When it boils down to it there are 2 ways to force appreciation in multifamily. The first is to collect more income. The second is to decrease expenses. When you have a net positive result from these, you will have created forced appreciation.
Let’s unpack that a bit further. To increase income, you could do this through collecting more rents. You could also collect more fees or provide other services besides renting the apartments. All this boils down to improving the Net Operating Income (NOI.)
Capitalization multiplies forced appreciation gains
Because commercial property is traded at a value by NOI divided by the Cap rate, the results of an NOI on the value of your rental property can be tremendous. This is different than single-family properties that are valued by comparative analysis. For instance, if you increase the NOI by $10,000 a year on a 5 cap property.
Value Increased = NOI Improvement / Cap Rate $200,000 = $10,000 / .05
This improvement of $10,000 a year, represents $200,000 of capital appreciation. Lenders will look at this value creation and will allow for a cash out refinance.
One of my favorite parts of multi-family investing is that the market-value of an income property is determined by how well it is ran and not by what the neighbors are doing.
Forced Appreciation can Benefit you at Sale or Refinance
The obvious benefit to increasing the value of an investment property is when you sell it. There is still a benefit to owning real estate that you have added value to.
By increasing the value of the property, the Loan-to-value ratio goes up when comparing two loans of equal principals. This means your interest rate will go down.
When refinancing the investment property, it is not a taxable event because you are just borrowing money not selling the property. This is because capital gains are taxable at sale of the property rather than refinance, or mid hold.
Does this Mean I Need to be a Value-Add Investor?
Just because you did not buy a property specifically aimed at a value-add strategy does not mean you cannot benefit from forced appreciation.
The capitalized benefits of forced appreciation apply to any investor that is interested in either refinancing their property or selling. The mere possibility of refinancing because you have added equity to your property through forced appreciation makes your investment less risky. Since real estate is illiquid, having equity that you can tap into can benefit a real estate investor greatly.
The result of increasing your income and reducing your expense is higher net profits. I do not know too many investors who would be displeased with this result. Even if they are not “value-add” investors.
1. Upgrade Kitchens: You know the adage in real estate that kitchens and bathrooms sell houses. Well, it is true in apartments too. Renovations of kitchens can add significant value to commercial real estate as well.
An upgraded kitchen will give your multifamily property a competitive advantage over properties that are out of date.
2. Add Bathrooms: Turning 2 bedroom 1 bath units into 2 bedroom 2 bath units can be a great way to increase the rental potential of your multifamily property.
Since it was more popular to build 2 bedroom 1 bath apartments, and 2 bedroom 2 bath are in more demand currently, there is a lot of demand for this improvement. Unfortunately, finding the space to add a bathroom into the floorplan will be a challenge.
3. Upgrade Bathrooms: Upgrading bathrooms can both give you an increase of potential rents as well as an opportunity to make your property lower maintenance.
4. New Flooring: Installing LVP or other flooring upgrades in the units can allow you to charge a premium for your units.
LVP also has higher durability than carpet, so there is the potential for reductions in maintenance costs. Though the replacement cost is substantially higher than carpet.
5. New Fixtures: It is amazing how much some new light fixtures, plumbing fixtures, and hardware will do to uplift the look of a space. These upgrades can allow you to get a rental premium while possibly saving on water.
6. Improve Curb Appeal: Landscaping can go a long way in improving the marketability of your units. Perspective tenants will see the landscaping, condition of parking lot, and the exterior of your building way before they get to see the upgraded interiors.
If a good renter sees a drab exterior and does not even bother to come in to look at the unit, what does it matter what condition it is in? It is hard to identify this problem because tenant quality will show up as a lagging indicator and your multifamily property will have higher turnover costs than needed if the exterior is driving away good tenants.
7. RUBS: Rubs stands for Ratio Utility Billing System. It is a way to pass on utility costs to your tenants. This benefit is twofold. First, you have the benefit of collecting income to offset your utility expenses. Second, you are decoupling utility pricing from your business. Since rents do not rise and fall as utility pricing rises and falls, paying for utilities directly creates volatility in your multifamily properties’ income.
8. Utilize wasted space: Many apartment communities put an office in a vacant unit. This can often be moved to another location on the property to create a higher potential rent for the property.
Other ideas for utilizing wasted space is to rent it out as storage or use it to add an amenity to your property.
9. Improve Amenities: Giving the pool area or other existing amenities a facelift can really improve a potential renter’s opinion of the place. This in turn will allow for a better rent premium.
10. Reduce expenses: Taking advantage of economies of scale, there are likely ways to reduce expenses if you go over the operation with a fine tooth comb.
11. Charging Pet Fee/Rent: You can increase your revenue by charging a pet rent. For a frame of reference, at a 5 cap, $25 a month in extra pet rent will add $6,000 in value to your building.
12. Adding Storage Units: Many of your tenants will have more items than they would like to store in their unit. This is an opportunity to turn some unused interior space into storage lockers. You could also build storage lockers as outbuildings on your property. Both of these options can lead to positive cash flow to your apartment building.
