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Sometimes it's just a lemon

Published March 27, 2014

Have you ever heard the expression, when life hands you lemons make lemonade? Well, sometimes you just have to accept that it’s nothing more than a lemon. There has been a lot of talk in the media lately about how fast rents are climbing. But oddly, nobody wants to talk about the real elephant in the room. We started to in December. Now here’s some more detail.

We just finished our annual audit of year-end operating statements for over 100,000 units in the region. Real estate taxes and utility costs in apartments jumped 9.6% last year.

Real estate taxes and utilities have climbed faster than collected revenue over the past ten years, and probably longer than that. This is a problem. These are the two fastest growing expense items and investors seem to be unable to reign them in.

apartment expenses

Between 2000 and 2013 collected revenue went up 3.7% a year while operating costs rose a little over 4% a year in King County. It’s never great when costs climb faster than revenue.

But now consider this. Taxes and utilities combined went up almost 6% a year compounded annually. So how does that actually work out in the long run? Good for investors? We think not.

Let’s take a look at what happens over the long term. We admit this is a really long term, longer than investors think about. But maybe they should change their thinking.

It’s really not ridiculous to look at the next 100 years. Yes, we’ll probably all be dead in 100 years, but if you and future investors take care of your property, it will probably be around 100 years from now doing just what it does today. So it is worthwhile to take a look at what issues your property might face in the early 22nd century.

If operating costs, taxes, and utilities keep rising at the rate we’ve seen since 2000 taxes and utilities alone will cost more than what we project for total operating costs in just 44 years. Well that’s just not possible, so it will force total operating costs to increase faster than they have historically. Hmm, would that higher cost increase have any impact on rents? Duh. So what does this mean for investors?

It means that if tax and utility costs continue to climb at the rate they have been increasing, then at some point these two expense items alone will eat up more than 100% of the rents investors collect. Projecting these trends out a little more, we find that taxes and utility costs are greater than revenue in 80 years.

Tax and utility trend

Of course that assumes rents just continue to rise at the same rate they have been increasing, and this scenario makes that impossible. The point is that these trends just aren’t sustainable. It doesn’t work.

If we can’t reign in tax and utility increases, rents will have to climb 30% faster than they have been increasing. That won’t be easy to do. In fact, it probably isn’t even possible over the long run.

As we said at the start of this story, there has been a lot of talk about how much rents are climbing. But as you can see from this little demonstration, that totally misses the point.

The real issue today is how much taxes and utility costs are climbing. Current rent increases are nothing compared to what they are going to have to be in the future if we don’t contain these costs.

Unfortunately for investors, there’s not much more they can do to get these costs under control.

Investors appeal their valuations to keep them reasonable. Investors have invested heavily in water conservation and more cost effective approaches to dealing with garbage.

And we don’t see anything in the future to suggest these costs will moderate. Quite the opposite. Seattle Public Utilities announced in December that they plan on rate increases of 5% or more for the next five or six years.

Okay, we’re finished with our rant. Please enjoy the rest of your day.


The slide show below contains the charts from this week's video.



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Next Friday

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December 21, 2014

Bill Austin: "Thank you for the valuable, timely, and accurate information you have provided me, Epic, and our entire industry over the years. Dupre + Scott is truly the definitive source for performance statistics in the region. Thanks and kudos to you both. And you do it all with a wonderfully self-effacing sense of humor which is particularly endearing." (Bill is Vice President of Operations for Epic Asset Management, an apartment investment, development and management company in Seattle.)