Some of these capital expenditure items may not be immediately apparent either. In an older property I owned, my property manager once called me and told me that the gas company was requiring me to re-pipe the natural gas lines in the basement before they turned the natural gas back on. Not something I had ever heard of, but it makes sense if you have gas piping that is 70 years old. 
    • 3. Regulatory Compliance: When dealing with the government, these regulatory issues can be challenging to determine if you are not well-versed in a city’s codes or have a property manager who is. One of the common issues we encountered with older properties was the city’s new codes regarding apartment buildings and the installation of fire alarm systems and fire extinguishers. You can purchase a property and then find out months later that you need to invest $5,000-$10,000 in new fire compliance standards. There really is no way of knowing 100% if or when these new codes will be required, and you definitely don’t want to call the city to ask.
    • 4. Insurance Costs: Insurance companies view older properties as having a higher chance of claims (fire, water, structural, and liability). Older properties are typically not 100% code-compliant with new codes and standards, and they are often grandfathered in. Deferred maintenance is prevalent in these properties, and typically, as properties age, their premiums also increase.
    • 5. Utility Inefficiency: This usually affects tenants more than it does property owners, but our goal as multifamily investors is to minimize turnover. If a unit has dramatically higher utility costs, it may convince a tenant to move rather than renew their lease. You want to make sure that your rental units are as efficient as reasonably possible. Electric heat is expensive, and during a renovation, an investor may opt to install an HVAC system instead of keeping the electric baseboard heating system. Adding insulation and replacing windows helps decrease the inefficiencies your tenants will experience.
    • 6. Renovations and Upgrades: With all aging properties, renovations and upgrades will be required in order to capture higher rents and maximize the NOI of your property. This requires a capital outlay, which might be prohibitive for many owners.
  • For investors looking to purchase older properties, they should budget for higher repairs and maintenance and higher reserves to plan for future capital expenditures and renovations. As an investor in older properties, I would ensure that any property manager I hire has experience in managing properties of a similar age and engage them prior to purchasing the property, so I can run the due diligence and inspection report past them before making a decision.
  • If you want to learn more about buying older and newer properties, check out episode SS220.

Transcript:

Charles:
The first three multi-family properties I owned were over a hundred years old. And I quickly realized the cost associated with maintaining older properties. Not that there were bad investments, but my thinking underwriting had to change regarding what I took for granted with newer bill properties. Welcome to Strategy Saturday, I’m Charles Carillo. Today we’re breaking down why property expenses increase as properties get older and what every investor needs to know before buying an older property. So let’s get started. When reviewing comparable properties whether to figure out sale or rent comps, the vintage of the subject and comparable properties is extremely important. So many investors will simply look for properties in units with similar square footage in the same number of bedrooms and bathrooms while overlooking the age of the property, making that metric less important. However, this couldn’t be further from the truth. So there are several reasons why the age of a property matters, especially with rental properties.

Charles:
Number one is older properties rent for less than newer properties, and this is true for both small properties with five to 49 units and large properties with 50 plus units in US multifamily markets. Number two, broadly speaking, rent collection decreases as properties age. If you’ve ever wondered why large private equity firms prefer newer properties, this is a significant contributing factor. Number three is as properties age, their expenses increase, which is why what we will be discussing today. But before we get started, my goal is really not to dissuade investors from buying all the properties, but rather to ensure that they are aware of the differences and the expenses compared to new or bill properties. And this doesn’t have to mean that they’re a hundred years old, like in my example of the first properties I purchased. But the thing is that you want to make sure that these properties that you’re looking at, you’re not comparing a property that was built in 1998 with something that was built in 1978 or 1968 and thinking that the maintenance, the repairs and maintenance is gonna be very similar between those two properties.

