The financial market has changed in the past decade with an emphasis on less speculative valuing of investment properties and more reliance on hard numbers. Investors evaluating multifamily assets are far more conservative in valuing a potential purchase for income growth in both the short and long term. As a result, it is critical to understand a property’s net value and continually look for areas to improve cash flow.
While market location and prospective neighborhood improvements are enticing, today’s buyer is more interested in the capitalization rate (Cap Rate) as a true measure of worth. Cap Rate is defined as the ratio of a property’s net income to its purchase price. The obvious first step in understanding a property’s value is to calculate the Cap Rate.
Let’s take this example:
A property of 300 rental apartments with a gross annual rent of $300,000
According to a 2013 NAAHQ survey, a master metered community spends about 46% of its income on operating costs. Of that amount, 13% is utilities. Conversely, a submetered or individual metered property spends about 53% of its income on operation costs with a cost of 6.2% for utilities.
A master metered property with an income of $300,000 will spend $138,000 in
A submetered property with an income of $300,000 will spend $158,000 in
The value of a property is calculated using a Gross Rent Multiplier or GRM. If the property is in a good neighborhood with good occupancy, take the Annual Income x a Range of 9-11 multipliers to get what the property value should be.
GMR = $300,000 x 11 = $3.3 million
Now put it all together to get your Cap Rate:
Master Metered Property with a Net Operating Income of $138,000/$3,300,000 valued asset
= 4.27% Cap Rate
Submetered Property with a Net Operating Income of $158,000/$3,300,000 valued asset
= 4.8% Cap Rate
8 Tips to Increase a Property’s Income and Reduce Expenses to Improve the Cap Rate:
- Never underestimate relentless collection actions – For example, if your residents know you will begin to call, email and send letters 5 days after the rent was due, they will know you mean business.
- Carefully screen all residents through a proven application process to avoid delinquent payers and property damage.
- Additional income opportunities, with little to no investment, such as coin operated laundry machines, paid parking for premium spots, storage, pet deposits and premium apartment locations are easy to implement on new move-ins and renewals.
- Utility recovery can be done two ways where allowed by law: submetering and allocation. A 300 unit community with a cost of $397 annually per unit and a $35,100 investment will recoup about $31,266 the first year, $85,737 year two and $97,387 year three assuming a 2.5% turnover and a 15% common area expense. Simply put, submetering requires an investment and measures each apartment’s utility use, allowing the owner to bill the resident back. A typical payback is 12-13 months. Allocation has no investment and is a billing method that assigns a portion of the utility expense to each apartment based on a number of possible calculations: by occupant count, square feet, number of bathrooms, etc. All residents signed up at move in and renewal would result in net income.
- Conservation of common areas in the area of lighting, building envelope, insulation and central system upgrades can greatly reduce utility expenses. Each likely upgrade would need to be carefully vetted to determine the payback so you would know exactly when to expect an increase in income.
- Reduce vacancy. Keep in mind that every day an apartment sits vacant on a rent of $1,000 per month, you are losing approximately $33. At a 5% vacant rate, that’s $495 a week and $14,850 a month. Make sure your leasing staff is dedicated, skilled and focused on leasing as a top priority. To borrow a hospitality phrase – “Heads in beds!” – is what the daily goal should be.
- Raise rents annually so residents expect an increase and are prepared for it. A lower, consistent annual increase is better than trying to increase rents drastically and losing residents.
- Property improvements: If there is an improvement you can make that you can charge for and show a payback within a reasonable period, consider it.
It’s worth taking the time to determine and understand your Cap Rate. Once you do, you can review your options for increasing income. Each property has the potential to increase its Cap Rate. The question is how will you make it happen and what’s the best way to do it?