Financial growth in commercial multifamily real estate revolves around net operating income (NOI). To make money in real estate, you need to grow NOI.
Net Operating income = Gross operating income (GOI) operating expenses
To better understand NOI, you need to understand gross operating income (GOI). In this post, I will explain GOI and the components that go into it. In multifamily real estate investing, GOI is expressed as:
GOI = Gross Potential Income ? Rental Losses + Other Income
Gross potential income is simply the income you would receive if your property was full at market rent. For example, a 100 unit property at a market rent of $500 a unit would have a gross potential income of $50,000 a month or $600,000 a year.
Now that you know your property’s gross potential income, the next step is to subtract out the rental losses:
- Vacancy
- Concessions / Promotions / Move-In Specials / Referral Credits
- Loss to Lease
- Bad Debt
- Model Units / Staff Units / Staff Discounts
Vacancy
Vacancy is simply the amount of rent lost due to the number of units not rented in a given month or year. In our example above, the gross potential income was $50,000 a month or $600,000 a year. If your property averaged 5% vacancy for the year, you would have a $2,500 a month or $30,000 a year loss from vacancy.
Concessions / Loss to Lease / Referral Credits
Concessions and loss to lease are similar. In general, concessions are a temporary financial incentive used to induce the signing of a lease. The common example you will see is one month free for signing a twelve month lease.
Loss to lease, on the other hand, is any amount of rent that is below market rent. A familiar example of this would be offering an existing tenant $25 less than market rent a month to stay on for another year. Another example of loss to lease can be seen in a high rent growth market. Let’s say you rent to a new tenant at current market value of $525 a month. The renter locks this rate in for 12 months. In three months, the new current market rent is now $535 a month. Assuming no further increase in market rent, that unit will have a $10 a month “loss to lease” for the next nine months.
Referral credits are prevalent in multifamily real estate investments. Some managers provide a one-time rent reduction for referring another renter to the property.
Bad Debt
Bad debt refers to the uncollected rent from renters who either skip out or have to be evicted due to non-payment.
Model Units / Staff Units / Staff Discounts
It is common practice with larger properties to leave a model unit unrented to show prospective renters. Additionally, some property owners will offer free or discounted housing to some of their employees as part of their compensation.
Other Sources of Income
After subtracting out the rental losses from your gross potential income, you now need to add in the other sources of income. Multifamily allows the owners to make money in real estate in many different ways. While not all inclusive, a partial list of other income sources include:
- Application Fees
- Late Fees
- Parking Fees
- Pet Fees
- Vending Machine Income
- Washer / Dryer Income
- Utility Fees / RUBS
- Month-to-Month Premium
- Key Income
- Club House Rental
Conclusion
Multifamily real estate investing is a business. To make money in real estate, net operating income is an important number to pay attention to. A key component of net operating income is gross operating income. The best real estate investments increase gross operating income which in turn grows net operating income. Do these things right year after year and you will experience financial growth that will ultimately lead to financial freedom.
P.S. Multifamily real estate in the right market, using the right management can increase gross operating income which will grow net operating income and can lead to significant gains for the smart investor.
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This is an interesting article. Are you using a Gross Rent Multiplier to value your properties? If so, how do you determine what a reasonable GRM is for any given area? NYC would have a different GRM than Harrisburg, PA.
Thanks.