Charles:
Now, the main reason that properties experience an increase in property expenses as they get older mainly revolves around the natural wear and tear on the building, the systems and the materials used. So let’s break down why this happens and what expenses an investor can expect to increase. So number one is maintenance and repairs. Older systems including hvac, electrical, plumbing and roofing will require more frequent repairs. Deferred maintenance is very common in older properties where the owners often patch up repairs instead of addressing the underlying issues. It is common for older materials to be of lower quality or to have additional issues such as like environmental concerns that are often not realized for decades after installation. There’s tons of different examples of this, but like it could be galvanized water pipes, polybutylene pipes it could be aluminum wiring stab electricals that they used a lot back in like I think like the seventies.

Charles:
That was a big thing too. Panels, all these different things. We found out years later that they just weren’t that good and that there was issues with them. And that becomes once you have an issue, once there’s materials that are out there that becomes issues or they find out later, you have to, now you might risk not having insurance on the property, paying a lot for insurance, but either way you’re gonna have to pay to have that changed, right? Which is gonna cost a lot of money. Number two is capital expenditures, CapEx. So building on the last point of maintenance and repairs and deferred maintenance. Capex investments typically required to correctly address issues that have been continually patched over the years, which is capital intensive. So a roof with leaks that requires a roofer handyman, the patch it every two months might cost an owner $20,000 to replace the correctly boilers that repeatedly experience issues throughout the winter, especially if they’re 10 years old or older, most likely require full replacement.

Charles:
And some of these capital expenditures items, they may not be immediately apparent either. In an older property I owned, my property manager once called me and told me that the gas company was requiring me to re-pipe the natural gas lines in the basement before they turned the natural gas back on. So I had a property with several units and the natural gas was turned off to all of them. Luckily it was during the summer, so it wasn’t during the winter. But the thing though was that that’s not something you can just wait around and get repaired. That’s something that you need to get repaired immediately. So, and it wasn’t even something that I’ve ever heard of, but it makes sense after paying for it, it made sense because that gas piping is probably 70 years old, right? Sitting down there in a damp basement, it’s gonna be something that’s gonna need repair.

Charles:
And during your initial due diligence on a property, not one of the things I was really checking. Number three is your regulatory compliance. So this is something that’s not as clear cut as seeing one broiler or a furnace is gonna break down, but it’s, when you’re dealing with government, these regulatory issues can be challenging to determine if you’re not well versed in a city’s codes or have a property manager who is okay. So this is one of those things when you’re buying a new property, if you’re starting in a new area, you have a property manager. This is why we always suggest like, you know, bring that property manager into the deal, pay them for assisting you with the deal looking at deals. It’s a great way because they might look at it and be like, these are the things you need to look at.

Charles:
Even if you don’t utilize or need that information for that property that you’re looking at, you can use it now for other properties in the area. So they might say, does this property have a fire alarm system? Okay, yes it does. Now I know even if I don’t buy that property or no it doesn’t, I know for future properties, this is something I really have to look at this fire alarm system and I know that it’s gonna cost $10,000. Let’s just say for this size property, if I speak to him and I see what he says and I know now I have this and I can put this into my underwriting knowing that this is gonna be one big CapEx item that I might need one month after buying the property, or might need, you know, 10 years down the road depending on when the fire marshal comes around and does their checks and my property is the next one on the list.

Charles:
Now, one of the common issues we encountered with older properties was the city’s new code regarding apartment buildings and installation, like I said, of the a fire alarm systems was one thing for us. And fire extinguishers. So if you purchase a property and then find out months later that you need to invest that five, $10,000 into that new fire compliance standards, there really is no way of knowing a hundred percent of this when these new codes will be required. And you definitely don’t know when the city’s gonna ask you to do it. I had my property so close to each other in this, the city and they like hit one property, you know, a couple years after this started. And then one property like a few years later, you know, they’re working this weird way through the city and these diff, I don’t know what their planning is, but there’s no way you would know.

