Multifamily Operating Expenses Continue to Climb | The Current Cost Landscape

Despite solid multifamily demand, rising operational expenses have put a strain on multifamily owners nationwide. According to GlobeSt, operational costs for apartments grew by 8.6% year-over-year (YOY) in Q2 2023, while operating expenses have risen 28% in the last 12 months, resulting in higher debt costs and stalled project proposals and construction delays.

Over the last 12 months, the most noticeable cost increases were observed in insurance expenses, which surged by over 10% compared to 2022. Increasing costs in administration, taxes, management, and payroll, each experiencing a growth exceeding 7%, also contributed adversely to their overall financial performance. – Source: GlobeSt

Last year, as the economy faced its highest inflation rate in four decades, expenses drew increased attention. While much of the focus centered on unprecedented apartment revenue growth, expenses grew at an even faster rate. This trend has continued into 2024. Cost pressures have risen, and the leveling of pandemic-era rent increases has forced a shift in how owners are operating. Creating new efficiencies will become the differentiator, allowing managers to deliver value by controlling expenses, increasing margins, and delivering a better customer experience.

The data presented in Exhibit 1 leaves no room for doubt: expenses rose significantly more in areas with lower costs. The Southeast and Southwest regions experienced the most substantial increase in expenses, while the Northeast and West regions had a comparably lower rise.

Slowing Multifamily Rent Growth

According to Yardi Matrix’s National Multifamily report, the average asking rent in the U.S. dropped by $3 to $1,718 in October, while YOY growth fell to 0.4%, marking a 40 basis point decline from September. This fall in rental rates has primarily been observed in markets with a high volume of new property deliveries and diminishing affordability levels.

Increasing Insurance Costs

The hike in multifamily expenses can be heavily attributed to the significant rise in insurance costs, with a year-over-year surge of 33%, amounting to $180 per apartment unit. Insurance comprises over 8% of a property owner’s quarterly per-unit operating expenses, nearly twice the percentage from five years ago.

The property insurance market is undergoing significant disruption, marked by steep increases in multifamily premiums, an uptick in policy cancellations, and the exit of insurance companies from entire states. Apartment owners are feeling the pressure, with premiums rising between 50% to 200%.

Natural disasters, from drought and wildfires in the West, flooding in Kentucky and Missouri, and hurricanes in the Southeast, have all become more frequent and expensive. A doubling in premiums is not out of the question, according to Yardi Matrix.

This situation is not expected to improve soon, with premiums predicted to remain high throughout 2024. Carriers have become selective about the properties they consider acceptable risks, limiting options, especially in older properties. Many Multifamily operators have had to increase deductibles and switch to excess and surplus (E&S) carriers to keep coverage in place.

Utilities On The Rise

Utilities, including water, gas, electricity, telecommunications, and other essential services, account for 15% to 20% of the overall operating expenses for a multifamily property. The average change across the top 50 metros reached a “record-high” of 10.7%; this implies an additional 1.6% to 2.1% increase in operating expenses, excluding other factors.

The elevated figures are observed in regions with notable gas or oil expenses rising due to increased energy use toward heating the building. The winter of 2022 was exceptionally cold, and despite a substantial decrease in energy prices during a period of slowed inflation, recently, there have been significant increases. This indicates that there will be increased pressure on all energy prices.

Anticipating future changes in utility prices, the primary factor driving this increase is the surge in natural gas prices. This pattern is expected to continue, given the decline in natural gas production, as the U.S. Energy Information Administration reported.

Repairs & Maintenance Costs

The costs associated with tenant turnover have experienced a noteworthy increase since the onset of the COVID-19 pandemic. This increase is not only due to costs incurred when physically turning a unit and attracting new tenants through marketing but also the loss of rent during the vacancy period. Particularly in Class B or C properties, the cost of turnover can easily exceed one month’s rent.

The surge in these expense lines is attributed to the inflationary rise in material and labor costs, as well as the influx of new rental properties into the market. The increase in supply presents renters with more options and often results in discounts, thus leading to more tenant turnover.

Other parallel line items, such as R&M, payroll, and administrative expenses, have also significantly increased. Contractors have used inflation to their advantage, leading to higher costs for services like painting, plumbing, and landscaping. Maintenance technician wages have continued to climb, making them difficult to hire, resulting in a greater reliance on costly outside vendors.

How Owners Can Combat Rising Expenses

Multifamily owners have a range of strategies at their disposal to counter the challenges posed by rising operating expenses. In the face of slowing revenue growth, operators will need to focus on controlling and reducing expenses to achieve proforma assumptions and mitigate the impact of higher interest rates on property values. Many Multifamily investors who have been profitable for years are now looking for ways to adopt new technologies and centralize operations in a way that can improve their bottom line.

Proactive maintenance and routine inspections also play a crucial role in identifying and addressing issues early on, thus preventing costly repairs and ensuring the overall infrastructure remains in good condition. Owners can also begin implementing flexible rent structures, including variable utility billing or energy-efficient incentives. This not only provides tenants with options but also encourages responsible resource usage. Many investors have chosen to invest in energy efficiency upgrades, which enhance the property’s sustainability and contribute to long-term cost savings on utility bills.

Working with an expert to evaluate your assets’ historical data is an imperative first step to identifying any operating inefficiencies. A comparative analysis using proprietary market benchmarks can shed light on certain line items, that may be otherwise overlooked and necessary to make budget adjustments or future buy/sell decisions.

To read an article on the ongoing challenges facing multifamily supply, click here.