4465.1 CHG

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CHAPTER 6. OPERATING EXPENSE ESTIMATES

6-1. ANALYSIS OF OPERATING EXPENSES. A determination is made of the

portion of gross income which must be used to maintain, operate

and repair the property and to defray the costs of ownership

arising from it. Under proper management, these expenses are

a first claim upon income and must be met if predicted gross

income is to be realized. Accurate analysis of operating

expense is essential to determining realistic net income.

6-2. EXPENSE DATA. Estimates of operating expenses can be made

valid by comparison with operating expense developed by

comparable properties situated in areas which are comparable with

regard to climate, custom, labor and operating material costs,

type and amount of services provided, and methods of operation

and management. Differences in type of building materials,

construction and design also must be considered in comparing

operating costs. Estimates of operating costs made by engineers,

cost estimators or other competent persons after study of project

plans, specifications and locations also may be accepted. It is

imperative that estimates be based on the project under

consideration. The use of statistical average or formulae can be

extremely misleading particularly if the project involved is markedly

different in design or use of materials. Averages arrived at

by the use of widely divergent or unverified data are of no value.

6-3. FILE DOCUMENTATION. Multifamily project expense data will be

recorded on Valuation Data Sheets, Forms FHA-2275, 2276, 2277,

and stored in the data bank. Comparable projects are selected

from the bank and the amount of individual expenses from such

projects, adjusted as necessary for significant differences, is

utilized in processing. Where the sponsor\'s expense estimate is

reasonable, his dollar amount should be used in processing to

eliminate conflict over immaterial differences. Processing of

Operating Expenses and Taxes on Form FHA-2274 must include the

individual expense estimates for each component item listed.

The expense estimates will be documented in the processing file

by the inclusion of Form FHA-2274 which will contain the information

for at least three similar projects and an explanation of

the adjustments made to this operating experience in the

development of the expense estimates.

a\. See Reference 2 of the Foreword for the Operating Analysis

Worksheet, Form FHA-2274 to be used in the development of

the expense estimates.

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Page 6-1 4/74

HUD-Wash., D.C.

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4465.1 CHG

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\*(6-3)

b\. The appraiser must pay particular attention to the trending

adjustment when analyzing the operating expenses and the

rental estimate.

c\. Inadequacies in the expense estimate are often attributable

to improper time and trend adjustments. The result is the

necessity of increasing rents at the beginning of the first

year of operation to offset the deficient expense estimate.

d\. The factor used as trend will consider past and anticipated

economic climate and occupancy experience. Included in the

analysis of data relating to past performance as a forecast

of future performance, the appraiser must consider rates of

change of various expense components and arrive at a component

trend rate.

e\. Consideration must be given to the age of the data used; the

time required for processing through the initial closing and

the estimated construction time. For purpose of calculating

trend, time of initial occupancy will be that time when

construction of the project is estimated to be completed

plus 2 months leeway normally allowed for the time between

completion of construction to the time that cost certification

occurs.

\(1\) For example, assume an appraisal being made on 1/1/77

using expense data recorded on Forms FHA-2275 or 2276

showing a beginning date of the period of expense

operation of 1/1/75. Further, assume a six month target

date for initial closing and an estimated construction

period of 10 months plus 2 months for purpose of

calculating carrying charges. The operating expense data

in this instance would be trended a total of 3 1/2 years

from the beginning date of the expense data through

construction time to the date of anticipated initial

occupancy.

eg: 1/1/75 Date of data

To 1/1/77 Date of appraisal = 2 years

To 6/1/77 Est. processing time = 1/2 year

To 6/1/78 Est. const. time & 2 mos = 1 year

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Total Time and Trend Period 3 1/2 years

Note: Trend Factors for taxes may vary from other

trend factors.

\(2\) The foregoing procedure results in income and expenses

being trended to the same date. \*

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8/78 Page 6-2

HUD-Wash., D.C.

