By now we’re usually fairly familiar with how much a single family home would be worth. We have many tools available to us that would help with evaluating the rough price of a single family home.
Some of the popular methods for single family property (and small multifamily) is to look at comps in the same neighborhood. By looking at recent sold homes in the area we can come up with a rough order of magnitude as to how much one’s property can be valued.
Some of the best free tools include Zillow, Trulia, Redfin, etc. This data is readily available and can be accessed by anyone - thought I have always used it as a rule of thumb.
Commercial Property
What about some of the larger multifamily properties? An apartment building with 20, 50, 100+ units?
Well, let’s take a look……
Commercial property refers to a real estate that “houses” some sort of business. This can be an office building, a mall or other professional offices that conduct business within their four walls.
In the case of multifamily rental properties, they also fall within the commercial category since the property is used as a place of business. The performance of a rental commercial property is based on its gross income as well as the expenses that are incurred to operate the property.
How does it actually work?
Calculation of a commercial real estate property is rather simple. You only need to understand a simple formula to know how you’re able to add value to a property during operation…..
What are we looking at here?
Net Operating Income is the total revenue of the property minus all reasonable expenses that the property incurs while operating the property. What’s important to note is that the NOI does not include any debt service on the property.
Income:
Collected Rents
On Site Laundry
Parking, Storage, etc
Other Income
Expenses:
Property Management
Property Taxes
Repairs
Utilities paid by landlord
Many more examples fall into this category
Capitalization Rate (CAP Rate) is used to indicate the rate of return a property is to generate. Cap rates are usually used for similar properties to ensure income and value is being calculated properly. Although valuing a property doesn’t follow the same “market comparables” method, the CAP rate certainly looks at similar income-producing properties.
How is it done?
Many operators apply the value-add strategy to increase the value of their property to be able to return a significant portion of the investors’ money back to them - this can happen during a refinance or sale of the property.
We shouldn’t down-play the effort it takes to actually implement this strategy, but when it comes to the math it’s quite simple.
In order to increase the “value” of the property, the operator needs to focus on either increasing the NOI and/or decreasing the CAP rate. Since our capitalization rate is a byproduct of the market and the asset itself, it’s a lot simpler to look at NOI.
When revisiting the Net Operating Income (NOI) criteria, there are a few things we can do to increase the value of NOI - increase income and/or decrease expenses.
As part of a good business plan, an operator will highlight some of the ways they’ll enact in order to increase the overall income for the property. In most cases, the operator will inject capital into the property to make improvements in order to increase gross rents/income. Some of the examples include:
Upgrades to individual units
Upgrade curb appeal of the property
Add amenities such as a playground, gym, dog park, club house, storage for rent
Implement Fees such as pet fees, late fees, moving fees, etc
RUBS (Ration Utility Billing System)
Internet through property
On the flip side, one is able to increase the Net Operating Income of the property by implementing a few simple items to ensure overall property expenses are decreased. Examples include:
Negotiate service contracts
Go through an energy audit to ensure your energy use is minimized
When possible, include small expenses included as part of renter’s responsibility
Have property taxes reassessed
Shop around for property insurance
Although these are not an exhaustive list, it’s a simple way for us to remember how increasing income and/or decreasing our expenses will result in an increased NOI resulting in a higher property value.
How does it actually work?
Let’s look at an example of how this works in real life.
In this example, we purchase a property at $3,000,000 at an 7% CAP Rate
This means our NOI is $3,000,000 * 0.07 = $210,000.
As part of the business plan we sub-meter some of the utilities and have the utilities charged back to the tenants in form of a fixed fee. Let’s say this brings in an additional $7,500 a year.
Assuming we take the same purchase CAP rate, the increase in value is as follows:
NOI = $210,000 + $7,500 = $217,500
Value = $217,500 / 0.07 = $3,107,100
Value increase = $3,107,100 - $3,000,000 = $107,100
This is a simple version of how one is able to add over $100,000 in value by increasing the overall income of the property by $7,500 a year.
Adding value to a property requires the knowledge of the property and ability to take advantage of opportunities that’s presented in a specific property to be able to pull it off. It is no small feat and, at times, challenging but when looking at the overall business plan these are actions that need to be implemented as part of operating a property.
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If you’re looking to take advantage of the power of real estate or want to learn about various strategies of making money through real estate, be sure to contact us.
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Sam Khairi
Afto Capital
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