The number one goal when investing in multifamily real estate and to explode your wealth is to increase the Net Operating Income (NOI). Let me quickly define NOI as the total gross revenue subtracted by the operating expenses of a property. When an investor analyzes an asset, he will typically use NOI and cap rates to determine value. A cap rate is simply the rate of return on an asset based on income. The higher the NOI, the higher the value of the asset
How do you calculate value with cap rates? Let me show you a quick calculation. Let’s assume the NOI of a property is $100,000 and the prevailing market cap rate is 10. You would take the NOI and divide the cap rate to obtain the market value.
Thus $100,000/.10 = $1,000,000 value. Market value and cap rates have an inverse relationship. As cap rates lower, values rise and vice versa.
If the NOI on the same property increased to $120,000, the value of the asset at a 10 cap would increase to $1,200,000. As you can see, a $20,000 increase in the NOI boosts the value of the property by $200,000. Your focus is to expand the NOI by either expanding the revenue or decreasing the expenses of the property.
Let us show you our three-step framework on achieving this goal. (Your broker should be able to tell you cap rates in their market)
Step #1: Fill the Vacant Units
Once you take over the property, your number one priority is to lease up the vacant units. You should already have a concrete idea of what market rents are. Our preferred tool to use when analyzing market rents is Rentometer. It is an invaluable tool to compare rents in the market, and will tell you if your rent is reasonable, too high or a good deal. It also depicts other rentals in your area. Their resource center is also loaded with essential services and products for landlords and investors.
If you have a real estate broker as a team member, you can have him prepare a comparative market report for you. Have him collect the market rents of all rentals within a twenty-minute radius of your property. This analysis is always performed as part of your due diligence when purchasing the property to see if there is any upward mobility to rental increases. Once you take over, continue at least quarterly to monitor rents in the area.
A couple other strategies to implement: Visit craigs list and other rental sites to analyze current rents, google your property and visit all complexes near your property to analyze rents. Jake and I also pick up the phone and call the competition to see what they are charging and what amenities they offer.
Watch this video on how to fill the vacant units: FILL THE VACANTS
The video will give you tips and strategies on how to improve your property so you will be able to raise those rents.
Step 2: Implement RUBS
You may be asking yourself, “What is Rubs?” Also known as ratio utility billing, landlords utilize rubs to bill back a portion of the utility expense back to the tenant. Rubs can comprise water, sewer, electric and garbage. It allows the landlord to implement the system with no capital expenditure and is a very fair system to implement when sub-metering is not possible. It can be based on certain factors: square footage and number of occupants are the most common.
We target properties where landlords overlook this source of revenue. Why would some landlords ignore this simple system? I think there are a couple of reasons why. First of all, landlords are simply too lazy to try something new. Ever heard of “If it ain’t broke, don’t fix it.” In this case, it’s time to break it. Secondly, many landlords have not kept up with their education and continue the status quo. We have also seen that landlords feel that tenants will vacate the property if they are charged for their utilities. The only instance where this will happen is if your competition is not using rubs on their properties.
We are fortunate that in our market it is common practice to bill back the tenants for usage. I recommend visiting NWP for more information on how to implement a system for your property. Our plan has been to bill the tenants $30 per month for utilities. We are not recouping the entire portion of the utility expense, but more importantly, we are not exceeding 100% of the utility expense. Moreover, the rest of the market has set the rate at that dollar amount, and we feel comfortable charging this amount.
Let me illustrate the power of rubs. We took over a property with 136 units that was not billing back the tenants. We decided to charge the tenants $30 per month for utility. Most of the tenants were on a lease, and we had to wait until the lease expired to begin billing. Once the entire tenant base was switched over to rubs, the results were extraordinary. We were able to generate an additional $48,960 per year in revenue. More importantly the NOI increased by that amount and the value of the asset increased by $612,000 (based on an 8 cap- $48,960/.08.
Step 3: Raise remaining tenants to market:
Now that a lot of the heavy lifting has taken place, it’s time to reevaluate the market and begin to increase the current tenants to market. Don’t forget to use Rentometer to gauge current market rents. At this point, the tenants have seen a transformation at the property. The exterior has been painted, the common areas are attractive, the maintenance staff is very responsive and overall customer service has skyrocketed. It’s time to start raising rents. Our strategy is to choose a few units to begin the process. This is where you have to test the market and see if your property will sustain these rental increases.
One note: We have had very little resistance to rent increases when we followed our three step strategy. Some tenants will complain about the increase. Let them vent their frustrations and search for another apartment. When they calm down, they will realize the deal they’ve had the past few years and renting another apartment will cost them as much a what you are going to charge them.
Begin to analyze current rents in your market by using Rentometer and the other strategies outlined above. Target properties that do not utilize rubs, and look for properties that are underperforming. Look for properties that have bloated expenses and shortfalls in their revenue collections. Finally, take massive action!!
The objective is to increase the NOI of the asset!! Contact us if you have any questions