NOI as % of Gross Rent Assumption - Posted by BBMW

Posted by BBMW on September 03, 2011 at 16:57:42:

I’m wondering if this isn’t a negative indicator for an area?

NOI as % of Gross Rent Assumption - Posted by BBMW

Posted by BBMW on August 30, 2011 at 24:08:06:

I’m trying to work back the numbers to what I should be spending to build a multiunit residential building (I’m thinking a doubled modular fourplex for eight units.) The building doesn’t exist yet, the land isn’t purchased. I’m basically thumbnailing out what the project would look like financially.

One key number I need to assume in NOI as a percentage of gross rent. What is a safe assumption for this? Think a semirural area in eastern PA.

I have been using 50%. For planning purposes, does this seem high, low, or on?

Re: NOI as % of Gross Rent Assumption - Posted by ray@lcorn

Posted by ray@lcorn on August 30, 2011 at 12:53:18:


The industry average expense percentage for multi-family is 40% (leaving a 60% NOI). The expense range is from 30% to 45%. The three largest variable affecting the range are management, utilities and reserves.

For management the actual cost is affected mainly by the whether the property is self-managed, owner managed with an employee, or fee management. Smaller properties are typically self-managed. Owner employed managers are usually not economically efficient under 75-100 units, depending on the nature of compensation, e.g. free unit, whether some maintenance labor is included, some amount of wages. Fee management is market driven, usually a percentage of gross revenue ranging from 4% to 10% depending on size (larger is less) and market competition. Regardless of the management style used, a lender will always plug in market rate fee management expense when calculating NOI. If they have to take the property over they will have to hire a management company.

Utilities come into play due to several variations in delivery. In rural areas many projects use private well and septic systems. This can significantly reduce utility costs. Some markets will allow the off-loading of utility expense to the tenants through sub-metering. This can turn a large expense category into a wash, or even a small profit. (Note: Not all states allow this, check yours). Lastly, public utilities are generally owned by a government entity, and those costs have increased five fold in the last several years as localities look for rto end subsidies on services.

Reserves are a wild card. Most owners do not include reserves as expenses. However most non-bank lenders will, usually along the lines of $200-$350 per unit per year.

All that said, an eight-unit project will likely not fall into the 40% expense calculation. You have the option of putting in separate utility meters for water and sewer, which may include trash pick-up. You’ll likely self manage,a you won’t deduct reserves for new units and maintenance costs should be below average for several years.

My advice would be to use the build-up approach rather than ballpark percentages. This is not hard. Get the property tax rate and do the math for the taxes; get a quote for insurance, and make the decisions regarding utilities and mgmt.


Re: NOI as % of Gross Rent Assumption - Posted by BBMW

Posted by BBMW on August 30, 2011 at 16:25:33:

Thanks Ray,

I had to do some plug in numbers to thumbnail whether doing a project like this would be stupid or not. I used 50% expense ratio, and it still works out pretty well.

I need to cost up how much it would take to get the units built (I’m thinking a doubled modular fourplex for 8 units to start.) I’m hoping to get it done (including the land) for

Re: NOI as % of Gross Rent Assumption - Posted by ray@lcorn

Posted by ray@lcorn on August 31, 2011 at 08:24:43:

Using 1,000 sq. ft. per unit, $450T is about $56 PSF. Probably too low.

In my area basic modular construction (sans land) runs $75-$95 PSF depending on foundation type, i.e. basement or crawlspace.


Re: NOI as % of Gross Rent Assumption - Posted by BBMW

Posted by BBMW on August 31, 2011 at 10:42:03:

I was running the numbers in my head last night, and end up thinking the same thing. I’m glad you’re giving me a ballpark for the construction costs.

Thanks again.

While we’re talking ballpark numbers, what would be a good thumbnail cap rate to think about valueing the complated units at? I was thinking 7-ish. Does this make sense?

Re: NOI as % of Gross Rent Assumption - Posted by ray@lcorn

Posted by ray@lcorn on August 31, 2011 at 12:18:06:

Even though cap rates are used for 5 units and up, the dominant valuation metric for small projects is comparable sales in the market, averaged with replacement cost. Many appraisers are shying away from income valuation on projects below 10-12 units due to the low LTVs (

When I run the numbers… - Posted by BBMW

Posted by BBMW on August 31, 2011 at 15:58:30:


Thanks again. The numbers you’ve given me have been a real reality check, so much that I don’t think the concept I was thinking about at makes sense.

I have the cash to self finance potentially buying the land and the construction of the first 8 unit building. I figured I do this, get it rented, then shop it to the banks for the money. As a completed, rented, completely non-pro-forma deal, I figured I could get better rates that trying to finance pre-construction. I was hoping I could build the project for signifcantly less than its final value based on it’s cash flow at completion. I could then finance at 75% of value, but get all my money out, with the property still in positive cash flow.

