In multifamily real estate, the value of a property is based on the net income it is producing. The formula used to calculate the value of a property is net operating income divided by the cap rate. Forcing appreciation in a multifamily property is done by increasing the net operating income.
Net operating income (or NOI) is the property’s revenue minus it’s operating expenses. The cap rate is an anticipated rate of return on an investment based on income it produces.
Forcing appreciation in a multifamily property requires an increase in NOI. This can be done by increasing revenues and/or decreasing operating expenses. Increasing the value of a property can also be accomplished by making capital improvements.
Capital improvements are improvements that directly increase the useful lifespan of the property and reduce the risk profile of the property to investors. Things that may take a property from a C class to a B class can lead to decreasing cap rates.
Value Add Investing
Looking at the formula, it is clear that a decreasing cap rate is another indication of an increasing property value. By adding significant value to the property and decreasing the risk of making a return on investment, the cap rate decreases.
In value-add investing, investors are purchasing higher cap rate properties (higher risk) and decreasing the cap rate through value add methods. Updating units, lowering vacancy, and increasing efficiencies around the property all reduce the risk of the investment and lower the cap rate.
The primary way investors force appreciation in a multifamily property is by increasing the net operating income (NOI). Increasing NOI is done by raising rents, minimizing vacancy, and cutting expenses.
We will be diving into several different ways to go about doing these, as it is important to have many tools in your toolbox. The more options you have when forcing appreciation, the more value you can create.
When forcing appreciation by increasing income, you have multiple options worth pursuing. Raising rents, adding laundry facilities, vending machines, premium parking, updated units, and other amenities that command a premium price. Each of these have different levels of impact, and knowing which to implement in what order sets apart new investors from the old guard.
Updating units to command higher rents will have the largest splash among the revenue increasing activities. Behind that, premium parking, laundry, and other income opportunities that are not directly tied to rent.
Finding creative ways to increase income will give you an advantage over other multifamily operators and investors.
Capital improvements add to the value of a property and increase its useful life. They are a permanent part of the property once added. They allow the asset to perform for longer than it would without the improvement.
An additional benefit of capital improvements is the ability to depreciate the value over their useful life. This offsets the upfront cash requirements that come along with improving a property. These tax benefits encourage investors to put money back into maintaining their real estate and to making sure it stays functional.
Examples of Capital Improvements in Multifamily Properties
Energy efficient windows and lighting, durable roofing, granite countertops, installing green features, and plumbing systems are all capital improvements. Replacing old wooden siding with long-lasting vinyl siding is another example of a capital improvement. Additionally, things like new flooring, appliances, and bathroom updates also fall into this category. All of these improvements are increasing the useful life of the property for both tenants and owners.
Reducing Operating Expenses
By reducing operating expenses, the NOI will directly increase with the property value following suit. Reducing operating expenses is the second most impactful action behind increasing rents.
Operating expenses include things like maintenance and repairs, property taxes, insurance, and property management. By making small changes to reduce operating expenses, you will see a direct impact in the property’s value.
Reducing Expenses with Green Solutions
Sometimes, creativity is necessary when reducing operating expenses. After reducing the most substantial expenses such as payroll, taxes, insurance, and repairs, it is time to look for less conspicuous items.
Installing high-efficiency water fixtures (shower heads, toilets, sinks, and sprinklers) and LED lightbulbs has a significant impact on monthly operating expenses.
For more creative ideas concerning water conservation to increase your property value, check out these solutions. There is an entire industry within the value add community of real estate. One of the biggest niches is green solution consulting.
Green consulting companies visit your property and install all of the most modern high-efficiency fixtures and lights.
The great thing about real estate investing in value add multifamily is that there are always creative ways to force appreciation. By bringing value to an investment property, you are bringing value to your investors. The more creative you can get, the more value you can force in the property that translates to dollars in your bank account.