Don’t like to Force things unless it’s appreciation on Real Estate!

Well the stock market has been pretty incredible over the last several years, so it’s not surprising that so many are parking cash inside the market and those who did, have some solid returns to show for it. In fact the average return from 2016 to 2020 was over 14%!! Pretty incredible I must say myself, in fact I happen to have a reasonable amount of retirement savings money inside of an IRA that is fully invested in the stock market. The biggest challenge with selecting a company to invest into through the acquisition of shares, is that we really have no input or control over how the company is managed or whether the share price goes up or down. To be fair though, we can limit our risk by looking at all the key factors associated with a strong company, but again this is as good as it gets.

Real Estate investing on the other hand, we can make a REAL difference in the value of that cash producing asset. Now before we get into the details of how, let’s take a look at the financial benefits of a cash producing real estate asset like a multi-family home or an apartment complex. The first benefit of owning this type of asset is that the mortgage payments are being made monthly from the cash received as income from the tenants, and the principal reduction from these payments is now equity. Second is that any additional cash available at the end of the month once you have handled all the expenses in addition to the mortgage payment is called CASH FLOW and this is another great benefit. The 3rd financial benefit is appreciation of the property, which again provides equity to the owner and this is the factor that we will be discussing in more detail in this article. As a Recap, here is a critical formula to understand;

So if we look at this formula, we see that the Annual Gross Income would be defined as the rental income from the property. Annual Gross Expenses are exactly as described and this includes items like Heat, Electricity, Insurance, Taxes, Trash removal, Maintenance etc….. What remains is the Net Operating Income of the Property (NOI). Now in order to understand the VALUE of a building, we can utilize the following formula;

So in order to calculate the property value, we simply take the NOI of the building in question and divide that number by the CAP Rate for that area. The CAP Rate is defined as the returns you would receive on the property if you paid cash. These can range from 3–4% up to 13–15% and is dependant on the geographical location of the building. For the sake of this exercise, let’s utilize a CAP Rate of 10%. Let’s use the example as follows; The Gross Income is $100,000 and the Gross Expense is $50,000 and therefore the NOI = $50,000 and with a CAP Rate of 10% we would get a property value of $500,000!

There a number of ways to impact the NOI in the positive direction, the first and most common way is to increase the rental income, so if you acquire a building that has below market rents you can bring those rents up to market rent and see an immediate increase in the property value. The other side of the equation is expenses and by decreasing the expenses through energy management, reduced insurance costs, better efficiency of services etc… we can reduce expenses and therefore increase the NOI directly! So for this example, let’s assume that we increase the rental income by 10% and reduce the expenses by 10% and the NEW Gross Income is $110,000 and the NEW Gross Expenses are $45,000, we would have a NEW NOI of $65,000 and therefore by using the Value equation and a 10% CAP Rate we have a building now worth $650,000!!! If we put 20% down payment or $100,000 to acquire this building, we have already made 150% Cash on Cash returns by increasing the value by $150,000.

These are made up numbers, but I can assure you that having a strategy that incorporates a real solid effort on improving the NOI of your assets by increasing income and reducing expenses can by extremely profitable! In fact REAL numbers here…. We acquired a 31 unit apartment building 5 years ago that had an NOI of approximately $140,000 which would indicate a $1,400,000 valuation based on this approach. This building now has an NOI of $290,000 which would indicate a $2,900,000 valuation! These opportunities exist, especially as the baby boomers are exiting into retirement. Many of these owners have had these assets for decades and likely owe very little and so from a management perspective they have plenty of financial breathing room, and so they may not have been as proactive with rent increases or with cost reduction strategies and this is a HUGE opportunity for new owners coming in!

Good luck investing and love to hear comments and feedback, also if you got any benefit from the article, please share!