Turn $1 Into $120 With A
Rental Property Investment
One of the things I love most about being in the rental property
investment business is the cash flow.
In fact, the only thing I like better than the monthly passive income that I
receive from my investment properties, is when I sell one of those properties and
receive one VERY BIG check!
while I am waiting patiently for the right time to sell one of my real
estate investments and "cash in" so to speak, my focus is on improving
the NOI or "net operating income" of the property. Fortunately, by
patiently and methodically increasing the NOI of a property, I am at
the same time increasing the value of that rental property investment
I have used the terms "cash flow" and "NOI" above. It is important to
understand that the two terms do not refer to the same thing. NOI is
used for the purpose of valuing income properties and does not take
into account debt payments. Cash flow, on the other hand, is what is
left over after all the expenses of the property, including capital
expenditures and debt payments have been made.
How Does NOI Affect The
Value Of A Rental Property Investment?
properties containing five or more units are typically valued based on
the amount of net income that they generate. The more net income a
property generates, the higher its value. Makes sense right?
an example that will help illustrate the difference between cash flow
and NOI, and how investment property values are affected by both.
just received the monthly operating statements from the property
management company that manages one of my apartment complexes. This
particular building typically generates between $3,500 and $4,500 per
month in cash flow for me. This month's cash flow? About $3,800. Right
on target. (Remember, this is cash flow. In other words, the money left
over after regular expenses, mortgage payments and capital
there are two things that are happening with this rental property
investment in the next few months. First, the existing mortgage is up
Second, it has been about a year since the last round of rent
increases, and it is therefore time to look at raising the rents.
deal with the mortgage refinance/renewal first. The original mortgage
was amortized over a 25 year period. I have been paying it down for 10
years now, leaving 15 years of amortization left. But instead of
continuing with the same amortization schedule, I could choose to
stretch it back out to 40 years. By doing this I will be able to cut my
mortgage payments in half, putting an extra $2,000 cash per month in my
pocket. (Again, that is after all
expenses and debt payments.)
this extra $24,000 per year affect the value of the property? No. The
amount of the debt payments on a rental property investment do not
affect its value. The value is calculated using the NOI, which is
calculated before the cost of the debt.
So, if it doesn't
increase the value of my real estate investment, why would I choose to
"re-amortize" the mortgage? Good question. The obvious answer is of
course more money in my pocket each month. But that comes at the
expense of paying down the mortgage faster. At the end of the day
however, I would rather have that cash in my hands as either a safety
net or to reinvest at a superior rate than I could achieve by paying
down the mortgage.
Now let's have a look at the affect of a rent increase on the value of
the rental property.
How Can A $1 Rent Increase
Add $120 In Value To A Rental Property Investment?
the surface, a $1 per month rent increase doesn't sound like much does
it? And from a cash flow point of view you are right, it isn't very
much. Who would get excited by an extra $12 of income per year after
all. But let's take a closer look.
As I alluded to above, an
extra $1 in rent per month translates into $12 per year. All things
being equal, that will translate into an extra $12 in net operating
income. Now, remember how I said that revenue properties are valued
based on their NOI? Assuming a market capitalization rate of 10%, a $12
increase in annual rental income translates into a jump in the value of
the property by $120.
Sidebar: A quick way
the value of an income property is to multiply the NOI by 10. Of course
this a very rudimentary way to estimate rental property investment
values and assumes a
market cap rate of 10%, which of course, is not always the case.
A simple $1 increase in monthly rents adds $120 to your "profits".
jump back to my real life example. The particular apartment
that I spoke of has 23 suites. And instead of increasing the rent
one of those suites by $1, a more likely scenario would be to increase
the rents on all of the suites by $25 per month. Let's see how that
23 suites X $25 X 12 months = $6,900 in additional NOI per year
Assuming a 10 cap rate, this would add a total of $69,000 in value to
the property. (10 X $6,900 = $69,000)
What's The Bottom Line?
bottom line is that both cash flow and net operating income are
important when it comes to a rental property investment. Remember, cash
is king and NOI drives value. Try to structure your financing and
management to optimize both.
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