Charles:
You don’t know if they’re gonna go this street over here, they’re gonna go this direction. One of the properties never needed one, right? But the other ones did. So it was one of those things like you had that put aside because it’s not just something you can say, you know, you don’t wanna get into the bad side of fire marshal or anything like this or any government officials and you wanna make sure that your properties are all habitable, they’re compliant, all this kind of stuff. But these are one of the things that you don’t know what you don’t know. And having someone that knows the area, especially if you know, that’s in your corner like a property manager is especially important when you’re buying properties. Number four is insurance cost. So insurance companies view older properties as having a higher chance of claims. Fire, water, structural and liability.

Charles:
Older properties are typically not a hundred percent cold compliant with new codes and standards and they’re often grandfathered in. Deferred maintenance is prevalent in these properties and typically as properties age, their premiums also increase. And this can happen at all different parts of the property. I’ve had it before where you don’t have, you know, two forms of ingress and egress. You have stairs that go up that don’t have that go up too many stairs without having like a turn. I mean, there’s so many different things that can happen. Fire escapes not having like actual stairs coming down from this unit. And these are like grandfathered in things that would never fly in the future. And the thing that was that there’s not like a, when you buy a property like this that has something grandfathered in, you’re not gonna get some kind of sign thing from the city that says everything here is fine or this is done.

Charles:
And the other thing too is you maybe don’t want to go and talk to the fire marshal if you’re buying this property and go, Hey, is this, you know, is this a fire escape? Fine. You don’t wanna bring attention to your property. So you’re really just kind of waiting there and seeing what happens as you try to, you know, renovate this property and get it going, you know, in a better direction and value add it. But it’s something where you don’t, you can’t, you just have to have money in reserve. That’s the only way that fixes this, is knowing about it upfront that could be an issue. And having money in reserve so that you can really, you know, you can really address it immediately. I remember with one of my properties, I had years back, the fire marshal came through and gave my property manager was walking with him and they gave like a laundry list of stuff, right?

Charles:
My property manager, you know, he would’ve been in the city for 25, 30 years, something like this. He knew this guy and that was kind of, he kinda knew him, but he knew his boss, the fire marshal, the chief or whatever. And he was like, okay, you’re not gonna require all this, you know, after we reviewed it with him and he says, he goes, this is just what I see, blah, blah, blah. And I got a call from my you know, I got a call from my property manager and he was like, this is what they are. I told him, Hey, you know, like you can’t expect us to do all of this. We can do some of this. What can we do? And and he was telling me, he goes, if he doesn’t work with us, I can always call the chief, which is something I couldn’t do.

Charles:
I didn’t have that type of pole in that area, had been around that many decades. I didn’t know any of this. So that property manager saved me thousands of dollars because they were able to say, this is what we’re gonna do. We’re not gonna change all this. How about if we do this, these, you know, like the reflective tape on these stairs, we fix, we add in an additional handrail over here, we put a fire alarm system in, we add a few different fire extinguishers from the laundry room, up the back stair, whatever it might be. And that was fine. So, but it’s one of those things where if you don’t know, if I was a new investor there, I’m gonna pay, you know, contractors to work through this list and this thing would’ve cost me thousands of dollars more. And this is something again, you probably don’t know when you’re walking through a property.

Charles:
One thing you’re not looking at is probably how many railings are up. You’re probably not looking at any of these different things that’s coming through the lens of someone from the fire department. So it’s, it’s very important. And, and once they look through it, it’s also through the insurance company as well. And so as these issues, as these properties get older with these issues, these properties are typically gonna be, you’re gonna have premiums that increase and the requirements not just from like fire marshals and government associations, but you’re also gonna have it from insurance companies, okay? Had before where they’d say there’s something wrong with his back stairs. Like the outside stairs, they probably didn’t, I don’t think my insurance company went into the properties really that much. Maybe they’d take a picture of the electrical panels, but they would see it’s upgraded from the outside.