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4465.1 CHG

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\* f. After completion of the worksheet the appraiser will enter

in Section E of the Form FHA-2264 the total annual estimates

for lines 21, 22, 28 and 29 properly updated to the time of

initial occupancy. The individual expense items on the Form

FHA-2264 will not be required. A complete expense analysis

worksheet, Form FHA-2274 will be attached to the file copy

of the Form FHA-2264 and included in the project binder in

every case. \*

6-4. DATA ANALYSIS.

a\. Expense Estimates. The estimate of operating expense should

reflect the needs of the income group to be served. In some

cases the operating expense may be higher than the operating

expense of other similarly constructed projects. Additional

management expense may be incurred due to delay and effort

required in collecting rents. These problems are most often

found in those projects occupied by lower income tenants.

b\. Maintenance Expense. The total estimate of maintenance expense

should reflect the level of maintenance and repair costs which

may be expected because of the intended occupants. Such costs

may be higher because of tenant behavior in a lower income

project and also because there may be more vandalism from

the outside than is usually the case in similarly

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Page 6-2.1 8/78

HUD-Wash., D.C.

4465.1 CHG

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constructed but higher-income projects. In making

comparisons with either higher or lower income projects, it is

important that adjustments for the project in question be

applied to individual amounts of operating, maintenance and

repair expenses, rather than to an expense ratio. This is

true of all expense estimates.

c\. Reserve for Replacement. While processing requires utilizing

expenses based on data, the reserve for replacement estimate

must be identified as a specific dollar item for entry on

the commitment. The reserve will in all instances be

computed on a furnished factor times \"total structures.\"

This method recognizes that any laborious computation based

on expected life of various building items is inaccurate at

best and overlooks the various uses to which the reserve

account may be put. The reserve account may be considered

a contingency fund and as such need not specifically

identify the various items which will need replacement in

the life of the property.

d\. Estimate of Taxes. The methods of assessors in arriving

at the assessed value of real property vary so widely that

it is imperative that complete information be obtained in

order to make possible a fair estimate of future taxes. It

is necessary to become fully informed as to the various

practices and mechanics of assessing employed locally in

order to prepare a valid estimate of the probable real

estate taxes to be levied against a proposed project. It

will be necessary to compare the actual current tax on

competitive rental housing properties with the estimate for

the proposed project.

6-5. MARKET DATA. All offices must have a data bank containing

sufficient information to process cases. The data bank will

consist of not less than the following information:

a\. Absorption Data. FHA Form 184 will be maintained for each

HUD insured project. This data must also be maintained on

conventionally built rental projects. Each project binder

must contain absorption data to support conclusions reached

with respect to operating deficits. Where it is anticipated

that no deficit will occur, this must also be supported by

data.

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Page 6-3 8/73

HUD-Wash. D. C.

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4465.1 CHG

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(6-5) b. Data Forms FHA 2275 - (Rental). A Valuation Data Form will

be prepared at the conclusion of firm commitment processing

and thereafter maintained as annual operating statements are

received by the office. It is the responsibility of the

Field Office Director to see that copies of operating statements

(FHA Forms 2410, 92410, and 2474 or 9801) are provided

to the Multifamily Data Appraiser as soon as they are received

in the office. The Multifamily Data Appraiser must also

collect data and complete data forms on conventionally

financed projects.

c\. Rental Data. The rental and occupancy portion of the FHA

2275\'s must be kept current. This can be accomplished by

the processing appraiser when he uses a particular comparable

as well as the regular updating by the data appraiser.

d\. Land Sales Data. The land appraisal process is dependent upon

the collection, analysis and systematic recordation of current

land sales data. Land sales information shall be developed

and maintained by the Multifamily Data Appraiser, with basic

information required for proper determination of land values.

This land sales data bank must be maintained on an active and

continuing basis. The land sales data card should contain a

sketch or photo of the site, information on any unusual site

conditions, available utilities and distance to them, special

appeal features, zoning, taxes, special assessments, and

specific conditions of the sales transaction.

\(1\) Items which represent a cost to the purchaser, in

addition to the sales price, should be noted. These may

include off-site improvement cost, demolition cost, and

any cost to bring the site to a usable condition.

\(2\) Five appropriate arms length land sales will be selected

from the data bank, of which two must be conventional

sales. A conventional land sale for this purpose is:

\(a\) A site on which a conventional (non-HUD insured)

rental project is under construction or recently

completed.

\(b\) A vacant site, whose sale has been closed, and has

not been submitted to the Field Office for project

mortgage insurance.

The appraiser will indicate the conventional sales by the

letter \"C\" preceding the comparable number, on FHA Form 2264

Section J item number 8. The land sales cards selected will

be reproduced and made a part of the processing package. \*

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11/73 Page 6-4

HUD-Wash., D. C.

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