Operational Expenses Are Becoming 'Full Deal Breakers'

The increasing cost of insurance, labor, property taxes and other operational necessities is making investment deals hard to pencil, putting pressure on property managers to drive value where they can.

And to be honest about when they can’t. 

As interest rates remain elevated and apartment occupancy and rent growth have stagnated in Houston, operators are working closely with owners to survive until economic conditions improve, Greystar Managing Director Ryan Terrell said.

“It is a knife fight across the country,” Terrell said at Bisnow’s Houston Property Management Summit at Houston Grand Hotel on Thursday.

“We are really locked arms, saying, ‘OK, that's the goal, that's what we have to get to,’” Terrell said. “‘We have to get to next year, we have to get to lower interest rates, so I can refinance.’”  

Managers have had to push for transparency, asking landlords for details about their loan maturity dates, cash on hand and disposition plans, he said. 

Property managers also have to be transparent themselves, Asset Living Division President Pauline Houchins said. Some owners may want to have a higher cash flow per unit so they can be at an advantage when they sell, “but it just may not be there,” Houchins said.

Part of a property manager’s role has become to determine what can drive value at the property, whether that’s initiating a partial or full renovation, adding a dog park or programming events.

“How you determine that is not just throwing capital at it but doing a lot of different test options,” Houchins said.

Property managers hold pertinent information about what will benefit a property. Sometimes, regional directors will request a dog park be added at a community, not knowing that only five pets live on that property, she said.

In some cases, a property can be exceptionally beautiful, but its submarket location will still limit its trade value. 

“Especially in a market like this where operational costs are high, even as you're doing renovations, if it's not going to work, it's just not going to work,” Houchins said. “You need to be transparent with your client at that point.” 

Any property bought in 2021 or 2022 will be reduced 20% to 30% in value by 2024, Terrell said. Borrowing money based on that inflated value could create a terrible loan structure, and every investor has a property in their portfolio like that, Houchins said.

“They obviously overpaid for the property, the loan structure sucks,” she said. “So operationally, even if you were at 100% occupied, you still would not make any money. You'd be barely breaking even.”

Even without being overleveraged, operational line items like insurance and labor have risen to the point of being deal killers, said Jamail Virani, partner of Level Capital, which develops and invests in hospitality, retail, industrial and other asset classes. 

“It's not necessarily just a financing issue, it's not necessarily an investment issue,” Virani said. “They're all full deal breakers.” 

These circumstances have created the toughest market in decades, forcing Level to have difficult conversations with investors and lenders to explain why it can’t perform, Viranit said. The company has to be transparent about legacy deals that didn’t perform well, sometimes explaining why investors should trust it again or even continue to invest in real estate.

“It's not painting a rosy picture, it's being honest about the situation that we're in,” Virani said.

In the multifamily market, a huge wave of Houston apartment development has crested but left behind oversupply. 

Houston generally sees positive rent growth when the multifamily market is 90% or more occupied, and it is about 88% occupied right now, Terrell said. The market needs to absorb 16,000 to 18,000 units to get there, and it’s going to take some time, he said.

“It's going to be this time '27 before we see positive rent growth in Houston,” Terrell said. 

In the meantime, property owners are focused on upping renewal rates from the industry-acceptable standard of 50%. They’re now aiming for 65%, 70% or even 80%, depending on the property, panelists said. 

It costs about $3K to flip an apartment unit, so even offering a tenant a $50 monthly rent reduction to stay could be a net positive, Terrell said.

Again, that makes it important for property managers to be transparent with owners about their potential for profit or rent growth, which might be little to none for now, said Aaron Almanza, vice president of property management for the Morgan Group.

“Owners don't want to hear that, but if you're having a conversation with them early about what you're seeing in the next six months, 12 months, 18 months, that's an expectation that they're going to align with you on very early,” Almanza said.

“But to expect to buy a property at $300K a door and sell it for $450K in three years, it's not going to happen.”