The best real estate investments fuel financial growth. The business model for Multifamily Real Estate investing is no exception. This model revolves around the following formula:
Value = Net Operating Income (NOI) / Capitalization (CAP) Rate
NOI is defined as gross operating income minus all operating expenses. CAP rate is the percent return you would expect to receive if you bought the property for all cash (unleveraged).
While the formula may be simple, it’s very powerful. Unlike residential real estate, where you can be held captive by the residential market cycle and the comparison appraisal model, commercial real estate derives its value largely from NOI. Why is this important? It’s important because you can DRIVE appreciation. In other words, you can force the value of the property to go up year after year.
To drive value, you must drive Net Operating Income. There are three ways to increase NOI:
The most common way to increase revenues and make money in real estate is to increase rents. Current national rent growth averages 3% – 4% annually. However, every market is different. Some markets are experiencing astronomical rent growth while other markets are contracting with negative numbers. It’s important to know your market’s current, historical, and projected rent growth.
Raising rent is not the only way you can increase revenues. Other ways to raise revenue include, but are not limited to:
-Washer / Dryer Rentals
-Vending Machine Income
-RUBS (Ratio Utility Billing Systems)
Remember that NOI is gross operating income minus all operating expenses. Consequently, each and every expense that you can decrease will raise NOI. The common expenses associated with operating a multifamily building are:
-Repairs & Maintenance
-Salaries & Wages
-Property Management Fees
-Advertisement / Marketing
-Turnover / Make Ready
The best way to decrease repairs and maintenance is to buy a property large enough to warrant an onsite maintenance person. Without one, you will be overpaying for most repairs. Plumbers, electricians, HVAC repairmen and other outside contractors charge an upfront fee just to step on your property. In addition to that, their hourly fees can be exorbitant. There will be times when you need these experts, but most repairs and maintenance can be handled by a salaried onsite maintenance person at a much lower price point.
Property taxes are largely outside of your control. However, you should protest them anytime increases occur. Tax protest firms specialize in getting tax assessment reductions and frequently tie their compensation to the results they get for you.
Insurance and contract services (landscaping, pest control, alarm monitoring, etc.) should be bid out regularly. Make sure you are making apples to apples comparisons. You’d be surprised at how different quotes can be.
Salaries and wages is one of those items in which you may not find significant savings. While it’s prudent to always look for savings, you should also remember that good help is hard to find and you get what you pay for. For the best results, when it comes to salaries and wages as well as property management fees, you should pay a lower base amount and incent up with bonuses for meeting certain NOI improvement benchmarks.
There can be several opportunities to save money on utilities. Installing water savings devices, like low flow shower heads and toilets, can save you money over the long run. Xeriscaping can also save you money on water and grounds maintenance (contract services). Instituting RUBS (ratio utility billing systems) can be quite lucrative for the investor. In markets where RUBS is common, renters are billed for things like water, trash, and electricity.
Administrative expenses are largely made up of office supplies, computers, phones, faxes, internet connections and anything else needed to run an onsite management office. This will be a small percentage of your total operating expenses. Nevertheless, it should be monitored monthly. Just like any business, employee theft can be an issue. Requiring receipts for everything and scrutinizing irregularities is important.
Finding the right mix of advertising to get the most bang for your buck is also important. Your goal should be to keep your property full at the lowest price possible. The options are many and vary in cost. In this day and age, the internet has largely replaced newspaper advertising, especially with younger demographics. Some of your older renters will still exclusively search newspaper ads and printed rental guides. Online versions of these guides also exist. Lower cost options include Craigs List, roadside signage, and existing renter referrals.
To decrease your turnover or make ready cost (paint, carpet shampooing or replacement, cleaning, etc.) focus your attention on renter retention.
Renters moving out, also known as turnover, can be very expensive to the owner in the form of lost income and make ready costs. Consequently, every renter you get to stay and renew their contract is money in your pocket that leads to financial growth. To do this, your strategy should be to create an environment in which renters do not want to leave. Don’t look at renters as “tenants”, but rather as “residents”. Create a community environment in which residents feel connected. The list of ways to do this is unlimited. Below is a partial list – I am sure you can think of several more.
-Author a Monthly Community Newsletter
-Offer Coffee & Donut Days in the Office or Clubhouse
-Community Barbeques & Picnic Tables
-Free Clubhouse Movie Rentals
-Drawings or Raffles for Tickets to Local Sporting Events and Concerts
-Sponsor Community Tournaments (Chess, Basketball, Volleyball, etc.)
-Offer Free Copying Services (with limits) in the Office
-Shaved Ice Saturdays During the Summer
While many renter retention strategies may seem touchy-feely, the truth is that you will be leaving money on the table if you don’t encourage renters to stay. To make money in real estate, it’s important to maximize renter retention.
The formula, Value = NOI / CAP Rate, is critical to multifamily investing. By investing in quality markets, submarkets, and properties, you can drive NOI which increases cash-flow and drives appreciation. By mastering the three ways to increase NOI (raising revenues, decreasing expenses, increasing retention), you can accelerate your financial growth and make money in real estate hand over fist.
To Your Wealth!
Dennis Bethel, M.D.
P.S. The best real estate investments fuel financial growth through NOI increases – turning good investments into cash machines that can seriously make money in real estate.