How to Add Massive Value on Multifamily Properties by Slashing Costs!
Updated: Sep 8, 2021
What is the added value in a “value add” deal?
If you’re familiar with commercial multifamily properties (5 units or more), then you know you are not simply purchasing a property, you are purchasing a business.
As such, the value of a commercial multifamily property is largely based on the income it produces. Unlike investors in the stock market, real estate investors are able to take steps to impact the value of their assets. While there are multiple avenues to increase the net operating income of a property, they usually break down into two categories;
1. Reduce expenses
2. Increase revenue
For this issue, we’re going to focus on the many ways we can reduce expenses, but fear not, we will cover how to increase revenue in the next issue.
The number of ways you can reduce expenses or increase income is limited only by your imagination. While that may be a bit of an exaggeration, I’m continually surprised at the creative methods owners implement to increase their bottom line.
In analyzing the current expenses of a property, one of your first questions should be, “Who pays the utilities?”. As most people know from personal experience, utilities can represent a significant portion of overall living expenses, and it is no different for apartment complexes.
If all units are already individually metered and you won’t be responsible for any utilities (outside of common areas), then great! That is a major win and is something I certainly prefer on my deals.
It is not just a matter of having one less expense to worry about (although that is part of it). Far more important for long-term projections and building a viable business plan is the predictability of expenses. Tenant usage can vary greatly from month-to-month or season to season and it may be difficult to accurately project those variances.
If you are responsible for the utilities and getting units separately metered is cost-prohibitive, one way to share some of the burden with tenants is through a Ration Utility Billing System or RUBS.
At its core, RUBS is a way of sharing the costs associated with utilities in the most equitable way possible. While the simplest way to divvy up the cost among tenants is to take your total bill and divide it up among the total number of units, this wouldn’t exactly be fair. Imagine if you lived in a one-bedroom unit and were asked to pay the same toward utilities as someone in a three-bedroom unit. I would certainly start shopping for a new place to live.
While you can’t please everyone all the time, the fairest way to determine utility bills under the RUBS systems is to hire a third party to conduct a thorough analysis to determine rates. These companies will take into account variables such as square footage, numbers of occupants, and the number of water fixtures.
Besides spreading the economic burden, there are also environmental benefits to implementing a RUBS system. Because tenants are now paying based on their aggregate use, they are incentivized to reduce their use. According to multifamilyutility.com, “Over time, having your master utility bills decrease up to 20% is common based solely on resident’s conservation efforts.”
It’s important to note that each state and municipality sets its own rules regarding what criteria can be used for RUBS billing, so be sure to check with your local consultant.
If you do find yourself in the unenviable position of paying for utilities, then it is in your best interest to find ways to lower those bills. This is a bit more straightforward and largely mirrors the steps you would take to reduce costs in your own home. There are firms that will do audits of your property’s current usage and tell you the most cost-effective solutions to become more efficient.
Low-flow/high-efficiency toilets use only one-third of the water of their more wasteful counterparts. Replacing legacy shower heads and faucets with low-flow models can have a huge impact as well. The most logical time to make these transitions is planned renovations or unit turns. Just be careful not to go overboard and lose sight of priorities. If you lose tenants because you have terrible water pressure in the shower, those water savings won’t mean much.
Maintaining the landscaping can also be a huge component of the water bill, depending on size, location, and composition. If you’re out in the Southwest, you might be able to get away with rocks and a few cacti, which will require virtually no water to maintain. But if you’re in other areas where landscaping can have a very real impact on your foot traffic, then you will need to find more creative ways to use less water.
Using more mulch, which retains water, is one way to reduce your water bill. Another is to be very intentional about the plants you have and ensure they’re not as “thirsty” as other options.
Another low-tech recommendation that comes from my own experience with C-class apartments is having locks for external faucets. It’s hard to imagine someone would steal water, but trust me, it happens. Not too long ago my property manager was mentioning external faucet locks would be required because a homeless person was using the property’s water for his carwash “business”. While I applaud his entrepreneurial spirit, he could at least offer a cut of the profits!
On the electricity side, again, some of the solutions are the same ones you would use in your own home. Replace old light bulbs, especially in common areas, with energy-efficient bulbs. Ensure that your insulation is adequate, and there are no major points of air leakage throughout the property.
These should be discovered during your initial inspection, but if you would like to be sure or it’s been a few years since purchase, you may want to have your electricity provider or third-party consultant come out and do an energy audit. Even better, many electricity providers offer these audits for free!
If you’re going to be doing renovations in units and you’re paying the electricity, you may also want to consider buying energy-efficient appliances. You may not see a huge difference in replacing one refrigerator or stove, but over time and with scale, they can create significant cost savings.
Renegotiate Recurring Expenses
Unless you are a glutton for punishment or happen to have a property management company, then you will have to outsource the management of the asset to a third party. It’s worth noting that many lenders prefer to see third-party management with a record of success before lending, as it reduces their risk.
The larger the property, the more room there is for negotiation on the rates. In the single-family and small multifamily space, it is common to see rates of 8-10% of rents per month go to the property management company. In the 100+ unit apartment space, the rates can be anywhere from 3-8% per month. If in your review of the offering memorandum (OM) for an apartment you see their property management costs are above the local average, that might be an opportunity for cost savings.
Lawncare, to include snow removal, is another recurring expense that might be worth reviewing and renegotiating. Another option is to reduce the percentage of your property that requires maintenance through creative landscaping. After all, less grass to cut means a smaller bill. Other examples include pest control, pool maintenance, and even insurance. It never hurts to shop around.
This list is by no means exhaustive, but it should give you an idea of some of the ways you can reduce expenses to increase your NOI. I didn’t go into the more intangibles like reducing tenant turnover, reducing vacancy, or challenging tax valuation.
While the specifics are important, what should make you most excited is the fact that there are so many ways for you to reduce expenses and increase your NOI. This means you make more money whether you’re the operator or a passive investor.
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Ready to start passively investing in multifamily real estate and want to see if our opportunities might be a good fit for you? Click here to set up a time for us to chat or shoot me a note at Tim@ZANAinvestments.com.