Charles:
So usually that wasn’t much of an issue, but that would be a thing if you had electrical that hadn’t been updated, that’s a big thing. They usually have to get a picture of those and make sure that everything’s compliant. The other thing was like sidewalk issues because of tripping, because of someone falling, whatever it might be, stairs, huge thing that they’re gonna check, especially outdoors. They’re gonna check the driveway, had them, you know make me do a number of different things with driveways as well. So these are things that probably if you’ve had a driveway that was done in the last 30 years, it’s probably not an issue. But when you had driveways that were done 60 years ago, especially up north where you’re having freezing water, getting in water, expanding, you know, water coming out, all these different things that goes on every year with these properties, that’s gonna really put a dent in the life of these properties and it’s gonna require you to do a lot of maintenance on the properties to get them up to the insurance.

Charles:
That new level of an of what the insurance company wants to see. That’s also something that you might not know initially, you might know. ’cause You can put the property out the bid and get a, get kind of an idea, an estimate on what insurance is. However, you’re not gonna know exactly what it is until you buy the property and maybe until the first renewal. Or if you have you know, hopefully you don’t, but until you maybe have a claim and then they come out and they go, they go, what’s going on in this property? And they’re gonna like, check all these things or they maybe not renew you at all. So these are things that you have to be aware of when you’re looking at properties and what could be hazardous beforehand. Number five is utility inefficiency. So this usually affects tenants more than it does property owners, but our goal as multi-family investors is to minimize turnover.

Charles:
Okay? So if a unit has dramatically higher utility costs, it may convince a tenant to move rather than renew their lease. And you wanna make sure your rental units are as efficient as reasonably possible. So electric heat is expensive and during a renovation and an investor may opt to install kind of like a real HVAC system instead of keeping electric baseboard heating, which is less expensive to install, less expensive for maintenance, but adding insulation, replacing the windows, you know, helps decrease the inefficiencies your properties, your tenants will experience in your properties. It can be a little expensive, but the thing though is that if someone’s getting high bills that they’re probably gonna leave if it’s really stretching their budget during those winter months or during those summer months if you’re not insulated for the AC stuff like this. But mainly it’s usually during the winter when properties that aren’t well insulated it’s really gonna show, or they’re using expensive heating methods.

Charles:
That’s something that you kind of want to avoid. And that’s why a lot of tenants, I remember when I would rent apartments myself, it was something that they’d always want to know if utilities were included, right? Because they didn’t want this, they wanted to have some kind of control over their budget, which I don’t blame them, but the best thing that we can do is provide them with as much efficiency as possible on those units. And this can be something, I mean obviously we’re going to a property, there’s gonna be a lot of things that you want to fix right away. You’re probably not gonna fix stuff that’s already working. Like those electric baseboards, especially if you’re on like second and third floors where you have the heat that goes up your first floor is you’re probably, that’s where you’re gonna be spending your time or larger units.

Charles:
That’s where you’re gonna be spending your time fixing first. And stuff that’s already broken, right? But these are things you have to keep in mind when you’re leasing properties and when you want people. ’cause If you’re giving them a rent increase, but they’re like, well, during the winter my electrical goes up, you know, two, three XI mean, that’s gonna be a tough sell because you’re gonna have that with every tenant coming through. So it’s something that you need to do if you want to keep tenants and not have all that turnover. Number six is renovations and upgrades. So with aging properties, renovations and upgrades will be required in order to capture higher rents and maximize the NOI the net operating income of your property. And this requires a capital outlay, which might be prohibitive for many owners. And for investors looking to purchase all the properties, they should budget for higher repairs and maintenance and higher reserves to plan for future capital expenditures and renovations.

Charles:
And as an investor in all the properties, I would ensure that any property manager I hire has experience in managing properties of a similar age and engage them prior to purchasing the property so I can run the due diligence and inspection report past them before making a decision. Now, if you wanna learn more about buying older properties and newer properties, you can check out episode SS 220. That’s SS 220 and I hope you enjoyed, please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Links Mentioned In The Episode:

  • SS220: Comparing Investments: Older Properties vs. Newly Built Properties

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