There is a line on almost every multifamily pro forma I reviewed between 2019 and 2022 that read like a small miracle. Operating expenses were projected to come in below the prior owner’s actuals.
This was rarely explicit. No pro forma said “we will operate this property more cheaply than the seller.” It lived inside the expense ratio assumption. The seller had been running the property at a 48% expense ratio. The buyer projected 42%. That arithmetic difference, applied to gross revenue, produced an NOI lift before any operational change had occurred.
The confidence underneath the number
Sometimes the compression was justified. The new operator had genuine systems, scale advantages, or vendor relationships that produced real cost savings. Often, however, it was rooted in nothing more than confidence. Confidence that the new sponsor was simply better than the prior owner. Confidence that inflation would stay low and expense growth would stay modest. Confidence that a property tax reassessment at the new purchase price would be appealed successfully. Confidence that insurance premiums would not move.
Each of these assumptions was tested during the cycle, and each failed in many deals.
Inflation pushed wage, maintenance, and supply costs up by roughly 15% to 25% across most expense categories between 2021 and 2024. Insurance premiums rose sharply in many markets, particularly in coastal and tornado-prone regions, where annual increases of 50-100% became common. Property taxes reassessed at boom-era purchase prices in many states, often producing bills 40 to 80% higher than the seller had paid. Utility costs rose. Maintenance vendor pricing rose.
The gap was not a rounding error
The expense ratio projected at 42% frequently came in at 50% or higher. That gap, applied to a property worth tens of millions of dollars, was material. It alone could account for a capital call, a paused distribution, or distress, without a single thing changing about the building itself. The assumption underneath the financing changed. The building did not.
The lesson here is not that operators should pad their expense projections. Disciplined underwriting requires honest forecasts, not conservative-in-name-only ones. The lesson is about the pattern of compression itself.
When every sponsor bidding on an asset projects expenses below the seller’s actuals, those numbers are no longer operational forecasts. They are competitive necessities. The sponsor who underwrites the asset to its actual operating reality loses the bid to the sponsor who underwrites it to a more aggressive expense projection. This is the same dynamic that showed up on the rent line and on the purchase price during the same years. The market punished discipline at every line, and the expense line was one of the quietest places it did so.
What to ask on expenses
For an LP evaluating a deal in the current environment, four questions separate a sponsor who has priced expense risk from one who is hoping it away.
The first is the simplest. What are the seller’s trailing twelve-month actual expenses, and what is the sponsor projecting in year one? Put the two numbers side by side before anything else.
If the sponsor is projecting compression, the second question is what specifically drives it. Scale, systems, vendor relationships, a shift from third-party to in-house management? A specific driver can be verified. A general belief in one’s own competence cannot.
The third question is about insurance. What premium has been quoted in writing, and is the underwriting using that quoted number or a placeholder? A placeholder from a soft market is one of the most common ways a pro forma understates real cost.
The fourth is about taxes. Has the property been reassessed at the new purchase price? If not, what does the sponsor assume the new assessment will produce, and how confident is that estimate? A tax line carried at the seller’s basis, on a property bought well above it, is a gap waiting to open.
A sponsor who answers each of these with specifics has thought through expense risk. A sponsor who says “we have good vendor relationships” or “we model this conservatively” without supporting detail is hoping. Hoping is not a forecast.
Closing thought
The expense line rarely gets the scrutiny the rent line does, because it looks like housekeeping rather than strategy. The last cycle showed that a projection landing eight points high on the ratio can quietly do what a missed rent assumption does loudly. The number that wins the bid is not always the number that survives the hold. Read the compression before you read the returns.
Vessi Kapoulian
Breaking down multifamily underwriting one step at a time to create educated and empowered investors
P.S. This issue is part of a short series drawn from the cycle we just lived through. The lessons culminate on July 11th at 11AM PT. Join the live event on LinkedIn or You Tube here.
P.P.S. If you would like a second set of eyes on a deal, or want to sharpen your underwriting through a risk lens, feel free to connect with me.