Want to immediately jump your net worth by $25,000, $100,000,$250,000, or more? Then put to work this simple method for figuring out the value of a property:
Value = Net Operating Income (NOI) / Capitalization Rate (R)
To refresh your memory, let’s go through another example. Assume that
you find a six-unit apartment building. This rental property currently
brings in a net income (NOI) of $48,000 a year.
Based on talks with realestate agents, appraisers, and other investors, you figure this property “as is”should sell with a cap rate of 9 percent (.09). With these two numbers you can calculate the “as is” value of these six units at $533,333.
48 000 (NOI) / 0.09 (R) = $533 333 (V)
If you could somehow boost that property’s NOI to say, $60,000 a year, you would jump its value by 25 percent. You would quickly gain another $133,000 in equity
60 000 (new NOI)/0.09 (R) = $666, 666 (V)
Even better, if you can reduce the riskiness of the property, you might beable to justify a lower cap rate than .09, say, 8 percent (.08). With a higher NOI and a lower cap rate, the value of that property skyrockets from the original $533,333 up to $750,000—an immediate gain in value of $212,000.
Are such large increases in value possible within a period of 6 to 12 months? Absolutely! Why? Because many owners of small investment properties still think of themselves as “landlords” (with the accent on “lord”) and their residents merely as “renters” who don’t deserve “customer care.”
But just the opposite is true. Today (and in the future) market conditions require savvy investors to treat their tenants as valued customers—not serfs. Search for Competitive Advantage Most small investors mismanage their properties because they do not intelligently survey and inspect competing properties.
Without this market knowledge, they can’t strategically customize their properties to make them stand out from other rentals. In other words, these ownerinvestors fail to monitor their competitors and they fail to carefully adapt their market and management strategies to wow their customers (tenants, buyers).
Your Properties Should Stand Above the Competition As a mental starting point for creating value, remember, never think of yourself as a landlord. Never define what you do as “owning rental properties.”
Instead, think of yourself as providing your customers with a product (housing) that stands out and stands above your competitors. If you adopt this modern attitude, your profits (and the value of your properties) will shoot far above average for two reasons:
- Better resident relations. The residents of your properties will reward you with lower turnover, fewer problems, and higher rents.
- Alert to opportunities. With a customer-oriented, constantimprovement attitude, you will consistently look for and come up with ideas that will add value to your property operations.
A Strategy of Your Own Good management and marketing depend on good knowledge of competing properties and resident (tenant) preferences. You want to create a specific strategy that will yield you the highest profits.
Certainly, you can read a dozen books on “landlording” and most of them will give you a precise list of do’s and don’ts that may cover every topic from applications to waterbeds. While ideas from these books often prove suggestive, never accept them as the final word. What works today may not work tomorrow.
What works in Peoria may not go over in Paducah. What works in a tight rental market may prove less effective in a highvacancy market. What works best with HUD Section 8 tenants may actually turn away those upscale young professionals who live in your more expensive buildings.
Should you accept pets, smokers, or college students? It all depends. Offer your selected target market of renters (or buyers) the value proposition that they will prefer—yet, at the same time, a value proposition that fattens your bottom line (NOI).
In practice, you can find that profit-maximizing value proposition by knowing the competition. Then create your own competitive advantage. Adapt your local market. property to your Here’s the $100,000 question:
What can you actually do to boost your property’s investment value? Here are some ideas. First, Verify Actual Rent Collections, Not Merely Rental Rates Before you buy, verify. Too many new investors merely accept an owner’s rent figures and then subtract a so-called standard 5 percent vacancy factor.
In truth, many property owners do not collect 95 percent of their scheduled rents—even if they achieve 95 percent occupancy. To verify rents, first verify the lease rates the tenants have agreed to pay.
Second, realistically estimate vacancy and collection losses. Your profits, and the building’s value, rest upon bankable funds, not leaky leases. If you overpay for a property because you overestimate the property’s current rent collections, you are trying to increase value in a headwind.
Talk with Tenants Prior to buying any investment property, I always talk with a sampling of the renters who live in the building. This practice serves four purposes.
◆ Identify problems in the building.
◆ Identify problems with tenants.
◆ Verify lease application data.
◆ Generate ideas for improvement.
Problems in the Building
“Not enough parking.”“Too much noise.”“The bills for heat and air are outrageous—$277 last month.”“These walls are paper thin.”“This place lacks security. We’ve had three break-ins during the past six months.”
“The closets in this apartment are too small, and there’s no place for long-term storage.”“No place to park or store my boat—or even my bicycle.”“Cockroaches, ugh. This place is crawling with cockroaches.”
To really learn about a building, talk with the tenants. You can gain valuable insights by asking tenants,“Tell me, what don’t you like around here?”On occasion, the tenants will speak well of the building (or its owner).
But more often they like to complain. Will you hear glowing praise? Not likely. Tenants know that too many good comments might bring on a rent increase Ask tenants, “What don’t you like?” Problems with Tenants Bad tenants can ruin a potentially good building.
If some tenants create hassles for others, you want to know about it before you offer to buy the property. Problems within a building and problems with disruptive tenants can stir up vacancies, turnover, and rent collections. Solve these
problems and you create value.
Verify Lease and Application Data
Leases and tenant application data do not always portray the true facts about a property’s tenants. Do you realize that some sellers actually show beginning investors phantom leases with false data?
Aside from outright fraud, your talks with tenants might reveal rent concessions that aren’t recorded in the written file that the sellers gave you to review. You might also find that some tenants are subletting their units.
Or maybe they’ve let additional friends and family move inwith them. Before you buy, put together a rent roll that’s as accurate as possible. Otherwise, both your NOI and cap rate (risk rate) figures may err.
Generate Ideas for Improvement
Whenever you value a building, divide the “problems” you find into two
piles: (1) economically unsolvable and (2) opportunity-laden. As your talks with tenants reveal the strengths and weaknesses of the “as is” property, you’re valuing the property as it stands today.
But at the same time, you’re constantly rolling ideas through your mind. How might you profitably improve the property tomorrow? Through the eyes of a critical buyer, you find faults and profit-draining negatives. Through the alert eyes of an entrepreneurial investor, you visualize ways to turn a lump of coal into a diamond.