Scattered Site Rental Toolkit:
Business Planning for Development & Management
VI.C. Planning for Adequate Development and Operating Costs
There are a number of values that will need to be plugged in and assumptions that will need to be made as you work through the pro forma. As discussed in the section on “Management”, it will be critical to have staff on board by this point that are experienced and knowledgeable in both rental housing development and financing of rental projects. Below are a few of the “numbers” that you will need to address in the pro forma.
Because of the need to secure funding, often from multiple sources, in order to make these projects work and because of the scattered and diverse nature of properties, acquisition can be very complicated. You will need to plan for a way to either purchase properties with already secured funds, or negotiate with sellers for an “intent to purchase” agreement. This is complicated because of the need to purchase many separate properties from multiple owners and because waiting on funding agreements, working through environmental reviews, and potential relocations can take several months. Even if you purchase the property with already secured funds, you risk not getting the remaining funding that you need to complete the project and will need to meet any required environmental review requirements prior to purchase. In addition, you will incur holding costs such as property taxes, securing of property, and lawn care.
Another option, if you can negotiate it with funders, is to obtain funding prior to the selection of specific properties. If you pursue this alternative, you will have to do your homework: checking the sales price and condition of multiple neighborhood units very carefully and then using previous experience and research to develop all of the remaining details regarding acquisition and rehabilitation estimates.
Development and Construction Costs
These should be similar to costs associated with project-based rentals, however, the scattered and diverse nature of these units will once again add to the costs. Contractors will likely add more costs related to travel time between units, lack of building component uniformity, and difficulty in securing multiple sites.
Remember that you are developing quality homes and estimate your costs accordingly. Also remember to plan for a reasonable developer fee, so that you can ensure that the development process is well managed.
Rents and utilities
Rents are primarily a function of two factors: a) what the market will tolerate and b) what the funder will allow. Reasonable market rents can often be captured through your market study. In addition, most sources of funding have a cap on rents. It is important to learn what that cap is and whether that cap includes or excludes utilities. It will also be important to establish who will pay for the utilities. This is an issue that is made more complex by SSR, as utility costs per unit can vary considerably.
For example, you may have what was previously a large single family home that was converted to a duplex, which has a shared heating system. Meanwhile down the street you have a newer duplex with separate heating systems and separate meters. It will be up to you to determine whether you will allow for different utility payment models for each unit, will pay for all utilities, or will go to the expense of installing separate systems and meters in the units, so that the utilities can be paid for separately. Adding to this complexity is the fact that utility cost is one of those areas where tenants get themselves into difficulty. In cases that we learned about in our research, some tenants would turn the heat up to 80 degrees during the winter season, even though the resulting utility bill would be enough to make their unit unaffordable and place them in danger of losing their housing.
Vacancy rates can partially be captured by your market study, though the realities of each SSR unit are different and this will reflect not only the market rent, but the associated vacancy rate. For example, the poor foot traffic circulation pattern of the house, with the bedroom right off of the kitchen and the bathroom at the other end of the house may make a particular house more difficult to lease, or the view of the river and park out of the big picture window may make a particular unit especially marketable. Aside from these issues, lease-up and turnover rates are often better for SSR projects as compared to multifamily projects, as a single family house with a yard that is typical of this model is often more desirable.
Another issue related to vacancy is the length of time that a property sits vacant at each turnover. This is more than just a measure of the unit’s desirability, it is also affected by the ability of the agency to get non-paying tenants out quickly and get the unit cleaned up and fixed up so that it is in move-in condition in a short period of time. In our research we found that this is one of the areas in which agencies struggled. Often the maintenance personnel are overworked because units require more maintenance than was anticipated and units can sit for months until staff can get to them. This costs the agency the revenues from rent for this time and is self-perpetuating. Staffing need will be further discussed in the section on management, but units must be turned over quickly. This will require both adequate operating funds and adequate maintenance and replacement reserves. It will also require you or your management company to hire or contract with an adequate number of skilled maintenance personnel.
As described above having adequate operating, maintenance and replacement reserves is critical to success. Funders will have to be persuaded of your need for the high levels of reserves you are requesting, as you will often max out or exceed their caps for reserve amounts. It is important to note that one of the issues that we found is that the inflation trend factors developers use in their proformas are often overly optimistic: projected rent increases are too high, and project operating and maintenance cost increases are too low. In reality, what often happens is the trend lines for rents and costs cross somewhere between year five and year fifteen, leaving the project with negative cash flow.
Operating Costs & Long-Term Cash Flow
Keep in mind the time consuming nature of this enterprise as you plan for staffing and other operating costs. For example, whatever model you use for transportation (agency purchased vehicles or staff reimbursement for miles driven), it will be more costly than for multifamily rental projects. Even if you contract out for management services, you will have asset management costs. You will need to negotiate with your funders an adequate management fee to professionally manage your properties.
· Delineating costs and expectations: How you build your annual operation budget is a reflection of your ongoing management plan: it indicates who does what, where it gets done, and how much it will cost. Traditionally, organizations charge a general management fee to the project or portfolio but charge maintenance and leasing staff to a specific multifamily property. How do you do this for SSR? Some work can be directly linked to an address, but other work is done across the SSR properties. How costs will be assigned must be clearly defined.
Moreover, for SSR there are operating costs you may not consider. For example, you may need to pay for security during periods of vacancy. You may have to pay for two leasing staff members to show vacant units if safety is an issue, thus increasing the cost of staffing your SSR portfolio. Likewise, maintenance staff will spend more time traveling between units, decreasing the number of work orders each maintenance staff person can complete.
· Property taxes: For example, you may be able to negotiate on property taxes or your state may waive them altogether for affordable rental properties owned by nonprofits. You may want to pay some taxes to be able to make the claim that your properties are contributing to the tax base. Try to keep debt as low as possible and avoid it if possible. If rents support debt, keep debt service at no less than a 1.25 debt coverage ratio (DCR).
· Lease purchase variability: If you plan to administer a lease purchase program, this will make your operating cash flow highly variable. As units are sold to tenants, they leave your portfolio, decreasing rental revenue and some operating costs. However, in spite of selling a few units, you or your third party manager may not be able to reduce maintenance staff commensurately. So, revenue may decline faster than costs, creating the risk that your operating cash flow will see deficits in later years of your lease purchase program if you haven’t planned for the reduction of staff, contractors, and services.