Inflation, Operating Budgets, & More

release edition [015]

read time [6 minutes]

Welcome to The Multifamily Download, a weekly newsletter where I provide institutional insights to help you build an exceptional Multifamily career.

Today at a Glance:

Inflation: Where are we today?
Budgets: In-Place vs Proforma
Weekly Listen: Trepp Wire Ep. 321

Your ideal Real Estate career awaits...

Inflation

You're probably tired of hearing the word 'inflation', and understandably so, as inflation has been the hot topic for the past five years.

Inflation is a complex topic, but hopefully the section that follows will provide some helpful context about both where we've been and where we are today.

By definition, inflation is the loss of purchasing power that is reflected in a broad rise in prices for goods and services over time.

As you can see in the graph below, which shows the annual rate of inflation from the Bureau of Labor and Statistics using CPI, inflation is almost always positive and has averaged 3.56% annually since 1935.

An easy way to observe inflation is by thinking about the cost of one gallon of gasoline.

In 1935, one gallon of gas cost $0.19 versus $3.21 in 2025. The quantity of the good is the same, but the price is nearly 17x greater.

The graph below shows the erosion of the dollar's buying power over the same time period.

A common view of inflation is that it is caused as a result of excessive government spending, and it's easy to observe the validity of this argument.

In 1935, the total U.S. government debt was $29B, where as that figure today is more than $36.7T.

Absolute spending isn't necessarily a problem if there is production (and therefore revenues) to offset it.

However, not only has the total debt risen by ~1,265x since 1935, the debt-to-GDP ratio has risen significantly as shown on the graph below.

Not only is debt rising, but it's rising faster than it ever has on a relative basis. Yikes.

Now that we're on the same page in terms of inflation, both what it is and why it matters, let's look at the recent trend.

The March 2025 CPI report was released earlier this week on April 10th. The CPI for all urban consumers in March fell -0.1% and rose just +2.4% over the last 12 months (remember that +3.56% annual average from above?). Notably, energy was down due to energy commodities being down -9.5% YoY.

Then, the March 2025 PPI report was released yesterday on April 11th. The PPI, or Produce Price Index, decreased -0.4% in March and was up just +2.7% YoY, which was well below the 3.3% expectation.

The cost of crude oil (shown below, per barrel) is an efficient way to look at supply and demand of an inelastic good (meaning that oil is purchased almost regardless of it's cost).

For context, the cost of crude oil is down from $85 one year ago to $60 today.

Generally speaking, when oil prices rise, the cost of goods and services have a tendency to rise with it.

Although the CPI measure includes only a 7-8% allocation for gasoline and heating, energy costs are inherently embedded in every corner of the economy because of the vast supply chains that have resulted from globalization.

Inflation impacts all of us, whether we realize it or not.

As Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output."

As Warren Buffett has said, "Inflation swindles almost everybody".

This is why the combination of growing GDP and shrinking the overall U.S. Government debt will have a positive influence on inflation regardless of the tariff outcome.

(I wrote about Tariffs last week if you'd like to read more here, but generally, tariffs can be viewed as a consumption tax. If good and services rise to unsustainable prices then consumers stop buying. When consumers stop buying, producers find a way to regain access to the consumer. This is why Kevin O'Leary is calling for 400% tariffs on China today).

Due to many factors, including the Fed's "higher for longer' approach and rapidly declining oil prices, the Core CPI reading from March was just +2.8% YoY, or the lowest since May 2021.

This should be welcomed news to those of us in the Multifamily industry as the past few years have been extremely challenging from an operating standpoint. Operating expenses have risen dramatically, placing immense downward pressure on Net Operating Income.

The optimist in me is hopeful that rent growth will outpace expense inflation in 2025, but the realist in me is not so sure.

Ultimately, rent growth will be market-specific based on supply and demand, whereas inflation is generally more pervasive across the entire economy.

Like most things in life, some inflation is good, but too much or too little is not good.

Keep an eye on the CPI and PPI over the next few months.

Budgets

Operating budgets are critical because they serve as a benchmark for how a property should be operated in any given year.

As I've been deep in due diligence this week, I've been reviewing proposed operating budgets from our management company for the properties that we have under contract to acquire, and comparing them against the Seller's actual trailing financials.

Here are a few observations that I hope you find helpful.

1. In-place Numbers Tell a Story

The properties that we're under contract to purchase have payroll figures that are $3,000 or more per unit per year, which is crazy for properties of this size. My job is to understand why this is the case so that we can more accurately determine what our Proforma payroll figure should be. As it turns out, the properties have been owned by one family for 30+ years, and the staff have benefited from healthy salaries, bonuses, and paid-for housing on-site at each property. This, coupled with expensive employee health insurance, has cause the in-place payroll expense to balloon out of control.

2. Coding is Important

How items are categorized on the financials is important to understand. For example, some owners include pest control in their contract services, and some code it separately. In the case of this portfolio acquisition under contract, the owner is paying cable & wifi inside of their utilities expense even though it is actually a contract expense. When I was speaking to a potential investor about it this week, they couldn't reconcile how our utilities expense was being materially reduced compared to the trailing financials, until I made them aware of this distinction. Understanding how items are coded is important.

3. RUBS May Be a Catch-22

Most professional investors consider adding RUBS to be 'low hanging fruit', but that's not always the case. It's important to remember that adding RUBS increases the overall burden of the resident base. In many cases it is market to charge RUBS (as is the case with our portfolio under contract), but even so, be prepared for the existing residents to be upset and/or leave. It's important to consider how certain decisions (like adding RUBS) will impact operations (residents moving out) on both a short- and long-term time horizon.

4. Everything Works Together

The most important part of raising money is being able to communicate the story to the investor(s). In this case, the family has owned the assets for 30+ years, has treated the staff like family (ex: inflated payroll), manages for occupancy (ex: each property is 95%+ occupied), and has not been strategic in growing their income (ex: little to no RUBS, below market rents, and offering free cable & wifi to residents). This combination of factors paints a very clear picture that there is significant operational upside without undertaking significant capital risk.

I'll continue to share more as we continue our due diligence process, but these observations stood out from this past week.

What do you look for when evaluating an Owner's trailing financials?

Hit reply and let me know.

Weekly Listen

This week's listen is Episode 321 of The Trepp Wire Podcast.

In this episode, the Trepp team discusses an economic update, the 10-yr UST, the potential impact of tariffs on various sectors, and a segment on the multifamily sector which includes comments about rent growth.

You can listen to the full episode here.