Because CRE property value is based on NOI, if you can increase the NOI, you can not only increase your cash flow, but you can also increase the property's value as well.
Let's take an example: a 100 unit apartment complex producing $100,000 of NOI in a 10 Cap market is valued at $1,000,000.
NOI/Cap Rate= Value
$100,000/.10=$1,000,000
By increasing that NOI to $190,000, in that same 10 Cap market (meaning the market pricing that investors will pay for that income (NOI) hasn't changed), POOF, the property is now valued at $1,900,000.
$190,000/.10=$1,900,000
So in addition to putting $90,000 per year more cash in your pocket you just increased your equity by $900,000. Sound good? Are you amazed by way I quickly manipulated those numbers to make the example fall into place? Are you saying to yourself, "Well Karen, that's all good on paper, but how could I just magically increase the NOI by $90,000?" Well, after all of the articles I've written as an authority on CRE, you should just trust me but since you're the skeptical type, I'll show you!
As stated previously, if you can increase NOI, you can increase the value of the property. There are 2 ways to increase NOI.
1. Take in more money
2. Spend less money to operate the property.
Notice I didn't say, reducing the debt service paid to the lender. Although this will ultimately increase your cash flow before taxes, it has absolutely no effect on the value of the property. The property is worth the same amount of money whether it has a mortgage or is owned free and clear. Make sense?
Let's just say that after you purchased this 100 unit apartment complex, as the leases expired and were either renewed or the units re-rented, you increased the rent by a mere $25 per month. That's a monthly increase of $2,500 and a yearly increase of $30,000.
$25 x 100 units = $2,500 per month $2,500 x 12 months = $30,000
So POOF, you just gave yourself a raise of $30,000 per year. Congratulations!
By the way, how much would you have gotten if you increased rents by $25 a single family house? That's right... $25! That is the beauty of commercial real estate!
Now, let's just say that to reduce operating expenses you make the capital investment into individually metering the units with their own utility meters so the tenants can pay for their own utilities instead of you, the landlord. If the savings to you is a mere $50 per month, that would equate to $60,000 increased NOI because of decreased expenses.
$50 x 100 units = $5,000 per month (decreased expenses) $5,000 x 12 months = $60,000
So POOF, you just saved yourself $60,000 per year in utility expenses thereby putting the extra $60,000 into your pocket each and every year you own the property. Remember you earn these cash flows year after year, not just once. Now let's look at the effect on value in the same 10 Cap market. $100,000 + $30,000 (increased rents) + $60,000 (decreased expenses) = $190,000.
IF: $100,000/.10 = $1,000,000 THEN $190,000/.10 = $1,900,000
So you can see that you can not only influence the amount of money you earn from cash flow, but you can also control the value of your investment regardless of market conditions.
In residential investing, there is only one strategy. Regardless of how you acquire the property (foreclosure, etc.), the goal is to buy low and wait for the market to go up so you can sell at a profit or refinance. In this market, residential investors may be waiting a long time... a very long time. Additionally, if they don't have positive cash flow in the interim, they will not see a return on that investment for years to come.
By investing in CRE, you earn a return on your investment from Day 1 because of the significant cash flows. Additionally, by improving the NOI through your own efforts, you can increase the value of your property regardless of market conditions. It is for these reasons that CRE is a much safer and more profitable investment than residential investing.
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Karen Hanover is well known as a Certified Commercial Real Estate Advisor, President of the National Apartment Investors Association, Chairman of the National Commercial Real Estate Advisory Board and Senior Instructor for both the Self Storage Education Institute and the Apartments Education Institute.
As a CCIM Candidate, a highly prestigious designation, often called the "Ph.D. of commercial real estate" Karen works as a busy commercial real estate agent with Marcus & Millichap one of the nation's largest and most highly regarded commercial brokerage firms.
Sought by industry insiders for their toughest deals, Karen has helped thousands to create wealth in commercial real estate with less risk even in today's uncertain economy.
Karen founded the Commercial Investment Education Institute which provides educational instruction for investors on multiple subjects including apartments, self storage, office buildings, retail centers, mobile home parks and more. Her courses are taught in a friendly and easy to understand manner.
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