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BLOG #3 of 4 – ADDING VALUE TO YOUR INVESTMENT

2010-06-08T09:51:00.001-07:00

This blog relates to the third step in adding value to your investment or “Reducing Operating Expenses”. The four (4) ways you can create value for your real estate investment are:
1. Raising Occupancy
2. Raising Rental Rates
3. Reduce Operating Expenses
4. Make Building Improvements

SAVING MONEY - As in any business, excessive operating expenses can make or break the profitability of the business. What are some ways to reduce operating expenses and maximize the profitability of the investment? For commercial properties across the board (retail/office/apartments/industrial/etc), cost savings may be obtained in several categories, including:
• real estate taxes
• insurance
• maintenance/supplies
• utilities
• contracted services

When looking specifically at apartments, there are additional areas where an investor can save money, including:
• On-site payroll
• Marketing
• Legal/Administrative
• Repairs and Reserves

STAYING COMPETITIVE
How can you spot ‘high’ operating expenses? One of the better ways is to obtain data from industry averages, which you can obtain by asking brokers/agents/property managers who are in the business and have access to the data. Industry averages are important because you need to be competitive with your operating expenses, especially triple net leases where the tenants pay 100% of the expenses (typically in retail leases and partially in office/industrial leases). If you are not competitive, the building owner ends up ‘absorbing’ some of the expense, which is self defeating and reduces the net cash flow (and therefore the property value). For retail/office/industrial properties, I’ve found the best cost cutting measure is to get competitive bids for contracted services. For apartments, the categories that present the best opportunity to save money are on-site payroll, utilities, and maintenance/supplies.

ESTIMATING REAL ESTATE TAXES/INSURANCE/ COMMON AREA CHARGES ETC.
As far as numbers go in the Phoenix Metro Area, real estate taxes are estimated at $1.50-3.00 per square foot of building area, depending on the age and condition of the property. Property insurance is typically estimated at roughly .25 cents per square foot of building area. Common area charges (which are typically utilities, lot sweeping, landscaping, lighting, building maintenance, etc.) for commercial properties (retail/office/industrial) can range from $.75 per square foot, up to $2.50 per square foot, depending on the number of services provided. For apartments, the operating expenses run between 35-45% of effective gross income (EGI). These numbers would exclude capital improvements, which would be another 5-10% of EGI. When you see below normal operating expenses, take a good, thorough look when verifying the numbers to ensure the numbers are real/accurate. One last note about apartment operating expenses; in reference to utilities, older properties can be ‘master metered’, meaning there is only 1 electric meter on the property and the owner/landlord pays for this expense (i.e. utilities are included for the tenant). This expense is a key component in the analysis, as there is an opportunity to save money by converting the utilities (electric) to individually metered accounts, depending on the cost/benefit savings analysis. In our next discussion we’ll cover the last way to create value in your investment #4 “Making Building Improvements”.

ADDING VALUE TO YOUR INVESTMENT

2010-04-28T17:24:00.000-07:00

There are four (4) ways you can create value for your real estate investment:
1. Raising Occupancy
2. Raising Rental Rates
3. Reduce Operating Expenses
4. Make Building Improvements

Part 2 of creating value in your real estate investment is raising rental rates. On the surface it seems simple enough and an obvious way to increase value. Let’s look a 2 aspects of this topic; A) How increasing the rents increases the value and B) Ensuring/verifying the rental rate increase is justified.

In reference to how increasing the rents increases the value, I will use 2 examples, one a 4-plex and one a 96-unit complex; In the case of a 4-plex with the monthly rents for each unit at $500/month, just by increasing the rents 10% ($50/month for each unit), this will increase the property value from $136,200 to $157,800 (based on a 10% capitalization rate), which represents a 15.86 % increase in value.

For the 96-unit complex, the results are much more dramatic as you might imagine. In this case the average monthly rents are $546/month and by increasing the rents 10% again ($54 up to $600/month), the property value is increased from $1,906,260 to $2,409,300 (again using the 10% cap rate), a value increase of $503,040, which represents a 26.39% increase in value.

