The expense line items people always get wrong

Revenue projections are usually roughly right. Expense projections are usually wrong, and always in the same direction.

Here are the six that do most of the damage.

Property taxes after reassessment

The largest single error in residential underwriting.

Many jurisdictions reassess property value on transfer. The seller may have owned for fifteen years with an assessment far below current market value. Your assessment will reflect what you paid.

The increase can be substantial — in some cases doubling the tax bill, which on a small property can consume the entire projected cash flow.

The fix takes twenty minutes. Find the current assessed value and tax rate from the county assessor. Estimate the post-sale assessment based on your purchase price and the jurisdiction's practice. Calculate the resulting bill.

Also check for exemptions the seller holds that you will not — owner-occupancy exemptions, senior exemptions, agricultural classifications.

Insurance in the current market

Insurance costs have moved dramatically in exposed markets, and historical figures are worthless.

In coastal, wildfire-exposed and severe-convective-storm regions, premiums have risen sharply, deductibles have increased, coverage has narrowed, and in some areas carriers have withdrawn entirely, leaving state-backed plans as the option of last resort.

Get an actual quote during due diligence, on the coverage you will carry, with your loss history and the property's characteristics. Do not use the seller's premium and do not use a percentage rule.

Also check the property's claims history, which affects your ability to obtain coverage at all.

Management, whether or not you hire one

Self-managing investors omit this and it distorts everything.

Typical residential management runs roughly eight to ten percent of collected rent, plus leasing fees of half a month to a full month per new tenancy, plus markups on maintenance coordination.

Two reasons to include it. First, your time has a cost and the deal should justify it. Second, if you ever sell, buy more, or become unable to manage, the property must work with professional management in place.

A deal that only works because you do the work for free is a job, not an investment.

Capital reserves

Covered elsewhere at length, and it belongs on this list because it is the most commonly omitted line.

Reserves are not optional and not a percentage plucked from a forum post. Inventory the systems, estimate remaining life, divide.

On older property this is frequently fifteen to twenty-five percent of gross rent, which is several times what most pro formas show.

Vacancy and turnover, fully costed

People include a vacancy percentage and omit turnover cost, which is the larger number.

Each turnover involves: lost rent during the vacant period, cleaning, painting, minor repairs, possibly flooring, marketing, screening time, and a leasing fee if a manager is used.

On a modest unit that is frequently $1,500 to $3,000 per turnover, plus the vacant weeks.

Annual cost depends on turnover rate. A property with fifty percent annual turnover has double the turnover expense of one at twenty-five percent, and turnover rate varies substantially by property class and management quality.

Utilities the owner pays

Master-metered buildings, common area electricity, water and sewer, trash, and in some regions heating.

Two issues. First, the seller's historical usage may not reflect yours, particularly if occupancy differs. Second, water and sewer rates have risen substantially in many municipalities and continue to.

Where water is owner-paid, a single running toilet or an underground leak can produce a bill several times normal. Sub-metering or ratio billing, where permitted, is one of the higher-return operational improvements available.

The smaller ones that add up

Pest control. Landscaping and snow removal. Licensing, registration and inspection fees, which many municipalities now require for rentals. Bookkeeping and tax preparation. Legal costs. Bank fees. HOA dues, and the possibility of special assessments. Eviction costs where applicable.

Individually small, collectively several percent of gross rent.

The verification method

Request the seller's operating statements for at least two years, and preferably three.

Then verify each line independently rather than accepting it. Tax records from the assessor. Insurance from a quote. Utilities from the utility company, which will often provide usage history for a property. Management at market rate. Reserves from your own system inventory.

Build the expense budget from verified sources, not from the seller's statement.

The sanity check

Total operating expenses as a percentage of gross scheduled income — the expense ratio.

For residential rental property, figures in the range of thirty-five to fifty percent are common, varying widely with who pays utilities, the age of the building and local tax levels.

If your underwriting produces twenty-five percent, you have omitted something. Find out what.

General information about real estate underwriting, not investment or tax advice. Costs vary substantially by property and jurisdiction. Verify all figures independently for any specific property.