Increasing Income Increasing Value

Hello again, everyone!

In my last post we discussed a multitude of reasons why multi-family is a great investment. Of these reasons, one stuck out to me as a driving forces behind the high potential of multi-family investments. Because of this, I want to dive a little deeper into what forced appreciation is and how to make it work for you. When we talk about forced appreciation we refer to the processes that we can actively accomplish in order to increase the value of a property. If you remember from the last post, an increase in value is directly related to an increase in Net-Operating Income (NOI). Gross income - maintenance / operating expenses = NOI. So the question becomes: how do we increase our NOI on a multi-family property in order to force appreciate our asset? Fortunately, there are a LOT of things you can do in order to increase NOI but some are better to lead off with than others. The biggest, and I believe the single most important, action to be taken is decreasing expenses. If you decrease your expenses by a dollar, you gain a dollar in NOI. This may seem intuitive, but further reading will prove its elusiveness. So, back to the main idea, how do we decrease our expenses of a property? The answer is GREAT property management. A property that is managed correctly, uses the minimum required expenses to maintain the premise, and has the maximum income the market will allow. So what role should management play in decreasing expenses? The answer is a BIG one! We can discuss the pro's and con's of a third party property management company vs. self management, but for now, we will forego that discussion and only talk about what a correctly managed property looks like, and how it applies to expenses. The first action item in this equation is filling vacancies that exist in the property. I shoot for 95% occupancy, which tells me the Fair-Market Rent (FMR) is equal to the rent I am charging. If I have 0% vacancy my rent is likely lower than the FMR and if its much above 5% my rent is likely higher than FMR. The next critical step is to look at expenses from a maintenance / repair standpoint. Not all expenses are created equal. We have capital expenses and every day maintenance/operating expenses. We can use these two categories to our advantage. Capital expenses are not calculated in the NOI, therefore if you replace a toilet instead of fixing it, it is considered a capital expense and doesn't affect your NOI. A word of caution here, don't replace EVERYTHING. Do a cost benefit analysis of every repair and decide the cost to repair vs the cost to replace. If they are similar, replace it, if the cost to replace is much higher than to repair, I would suggest repairing it. This is also not an excuse to allow maintenance repairs to go undone on your property. This would be a grave mistake and the managers who allow this to happen are decreasing the value of the asset rapidly! Another large expense I have seen impact owners is utilities. A lot of owners pay water for their whole property. That adds up to THOUSANDS if not TENS of THOUSANDS of dollars in a year and DIRECTLY affects your NOI. If the tenants have no incentive to keep their utilities and, in this case, water consumption low, they will shower you right out of your profit! What can we do about this? If the property only has one meter you can use a Ratio Utility Billing System (RUBS) to charge tenants for the water. You have now effectively gotten rid of a monthly expenses costing you tens of thousands of dollars in value!! Not all areas do this or even allow it, but if the laws and the market are amenable, it is a game changer in decreasing expenses! Lets move on from expenses and talk about increasing income. In the third paragraph I made the seemingly obvious statement that if you decrease your expenses by $1 you increase your NOI by $1, but that wasn't the case when you increased your income. Why is that you ask? Part of the answer is how you are managing your property. Most third party property managers charge a percentage of the rent collected (anywhere between 5-10%). So if you increase your income by $1, you actually increase your expenses by $.10. It doesn't seem like much but multiply that by $20 across 100 units, you increase your expenses by $200 / month or $2400 / year! If the market cap rate (CR) is 8% you are leaving $30,000 on the table (NOI/CR=Value). I am not denying the fact that if you raised your rent by $20 over 100 units you increase the value of your property by $270,000, which is nothing to be ashamed of! However, in this case of planning and execution, a dollar raised is not a dollar increase in NOI. This is a big subject so in my next post I can give you some tips and tricks on other expenses to look at and some techniques to lower the cost. As always if you are interested in investing/partnering, or know someone who is, reach out to us! If you want to learn more about our investment strategy, our "Partnering and Investing" section has a wealth of knowledge on what we do and why we're so happy to share this knowledge and journey with others. To your success, -Douglas Vogel www.BlueWaterREI.com [email protected] #Investing#Multifamily#Realestate