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Forced Appreciation on a Multifamily Home
In my last blog post I talked about market appreciation on multifamily syndications, which is the increase in value of the property over time. This type of appreciation is determined by the market value of the property. It is passive. A single-family home appreciates in the same way: it is valued by comparable real estate sales in the area.
A multifamily home, however, is valued more like a business: when its net operating income increases, so does its overall value. This kind of appreciation is active because you can improve the net operating income manually. You don’t have to wait for the local real estate market to receive a boost in value. This is the advantage of forced appreciation.
What is Forced Appreciation?
Forced appreciation of a multifamily home is the increase of property value as the net operating income increases. But what exactly does that mean? Let’s break it down:
Net operating income is all revenue from a property, minus all necessary operating costs. This is what link to first advantage post--->your cash distribution is calculated from. Just like a business, the value of a multifamily home is valued by what level of income it brings in.
Let’s say you invest in a multifamily apartment complex. Once the property is purchased, you find out it has plumbing issues, isn’t at full capacity, and the previous owner wasted a lot of money on a renovation that went nowhere––what gives?? Why would your sponsor choose such a property?
A good sponsor looks for properties that have the opportunity to improve.
If an apartment complex has multiple inefficiencies––such as poor marketing, deferred maintenance, operational bloat––these are seen as an excellent opportunity. By fixing these inefficiencies, the net operating income of the property increases, and with it the property value.
An important side note:
This isn’t to say all inefficient apartments are good opportunities. A sponsor worth their salt will do their due diligence to make sure any property inefficiencies can be improved professionally and without excessive cost. This kind of due diligence includes lease and bank statement audits, and boots-on-the-ground professional inspections of the water/electric/gas/etc.
Why Use Forced Appreciation on a Multifamily Home?
Let’s take a simple example: a multifamily apartment complex has a revenue of $3 million per year, but takes up $2 million in operational costs. The net operating income of the property is $1 million.
$3 million revenue - $2 million operational costs = $1 million net operating income
By making improvements, the operational costs of the apartment are decreased to $1.5 million. New amenities are added, which compel more tenants to move in even at an increased rent. This increases revenue to $5.5 million.
$5.5 million improved revenue - $1.5 million operational costs = $4 million net operating income
The new net operating income is $4 million, increasing the value of the property itself. A bank or buyer’s appraiser take this into their calculation of appreciation and give the property a new, higher value. This forced appreciation means more profit for investors than would have been possible if the property was left to passively appreciate via the real estate market over time.
How to Force Appreciation on a Multifamily Home?
Forced appreciation is actively increasing the value of a property through your own means. And what are those means?
There are myriad ways to force appreciation on a multifamily home. You can focus on increasing property revenue and decreasing operational costs. Both lead to an increase in net operating income.
The types of forced appreciation fall these four categories:
- Add amenities
e.g. install a pool, build a terrace, set up an exercise room, plant a flower garden.
- Make capital improvements
e.g. reshingle the roof, fix faulty wiring, repair pothole damage, replace poor carpeting
- Raise rents over time
e.g. an annual percentage rent increase to tenants as amenities and improvements are made
- Reduce vendor costs
e.g. monthly dumpster fee, landscaping charges, property management cut
Forced Appreciation on a Multifamily Home: Next Steps
Forced appreciation is one of our main strategies to add value to acquired buildings, thereby helping our investors grow their wealth.
Forced appreciation also improves the value of a community asset. By making improvements to a distressed property, and making it a more appealing living space for families, you are making the area better for residents and neighbors alike.
Installing washing machines and dryers into apartments not only increases the value of potential rent of an apartment, and therefore the profit for investors, it makes a difference to the quality of life of those who live in those apartments.
All in all, forced appreciation is a great advantage to multifamily syndication investing because you don’t have to wait for the market to increase to dictate the property value––it’s within your own hands.
For more details on increasing property value, look out for my next blog posts in this series of ten advantages of passively investing in multifamily syndications.
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Delphine Nguyen, Investor
Delphine Nguyen is a real estate investor and a licensed real estate broker in Illinois. She learned to be successful from a variety teachers, including her own mistakes. Real estate investing is her passion. Helping others to achieve their goals is another passion that she has. She does what she knows best, therefore, her focus is solely on multifamily and co-living investment types.
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