HSA Weekly Report: From the Intern’s Desk - Part Two
How to Maximize Return on Multifamily Investments
Multifamily operators need to be innovative and strategic in their approach to maximizing value in today’s market. While some factors such as interest rates are less controllable, others like renovations and rent growth, can be properly executed by investors.
Since cap rates are generated based on net operating income and value, investors can maximize returns in countless ways. Below are three key factors to consider:
Property Due Diligence
It is vital in multifamily investing to thoroughly review all information regarding the property to find ways to increase income and decrease expenses, ultimately raising the property’s value and maximizing returns for investors.
One common strategy to increase total income is value-add. This includes when an owner makes targeted renovations of unit interiors, common areas, and amenities to achieve higher rents. However, estimating the additional rent expected after these upgrades are completed it is essential to assess the potential income accurately.
Additional income streams investors should look for during property due diligence include tenant reimbursement plans associated with parking fees, laundry, and water, to name a few. Leases should be reviewed for built-in escalations or the chance to add that into new leases after acquisition. Including rent escalations and/or reimbursements can help decrease expenses and increase income, maximizing return.
Understanding tenant bases is also important. While there are benefits of market-rate rents, subsidized tenants guarantee rents monthly.
Also, for deferred/ completed maintenance, it is important to note the capital improvements made to the property and what may be needed during the hold period to estimate a more accurate cap rate.
Market Research and Trends
To make well-informed and sound investments, it is essential to be aware of the market's health in the surrounding area, including vacancies, rents, absorption rates, and new developments. Demographic research becomes crucial to understanding the local demand drivers, such as the presence of employers and educators. This knowledge aids in accurately forecasting lease-up initiatives or tenant retention strategies.
Absorption, referring to move-ins minus move-outs, plays a pivotal role in the health of an area. Certain events, such as a major employer relocating to a new city, can aid in the demand for rental properties. Staying up to date with these influential factors presents lucrative opportunities for investors.
By keeping a finger on the market's pulse and staying informed about key factors affecting local dynamics, investors can position themselves to make strategic decisions that yield positive returns. With the wealth of data available today, arming oneself with insightful information is crucial for multifamily operators.
Interest Rates
Although cap rates do not account for debt service, borrowing costs affect capital distribution. When investors have target IRRs and capital distribution changes, other changes must occur to retain that target IRR.
For example, an investor with a target IRR of 15% on a $10,000,000 (70% LTV) investment with a 10-year hold.
A bank is willing to lend at 3.25% interest only on a property generating $500,000 of NOI with 3% growth YOY. The going-in cap is 5%.
With the same scenario and rates increasing by 100 basis points, to obtain a 15% IRR, the purchase price of the property would equal $9,000,000. This new value raises the going-in cap to 5.6%.
