Expense and rent strategies in real estate management

Journal of Real Estate Research, The, 1998 by Chinloy, Peter, Maribojoc, Eric

Affordability is RIP, the annual unit rent at a given apartment building divided by the average price of a house in Portland that month. When rents are high relative to house prices, a tenant is more likely to purchase. The data capture cross-sectional variation, since at properties with higher rents tenants are more likely to switch to ownership. Sample statistics are in Exhibit 2.

Exhibit 3 reports the hedonic rent equation, where the time and month coefficients summarize the price index. The results indicate a positive expense-rent correlation for three category types: general and administrative overhead, taxes and insurance, and marketing. There is no significant effect for repairs and capital expenditures. The results are similar for the rent roll and total income.

In general, the properties are operating optimally, in that it is not possible to increase expenses or operating scale without reducing profit, as measured by net operating income. Any expense addition at optimal operation should cause net operating income to be nonincreasing, and this condition holds for all expense categories. The only potential exception is for marketing. A one dollar increase in marketing, a discretionary and controllable expense, leads to a dollar recovery in rental income.

For the rent roll, the coefficient on marketing expenses is 0.96 and that for total income is 1.10. The implication is that a dollar spent on marketing yields at least a dollar in effective gross income, and positive net operating income.

By comparison, expenses for taxes and insurance, largely outside of the control and discretion of the property manager, raises rents but the coefficients are smaller than for marketing. A dollar of property taxes leads to only eleven cents more gross rent under both income definitions, and eighty-nine cents less in net operating income. The implication is that property taxes are shifted back to the owner, with the incidence largely avoiding the tenant.

A dollar spent on administration and management expenses leads to a recovery in rental income of between sixteen and eighteen cents. This category is controllable by management, and leads to a reduction in net operating income of between eighty-two and eighty-four cents per dollar spent. These expenses may be a source of friction between nonowning management and ownership, suggesting incentive contracts based on net operating income. The results support rent-expense positioning on an isoprofit contour. Properties have strategies with high rent and expenses, or low rent and expenses. Expenses and gross rents are positively correlated, although there is a difference by type of expense.

The annual hedonic rent index changes, based on the results in Exhibit 3, are in Exhibit 4. Allowing for corrections in quality, rents increase by 3% annually during the sample period, slightly less than the overall increase of the Portland area Consumer

Price Index

Estimates of the vacancy function are in Exhibit 5. Vacancy depends on the fitted hedonic rent, user cost, affordability, lagged vacancy and the financial condition of the property. Also included are property characteristics and identifying variables. Higher hedonic rents reduce demand for apartments, and at the given short-run supply increase vacancy. The hedonic rent coefficient yR of 0.071 is identical for the rent roll and total income, and the demand function is well-behaved and downward sloping. This is an augmented rent-vacancy trade-off, since it includes expenses and implicitly net operating income.