I could then use the recaptured funds to build further units on the land.

But based on the numbers you’ve given me, and my guess at land cost, I’m likely to spend ~$750K on a project that will be worth ~$630K, and have to leave nearly $275K in the deal. My income return on that money would be just above 5%.

Does this make any sense, either in my calculation, or in the entire project being worthwhile. It strikes me as I could put the money in REITs and get a better return.

Re: When I run the numbers… - Posted by ray@lcorn

Posted by ray@lcorn on August 31, 2011 at 16:42:24:

You didn’t mention having extra land. That may work as with a bit longer time-frame. Especially if the first deal clears the land for the additional units. But even if it doesn’t you may structure the deal for a better return.

Before going further, some questions:

How many units is the total build out?

You said it’s a rural market… Is the economy industry-based, agricultural, county seat? What’s the community’s “reason for being”?

How are the market fundamentals, i.e. population growth rate; HH income & growth trend; avg. unit rent and occupancy of existing multi-family? These attributes help determine the lease-up time (i.e. absorption)and rate of rent growth.

How much competition (existing rental units) and what quality? If nothing new has been built in years then the new units should lease-up faster at about a 5%-10% premium to market rents, affects the time horizon and carrying costs for total build-out.


Would it be typical for new construction… - Posted by BBMW

Posted by BBMW on September 02, 2011 at 16:59:47:

…to be underwater in terms of value from cash flow vs. construction costs? I though the reason people did new construction was to get properties for under the value of existing construction?

Are me expectations out of line?

Re: Would it be typical for new construction… - Posted by ray@lcorn

Posted by ray@lcorn on September 04, 2011 at 15:53:21:

Your expectations are not out of line, markets are.

Anecdotal evidence from my own experience and many investors I talk to across the country indicates current rent amounts and construction costs are incompatible for new projects in many markets (not all). Rents are slow-growing to flat due to high unemployment and low wage growth, but the materials component of construction costs has not declined due to the run-up in commodity prices.

[As to why, blame gov’t subsidies, tariffs, and the Fed’s QE1 & QE2, and ZIRP (zero interest rate policy) which fueled speculative commodity positions and produced the opposite of the desired effects in the general economy. Also read Bailout Nation by Barry Ritholtz.]

This state of affairs upends the classic real estate formula of ramping up construction and development in the first stages of recovery from a “normal” recession.

However, as financial writer John Mauldin has noted for two years, “what we just experienced was not a normal business cycle recession, but a deleveraging/balance-sheet/debt-crisis recession. And the latter takes 5-6 years to work through, after a country begins to deal with the problem, which we have not.”

In sum, soft rent growth and stubbornly high construction costs make it tough to justify building new projects. That’s a curse and a (bittersweet) blessing.

On the one hand we don’t get the boost to employment, income and supply chain material sales from contractor to consumer spending that construction generates.

On the other hand, commercial real estate will not be fighting over-supply problems anytime soon.

My firm has altered course to adapt. We’re buying existing properties at 50% (or less) than replacement cost (today’s dollars), then pitch “renovate-to-suit” deals to potential tenants. With tenant commitments in hand the ultra-low interest rate environment works to our advantage in structuring the financing. Renovations are much cheaper per square foot than new construction, and the project will yield a profit at current market rents without the ramp-up and absorption problems inherent in new construction.

Ex: We just bought an office building (with onsite parking, a big plus in downtowns) one block from a county courthouse for about $55 psf. We’re working with a good tenant on a budget of about $50 psf to renovate to their specs. That will put us in the building for about $105 psf. Replacement cost would be $125 psf, plus land. Result: we can deliver new, technologically current and energy-efficient space at a lease rate competitive to less-desirable existing space.

Last, to your question below about this being a negative indicator, the answer is maybe-maybe not. That’s why I asked the demographic questions in the previous post. Proper phasing can produce cost benefits and prevent the project getting too far ahead of the market.


Re: Would it be typical for new construction… - Posted by Brandon

Posted by Brandon on September 03, 2011 at 11:24:08:

I’m in NE Indiana in a town with a pop of around 10,000. Probably
similar market as you are talking and I’m looking at lower costs to
buy rather than build by a good margin.

Re: Would it be typical for new construction… - Posted by BBMW

Posted by BBMW on September 07, 2011 at 15:25:59:


That makes sense, especially after running the numbers. The one thing I was looking for out of building was the pop if the construction costs were less than the cash flow valuation. I was hoping to get all my cash back out at a 75% LTV.

That is now upside down. I’d probably have to leave more cash in the deal if I build rather than buy existing.