13. Trash Valet Service: Instead of your tenants taking the trash all the way out to the dumpster, you can offer a premium service where once or twice a week, your staff will take their trash to the dumpster for them.
14. Start a Community Garden: By starting a community garden, you can offer an amenity that can decrease your turnover and attract quality tenants with a minimal investment.
15. Become an internet provider: Getting one large fiber connection and setting up the infrastructure to become an ISP on your property can give you a large revenue opportunity and provide your tenants with affordable access to the internet.
There are providers that offer this as a full-service solution. Ubiquiti Networks offers a solution to build the internet product in-house, but currently, it would require someone on your staff being qualified to do tech support and the design of it.
16. Improve marketing: This can be a low hanging fruit if you are buying a multifamily property that was not being professionally managed. Chances are the only advertising for the property was a dated sign with a phone number on it. Getting web presence and updating a sign that will attract a premium tenant can go a long way towards your bottom line.
By bringing the marketing up to speed, you will be able to reduce vacancy. Proper marketing will improve the time it takes leasing up recently turned units.
17. Short Term Rentals: airbnb is becoming more popular every year. This growth creates an opportunity for capturing above market rents.
18. Laundry Income: Adding a laundry room to your property can be a great way to capture additional revenue.
If you already have a laundry room, improving it by adding more machines or making it nicer can capture additional revenue.
By upgrading the machines in your laundry room, you could potentially save money utilities.
19. Vending Machines: These will not provide a huge lift in your revenue numbers, but every little bit helps when you are capitalizing the results.
For example, if you make $100 per building and have 5 buildings and your community is valued at a 5 cap. There could be a $120,000 increase in the value of the community.
5 buildings x $100 per building x 12 months / .05 cap = $120,000
20. Preferred Parking: What if you made more income out of your existing parking lot simply by having reserved premium spaces and charging for them?
21. Clubhouse Rental: If your property has a clubhouse, you could allow guests to reserve it to through private events for a fee.
22. Dog Park: Creating a dog park can be an amenity that can draw in potential tenants. It also allows a way for your tenants with animals to better care for them. If you charge a pet rent, having a dog park could help increase the community’s income.
One great aspect of having a dog park is that there is a fairly low capital outlay to create this amenity on your property if you have some green space already.
23. Online Reputation Management: One way to increase the income of a community is by doing online reputation management. You can approach this from both the offence and defense
On the offence, you can make decisions and maintain the property in a way that is less likely to get poor reviews, and encourage guests to leave good reviews that will outweigh the bad ones as they come in.
On the defense you have your strategy of what to do when bad reviews come in. Since some reviews are meant to be malicious, they often times include content that break the terms of service of the site they are posted on. In this case, you can often report the review and cite the terms of service which the review might break. Some reviews will be best to respond to in a professional manor. Others might be best to just let sit and speak for themselves. This is for you and your property management team to decide what is the best strategy for your specific property.
24. Fitness Center: If your community already has a fitness center, you could upgrade or update it to make it more useful for your tenants. You can also consider offering group classes to your tenants for free as a way to create a sense of community and increase the average length a tenant stays with your property.
If you do not have a fitness center, it is an opportunity to add one somewhere on your property. There are solutions for keeping to a tight budget or a tight space while still delivering something of value to your tenants.
25. Reduce maintenance expenses: Finding ways to reduce your maintenance expense will continue to pay off year after year. There are probably many procedures that are inefficiently ran that can be improved.
One example is by having a stock of items that routinely break on site so the maintenance team does not have to make a run to the hardware store each time they have to replace one on your property.
Since you have to deduct the maintenance expense from the gross income, any decrease in maintenance expenses will result in an increase in the NOI.
26. Reduce management expenses: If you have in house property management, then improving their efficiency can decrease your expense tremendously.
You can do this by identifying processes which come up frequently but take longer than they should to complete. Then identify how to improve the process. Another thing to look for are situations that often cause a problem later that could have been solved the right way the first time so it doesn’t cause rework.
If you are using a property management company, learning how to work with them to reduce costs is important. In a lot of cases, the property manager's incentives are not lined up with the owner's in the contract. It is important to think through where these spots are and watch to see if there is waste.
27. Cable: Did you know that cable providers will often pay a fee to be the exclusive provider in that building? This is another possible way to increase the revenue of your multifamily property.
28. Appliance package premiums: If you have a mix of units, some with the older style black or white appliances and some with modern stainless steel style appliances, you can charge a premium on the units with the modern appliances. You can market this as a premium appliance package in order to justify the rent premium.
Wrapping it up
Hopefully this got you thinking about different ways you can force appreciation in your multifamily property. There are lots of ways to either increase your multifamily properties’ revenue, or to decrease its expenses. Hopefully some of these ideas will help you build a strategy next time you are underwriting a multi-family property.