Utilities, Two States Play Key Roles in Slowing Growth of Operating Expenses

Published by H. Blair Kincer on Monday, April 3, 2017 - 12:00am

In terms of predictability, few things were more stable from 2010 through 2014 than the annual increase in operating expenses for low-income housing tax credit (LIHTC) properties measured for the just-released Novogradac 2017 Multifamily Rental Housing Operating Expense Report. Each year saw an increase of between 2.41 percent and 3.06 percent.

Then 2015 happened.

The newly updated analysis (which added data from 2015) revealed that the most recent year was an outlier, as expenses grew a mere 1.25 percent, about half the previous rate. Is it a new trend? Did LIHTC property managers crack the code on a way to limit expense? Will we soon see a flattening of expenses–or perhaps a decrease?

All fair questions. In addressing these questions, it’s important to first note the reality that the underlying survey is based on properties in Novogradac’s database, not a census of all LIHTC properties–which means the conclusions reflect the dataset. History suggests the Novogradac & Company data is representative of the industry as a whole, but all surveys have limitations.

With that caveat, two significant factors play an outsized role in creating the smallest year-over-year increase in five years: utility expenses and the high number of Texas and California properties in the dataset.

Utilities

Of the eight categories in the Novogradac survey that make up total operating expenses, utilities generate a significant 18 percent of the cost. Utilities are often the second-largest category in terms of expenses, trailing only payroll (although administration costs also are larger in non-metropolitan areas).

That means that significant swings in utility expenses have an outsized impact on overall expenses–and from 2014 to 2015, utility expenses dropped 2.41 percent. Again: Utility expenses were lower in 2015 than a year earlier. That was the first time in the five years studied where a decrease happened. Of course, it didn’t come out of nowhere: Natural gas costs have dropped in recent years, while electricity costs have been fairly stable.

While utility costs are the main reason for the slower rate of expense growth, there’s a significant factor in how Novogradac & Company arrived at those figures: A disproportionate number of properties surveyed were in America’s two largest states, where utility prices were low.

California-Texas

While California and Texas have about 20 percent of the population of the United States (for comparison’s sake, the smallest 25 states make up just 18 percent of the population), they account for nearly two-thirds of the properties surveyed for Novogradac’s 2017 Multifamily Rental Housing Operating Expense Report. That creates an outsized impact when a significant operating expense drops in those states.

From 2014 to 2015, utility costs for surveyed LIHTC properties dropped by 5 percent in California, while increasing just 1.3 percent in Texas. In California, it was the first time in the five years studied that costs dropped in that category (after respective increases of 3.3 percent, 0.4 percent, 5.5 percent and 7.5 percent). And while Texas’ utility costs increased, it was the third straight year that there was a measurable lessening of the rate of increase.

What does it mean? One school of thought says that as California and Texas go, so goes the nation. And a decrease (or very small increase) in LIHTC properties’ utility expenses in the two largest states could herald a national trend.

Time will tell whether that’s true. Our survey showed that utility expenses are significantly more in the Northeast than in the rest of the nation, which is a predictable result of regional weather. But even those expenses only increased by 1 percent in 2015, so it’s not just a California-Texas phenomenon.

Does Change Matter?

So the decline in the annual rate of increase in operating expenses for LIHTC properties is primarily attributable to lower utility costs, specifically in California and Texas. Although it could be a one-year occurrence and it happened in two major states, does it still matter?

Yes. What happens in California and Texas matters. The two largest states have the most LIHTC units and bear a disproportionate influence on the national conversation. Sifting through the myriad charts and deep information available in the Novogradac 2017 Multifamily Rental Housing Operating Expense Report, it’s obvious that utility costs are important and any changes in our largest states can have a ripple effect throughout the nation. That’s especially true for properties where the owner pays utilities, meaning that a drop in utility cost means an increase in profit.

Novogradac will monitor this trend over the next year. And if you are interested in how utilities–or other expenses–affect your operating expense, be sure to get your copy of the Novogradac 2017 Multifamily Rental Housing Operating Expense Report