One of the largest obstacles developers and property owners face, in general, is how to successfully operate and manage their property. There are many cost factors to be aware of besides your mortgage payment. Determining what these costs are is a crucial component in positioning yourself to budget property expenses properly– and potentially, build some equity.
Less than 100 years ago, estate management was a more commonplace skill. For many modern homeowners, these are mysterious tasks. The millennial generation has been significantly slower to own real estate, purchasing property at much later ages than previous generations. There are many reasons for this, chief among them being ownership of extremely high college debt and having to live through a recession. But now, confidence in property ownership is back on the rise for the world’s largest and wealthiest generation. In order to see proper returns on that investment, coupled with equity growth, it is imperative that new property owners possess the knowledge to properly manage their assets, starting with a realistic budget.
Here is a list of principal operating and management cost factors to budget for. This is by no means meant to be comprehensive, and factors will vary from place to place.
- Utilities – Utilities are building services that power and sanitize your property. Typically, utilities are billed from a service provider to the property owner, recurring monthly for the duration of ownership. Common utility services include water, electricity, gas, cable/fiber-optic, telecom, internet, security system, storm sewer fees, and other specialty services.
- Land Management & Maintenance – These are costs associated with the upkeep of property grounds: services like lawn care, snow removal, tree/shrub pruning, landscaping & gardening, and others. These costs are often overlooked. Some property owners who assume personal responsibility for these tasks then don’t do them, while others hire a grounds service without keeping track of the monthly cost. Regardless, grounds maintenance should be in the budget– at the very least, a monthly lawn care/snow removal cost should be assumed.
- Building Repair & Maintenance – Sooner or later, something inside your property will need to be repaired or replaced: the boiler, furnace, roof, leaky pipe, broken window (the list goes on). The question is, when? That, we cannot know. Building repair and maintenance is not a recurring monthly cost, but smart property owners budget for it in preparation for that inevitable rainy day. Common practice is to put aside a little cash every month. Some stash away the annual equivalent of 1% of the property purchase price ( [purchase price x 1%] ÷ 12 months = monthly repair budget). Others try to save the annual equivalent of whatever $1 per square foot of property amounts to ( [property area x $1] ÷ 12 months = monthly repair budget ). Choosing a number that falls in between these two figures is probably your best guess. And, remember, older buildings will require more maintenance,o plan accordingly.
- Property/Homeowner’s Insurance – This is insurance specific to home/property owners and is typically paid by monthly recurring fee. It covers losses and damages to an individual’s home or other types of private property. It also covers accidents that happen on the property, protecting your investment against things like fire, “Acts of God,” break-ins, and bodily injuries. Because there are a lot of insurance products in the market, be sure to shop around for the best value. Depending on the project, financing strategy, and the lender of any debt, mortgage insurance may also apply.
- Property Taxes – This is a percentage tax levied on the value of the property, and is a major source of income for the governing bodies that collect them, helping to pay for services like transportation, trash removal, education, parks, and more. In the U.S., property taxes are calculated by a millage rate determined every year by the various governing bodies. That mill rate is multiplied by the taxable value of the assessed value of your house or property. The basic equation goes like this: Annual Taxes Due = [ mil rate x ( taxable value = assessed value x assessment rate)]. Tax breaks, should they apply, are usually included in the assessed rate as a lowered percentage. In Detroit for 2016, the total millage rate was 70.09 mills or 7.09%. Millage rates vary widely across the U.S.
- HOA Fees (Homeowners Association Fees) – These are costs uniquely associated with condominiums or planned communities of condos or single family homes. The fee is assessed based on property size and rates can vary widely, depending on the bylaws of the HOA organization.
- Contingency/Savings – If COVID-19 has taught us anything, it’s that you need to have an emergency or rainy day fund.This contingency fund is simply another bucket of cash that will keep you and your asset afloat for an extended period of time– typically 6 months, but of course, could be longer, should, lets say, a pandemic occur. If you’re a small developer operating an income property it is prudent to reserve some of your profit after your debt payments are made. Take some of those earnings and set them in an account specifically for emergencies on that project. Furthermore, contingencies should be baked into your proforma. If you’re a homeowner, make this another line item on your household expenses.
Add these costs to your monthly mortgage payments to get the true operating and maintenance cost of your property. Rates typically change every year, so you will have to adjust this number annually.
Operating costs are a critical component in determining the true equity you have gained or lost in a project. Equity = Assets ( Mortgage Payments +/- land/property value) – Liabilities (Capital Costs + Operation Costs + Maintenance Costs).
Depending on where you live, there can be many other components to this simple equation– but knowing these basics of how money moves in and out of your asset, and for what reasons, is the bedrock to successfully building sustainability. In America, it’s an attribute everyone should have.