Now is always a great time to purchase real estate!
With populations on the rise nationally and a shortage of affordable housing units forecasted, demand for apartments with continue to increase. With this increased demand, along with normal inflationary pressures, Rents are sure to increase as well…Just think about how much you paid for rent 10 years ago…….I’ll say no more….
Why is increasing rents so important when investing in Apartments?
Because the price of your investment is directly correlated to the Income the property produces.
This is a powerful metric when you are talking about a 50 or 100 unit property…Let’s look at some simple math. We will use round numbers just to make the calculations straight forward.
First we must understand some basic concepts in apartment investing.
Cap Rate: The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor’s potential return on his or her investment and ultimately to calculate the value of a property as outline in the formula below.
Formula for determining an apartments value:
Cap Rate= net operating income (NOI) / Price
The Cap Rate can vary depending on the area but we can talk about that on another day….But in our example, we will use a Cap Rate of 10%
Net Operating Income: Net operating income is what is left after subtracting the expenses of a property from the income it generates.
So, in our example here, we will talk about a 100 unit property with rents of $400 per unit. (Total rent is $40,000 per month or $480,000 annually)
Let’s assume 50% in expenses so that would make an NOI of $240,000 annually at $400 per unit.
In the formula above, this would mean the price (value) of the property with a 10% Cap rate would be $2,400,000 ($240,000 / .10 = $2,400,000)
Ok, so you are saying, so what?…
Well, the true power of investing in apartment buildings is this: If we raise the NOI just a small amount, the price of the property is increases SUBSTANTIALLY…let’s look at two different, VERY realistic examples…These scenarios could occur over a relatively short period of time once ownership starts.
Example 1.) You buy the property, you feel rents are below market, you raise the rents only $25.00 per unit (again, very realistic increase) Lets do the math!
100 * $425= $42,500 x 12 months = $510,000 / % 50 in expenses = $255,000 (NOI)
(NOI) * %10 (Cap Rate) =2,550,000 (property value)
As you can see in the above example, by raising rents just a small amount, the value of the property increased $155,000
Let’s look at another example….
Example 2.) let’s say you raise the rents and reduce expenses, maybe the utilities are high, or you are paying inflated insurance premiums or something else..There are many ways to get better control of expenses…Just for simplicity sake, let’s say we lower expenses to 45%. Let’s do the math!
We raise rents to $425 and lower expenses to 45% (see below)
100 * $425= $42,500 x 12 months = $510,000 / % 50 in expenses = $280,500 (NOI)
(NOI) * %10 (Cap Rate) = $2,800,500 (property value)
As you can see in the above example, by raising rents just a small amount, and reducing expenses just a slight bit, the value of the property increased an amazing $400,500!!
Keep in mind, these changes we made were small and very conservative. Imagine what happens to the value of your property if you owned this for 3,4 or 5 years and you increase NOI year after year…..
I think you get the idea…The change in your equity can be quite significant as you can see from the about examples!!
Sound interesting? Would you like to be involved in an investment like this?
Give us a call at 510-863-1447 to to find out how to invest in apartment buildings!