To me those are impressive numbers on paper, but before we get carried away with giddy excitement it’s important to realize the numbers can work against the investor as well. As you might imagine, if rental rates decrease by the same amount (in these examples 10%), you will have a corresponding reduction in value, which is very sobering and obviously something the astute real estate investor needs to avoid.

This leads us to the second topic of ensuring/verifying the projected rental rates being justified/accurate on the sales offering. This applies not so much to current property owners but to investors looking a purchase a potential investment. It is absolutely critical that the investor verifies they can achieve the projected rental numbers from the Seller/Listing Agent’s sales offering. This ‘due diligence’ is critical because if the numbers presented by the Seller are inaccurate, the investment is doomed from the start. The Seller may have ‘pie in the sky’ numbers, which are unrealistic and/or unachievable. You can verify the rental projections by driving the neighborhood and simply doing a market survey of other apartments in the same neighborhood as the subject property. When doing the market survey you need to compare ‘apples to apples’, and make positive/negative adjustments for factors such as age of the property, curb appeal, location, property amenities, deferred maintenance, etc.

In summary, you 1st create value in your mind, then transfer it to paper, but the step of verifying the accurate rents is critical to ensure your investment projections are successful. In our next discussion we’ll cover the 3rd way to create value in your investment; reducing operating expenses………………………

ADDING VALUE TO YOUR INVESTMENT …………………………

2010-04-15T09:39:00.000-07:00

There are four (4) ways you can create value for your real estate investment:
1. Raising Occupancy
2. Raising Rental Rates
3. Reduce Operating Expenses
4. Make Building Improvements
Today, we’ll focus on raising occupancy – This may seem like an obvious statement, but it’s worth considering this issue to determine what type of investment works best for each investor. For example, if a property has high occupancy (say 95%), I wouldn’t consider purchasing this property, unless you could find another alternative to creating value (i.e. raising rental rates). However, if you are looking for cash flow (instead of creating value) and the occupancy/tenant(s) are very stable, then this could be an attractive investment.
On the flip side, if an investment has very low occupancy (say 25%), there is great opportunity to increase income/value, but the turnaround process is much more involved than a high occupancy (stabilized) investment. An investor would need to set aside sufficient capital to ride out any negative cash flow during the turnaround process. Like any investment, there is a risk-reward relationship and an investor with the right mindset and experience can be very successful in this type of investment; other investors may prefer an investment that has higher occupancy (say 65-75%), where the reward is less, but the turnaround process is less involved and less risky as well. In our next discussion we’ll cover the 2nd way to create value in your investment; raising rental rates…………………………..

COMMERCIAL REAL ESTATE FORECLOSURES – 4/12/10………………

2010-04-13T20:47:00.001-07:00

Commercial foreclosures on the upswing – Have you noticed any media reports about the increase in the number of commercial foreclosures lately? I’ve seen a definite upswing in the number of commercial foreclosure activity since the beginning of the 2010 year. We’ve been told now for months that the commercial market ‘correction’ is coming, and based on the weekly reports I’ve received from escrow companies and foreclosure notices from the county tax records, the velocity of foreclosure activity is up. First the foreclosure notices were primarily vacant land and a few smaller multi-family structures; now I am seeing more retail/shopping center foreclosures and more office and industrial as well. Apartments listed for sale on various websites have dropped dramatically in the past 12 months; a property that was listed for maybe $40,000 per unit is now listed at less than $20,000 per unit in many instances. As expected many of the properties are in poor shape with higher vacancies and deferred maintenance; but there is always a ‘diamond in the rough’, meaning something priced below market, but in better cosmetic condition and with good curb appeal. Often times the property is only suffering from mis-management of the property, which provides a great opportunity for a savvy investor to provide a simple ‘value-add’ improvement and significantly raise the property’s value. We’ll talk later about simple things you can do as an investor to add value to your investment………………………..