Savvy real estate investors are always looking for ways to increase the returns associated with multifamily investors. This is true whether someone has owned the property for decades, or whether they are looking to acquire an asset and need to justify the purchase price. There are many value-add strategies investors can consider, but those looking simply to boost net operating income can begin by making modest improvements and operational adjustments that instantly add value to the property.
In this article, we look at ten ways to improve NOI at multifamily apartment buildings.
What is NOI in Commercial Real Estate?
Net operating income, which is generally referred to as simply NOI among real estate investors, refers to the total income a property owner collects after operating expenses and other costs have been deducted.
NOI = Gross Operating Income – Total Expenses
Note, however, that debt service is not included as part of the NOI calculation. Neither are capital expenditures, depreciation, and amortization. NOI is focused exclusively on gross operating income less operating expenses.
Why NOI is Important for Multifamily Investors
NOI is especially important to multifamily investors as they compare potential investment opportunities. This is because one of the primary ways investors evaluate properties is by looking at their going-in cap rates. The higher the cap rate, the more profitable a property is said to be. One of the key inputs to the cap rate calculation is NOI. Typically, the higher the NOI, the higher the value of the property on a cap rate basis.
There are several implications of this. For example, an investor looking at a property with a low cap rate might want to consider whether certain improvements could be made to increase the property’s NOI – either in the short term or long term. This creates a delta between a going-in cap rate and exit cap rate. However, investors will want to determine how much those improvements will cost and whether these costs are justified based on the resulting cap rate (i.e., property value).
Net operating income (NOI) among real estate investors, refers to
the total income a property owner collects after
operating expenses and other costs have been deducted.
Moreover, an existing owner can utilize various strategies to improve the NOI at their multifamily buildings. Doing so should generate additional cash flow that can be distributed to investors during the hold period. It will also increase the property’s value, which will benefit all parties upon refinance or sale of the asset.
10 Ways to Improve NOI at Multifamily Properties
1. Increase Base Rents
The most obvious way to increase the NOI at a multifamily property is by increasing the rent charged for each individual unit. This strategy is typically deployed upon lease renewal or unit turnover.
Landlords will want to be sure that the rent increases are at least keeping pace with the rate of inflation, generally measured by an increase in the Consumer Price Index (CPI). In recent years, the CPI only increased by 2-3 percent per year. More recently, inflation has skyrocketed to upwards of 6.5 percent or more, year-over-year. Increasing rents by this amount may seem unpalatable to some. To combat tenants’ sticker shock upon lease renewal, landlords should consider adding language to their lease agreements that stipulates that lease renewal rates will be indexed, at a minimum, to any increases in the CPI.
In an inflationary environment, the costs associated with owning and operating a multifamily property will increase (think utilities, property maintenance/management, etc.) which is why rent increases are important to not only cover these costs but also to increase NOI.
This is also why it is so important for prospective buyers and/or existing owners to have a strong grasp of the local market. Longtime owners often have a low-cost basis and therefore, do not feel any pressure to increase rents to any significant degree. A prospective investor will want to look at the current rent roll and assess whether the rents are on par with market rates, and if not, should consider rent increases upon taking ownership of the property. By bringing them to market rate, this will automatically improve NOI.
2. Evaluate Fees
Another way to boost NOI at multifamily properties is by increasing revenue associated with fees charged back to the tenants. This includes things like application fees, credit reporting fees, and late fees.
A growing number of tenants also have pets these days, so landlords should consider charging pet fees on a monthly basis—a strategy that is decidedly different than simply charging an additional security deposit for pet owners. Fees can be pocketed by the owner whereas security deposits must be held in escrow and need to be returned to the renter if there is no obvious damage caused by said pet(s) at the end of the lease term. Landlords who do not currently accept pets today should consider whether allowing pets, for an additional fee, would make sense given their property type, layout, demographics and insurance policies.
3. Consider Utility Income
Utility income can be a tremendous source of income for multifamily apartment owners. If an owner has not done so already, they should consider individually metering each unit. Doing so will allow the owner to shift the cost of utilities onto renters. Renters would be expected to put each utility bill in their own name and then will pay those bills accordingly. This may require landlords to adjust the base rent downwards, at least initially, but the landlord will immediately start saving on utility costs.
An alternative approach is to implement what’s often referred to as a “RUBS” system – or “ratio utility billing system”. Rather than submetering each unit, the landlord instead bills tenants for their pro-rata share of the building’s utilities based on several factors such as unit square footage, number of people living in the unit, or some combination thereof. Utilities billed back to tenants can include heat, hot water, gas, electricity, trash removal.
Let’s say, for example, that a RUBS system allows the owner of a 20-unit apartment building to earn an additional $30 per month, per unit. This generates $600 per month or an additional $7,200 per year. That additional revenue is sure to boost NOI if costs otherwise remain the same.
A RUBS strategy is arguably more affordable for owners since they do not have to incur the costs of metering each unit. Moreover, it is a way to increase NOI at an apartment building without increasing rents. One drawback, however, is that tenants must agree to the RUBS billing system as part of their lease agreement, which means it can generally only be implemented upon unit turnover when there are new tenants signing a brand new lease agreement. Existing tenants would need to agree via a lease addendum, which can be a hurdle for some landlords to overcome.
RUBS billing is not allowed in every city and town. Some municipalities have banned the practice, as it is thought to be unfair to tenants. Landlords will want to check local regulations before proceeding with this approach.
4. Add On-Site Storage
On-site storage, usually in the form of storage closets with locks, can be another great source of income for multifamily owners. Storage solutions can be added to any underutilized space, such as basements and/or desolate common areas. Owners can also explore adding an outbuilding – essentially, a new auxiliary structure – that is designed specifically for tenant storage. Individual lockers can then be rented out to tenants for an additional fee each month.
In some cases, landlords will run the storage area like a separate business. Tenants may be given first priority to rent the storage lockers, perhaps at a discount, and the remaining storage lockers can be rented to the general public. This strategy is most applicable when the storage area is located in an auxiliary building vs. located within the apartment complex.
5. Increase Laundry Income
This may seem like a no-brainer, and a concept most landlords will have already explored. Rather than providing free, in-unit laundry facilities, consider adding coin-operated laundry in a common area that is made available for all tenants’ use. In situations where in-unit laundry can be accommodated, landlords should charge a premium for those units.
Another strategy is to “rent” the washing machine and dryer made available to units when provided in-unit, for a small fee (e.g., $10 per month). Tenants will have the option of deferring these costs if they decide to supply their own washer and dryer. (Note: if a tenant supplies their own units, be sure to require professional installation to prevent any leaks, etc. that may occur if not installed properly.)
6. Maximize Parking Revenue
Most multifamily properties, particularly those located in dense urban areas, have limited parking. Multifamily owners will want to charge a premium for that parking, especially if parking is underground or covered. In some markets, a single parking space can rent for $100 or more per month. Tenants appreciate this flexibility: those with no vehicle are not paying a premium for parking they will not use; and those with more than one vehicle have the option of renting more than one space if they so choose.
At a 50-unit apartment complex, spaces that rent for $100 per month will generate an additional $5,000 per month in rent – not an insignificant number, especially for owners looking to increase NOI at their rental properties.
An increasingly popular way of maximizing parking revenue is by adding EV charging stations. With gas prices on the rise, more people will be looking to purchase hybrid and all-electric vehicles. Adding an EV charging station is a forward-looking strategy for those looking to appeal to renters with electric vehicles.
7. Convert Select Units to Short-Term Rentals
A more management-intensive way of generating additional NOI at rental properties is by converting one or two units into short-term rentals. Short-term rentals tend to generate more income, on a per night basis, than traditional rentals.
There are some special considerations to keep in mind with this approach, however. First, these units must be fully furnished to be used as short-term rentals. The landlord will also incur the costs of all utilities. Someone will need to be available to turn the unit over between stays, whether that’s an on-site property manager or third-party cleaning service. These costs should be factored in when considering how much additional revenue can be made using a short-term rental approach. Finally, be sure the local municipality allows short-term rentals as some cities and towns have restrictions on properties listed on Airbnb, VRBO and other short-term rental platforms.
In addition to the income-generating strategies noted above, there are also several cost-saving strategies that multifamily landlords should consider:
8. Reduce Turnover Time
“Turnover time” refers to how long a unit sits vacant between tenants. Turnover time generally depends on how quickly an owner can make a unit “rent ready” and ready to show to prospective tenants, as well as how quickly the landlord can sign new leases for those apartments.
Reduce Turnover Time refers to how long a
unit sits vacant between tenants.
Landlords should conduct market research to understand how long it takes to make units rent-ready in their market. Do units tend to turn over quickly, or should landlords expect some downtime between leases? What factors impact a unit’s ability to be re-leased? In some markets, particularly in college towns, units turn over on August 31st and have tenants move in the following day, September 1st. In markets like this, landlords benefit from little downtime, but must be able to move quickly to make any necessary repairs and clean units before the new tenants move in.
Multifamily owners should examine their processes for making units rent-ready. The less time a unit sits vacant, the lower the costs will be associated with that vacancy.
9. Reduce the Number of Turnovers
Related to the point above, multifamily owners should look for ways to limit the total number of turnovers they experience each year. This can be accomplished by carefully screening tenants (higher-quality tenants tend to stay longer) and by offering multi-year leases instead of the standard one-year or month-to-month lease. Tenant turnover costs are one of the most frequently overlooked costs that landlords will incur, and therefore, reducing the frequency of turnovers is an excellent way of improving NOI at rental properties.
10. Rebid Vendor Contracts
A final way to increase NOI at multifamily properties is by rebidding vendor contracts. Many owners purchase apartment buildings with existing contracts in place. They assume the prior owner negotiated the best rate, and for simplicity’s sake, keep the existing vendors in place. However, it’s worth revisiting those contracts and potentially rebidding the work from time to time. A modest 10% reduction in trash removal, landscaping, insurance premiums, and other costs can add up to thousands of dollars over the course of the year. It is important to be sure you are getting the best rates and terms on all contracts if you want to maximize NOI.
Finding new sources of income is incredibly important for landlords looking to increase NOI at their apartment buildings. There are endless ways to do so, the biggest limitation is generally an owner’s creativity. Identifying cost savings can be more difficult, as some costs are fixed (e.g., property taxes) or otherwise have little variability.
Net operating income is especially important to
multifamily investors as they
compare potential investment opportunities.
In any event, given the importance of NOI to a property’s value, it benefits every multifamily owner or investor to consider the many ways of increasing NOI at apartment buildings. In the short term, this will generate additional cash flow that can be passed on to investors. In the longer term, this will enhance a property’s value, making it more attractive to potential buyers when it comes time to dispose of the asset.
Are you interested in investing in multifamily property? Contact us today to learn more about the strategies Smartland uses to boost NOI – and therefore, returns – on behalf of our multifamily investors.