.jpg)
Introduction
As a real estate investor in Philadelphia, maximizing your rental property's Net Operating Income (NOI) is essential for financial success. Your NOI is crucial in determining a property's cash flow and overall property value. This article explores strategies to improve a property's NOI, such as boosting rental income and managing operational expenses, and how a professional property manager can assist in this effort.
Understanding NOI
Net Operating Income (NOI) represents the annual income generated by a property after deducting all operational expenses. This calculation can be simplified using the following formula:
NOI = Gross Operating Income - Operating Expenses
For example, let us assume a property has a monthly rent of $2,000 and monthly operating expenses of $500. This would result in annual revenue of $24,000 (assuming no vacancy) and operating expenses of $6,000. The NOI for this property is $18,000.
A property's NOI is an essential metric used to evaluate an investment property's financial performance and determine the property's cash flow. Cash flow is the money an investor can expect to receive from the property after all expenses have been paid. It is a critical factor in determining the success of a real estate investment.
The Impact of NOI on Property Value
The NOI not only influences cash flow but also plays a significant role in determining the value of your rental property. The higher the NOI means, the higher the property value.
When determining the value of a rental property, potential buyers or appraisers often use the capitalization rate (cap rate) method. The cap rate is the ratio of the property's NOI to its market value. You can estimate the property's value by dividing the NOI by the cap rate.
Here is a simplified formula:
Property Value = NOI / Cap Rate
Rental real estate generally sells for a cap rate of 5% to 10% depending on a number of factors. So, if we take the above example of a property with an NOI of $18,000 and assume a cap rate of 7.5% (Midpoint between 5% and 10%), this indicates a property value of $240,000 ($18,000 divided by .075).
But as the NOI increases, assuming a constant cap rate, the property value rises accordingly. So, if we increase the NOI from $18,000 to $20,000, the property value will increase to $266,666. This relationship demonstrates the direct correlation between NOI and property value. We add anywhere from $10 to $20 in value for each additional dollar in NOI.
Improving NOI can lead to a higher property valuation in several ways:
1) Enhanced cash flow: A higher NOI means increased cash flow, which positively impacts a property's profitability. This improved cash flow can make your property more attractive to potential buyers and increase prices.
2) Investor confidence: A property with a strong NOI demonstrates financial stability and profitability. This can instill confidence in investors and attract more interest, resulting in a higher property valuation.
3) Market perception: Properties with higher NOI are considered more valuable in the eyes of the market. Investors and appraisers often assign a premium to properties with strong financial performance, leading to a higher perceived value.
It is important to note that the impact of NOI on property value may vary depending on market conditions, location, and other factors. However, improving NOI remains a crucial strategy for maximizing property value and cash flow.
But How Do We Improve NOI
To improve NOI, it is essential to increase rental income while effectively managing operational expenses. Let us explore some strategies to achieve this.
Boosting Operating Income
1) Rental Rates: Rental rates have skyrocketed over the last few years and have increased from 10% to 25% in most markets. And many landlords have not kept their rental rates up with their local market rents, which has negatively impacted their NOI and property values.
So, we recommend regularly reviewing your rental rates to ensure you are aligned with your local market rates. Even a 5% to 10% increase in monthly rents will significantly increase your NOI.
There are several simple tools that will assist you in determining what rents you should be charging.
Zillow.com: Zillow also has an algorithm designed to predict rental prices known as the Rental Zestimate. Zillow's Rental Zestimate is a proprietary algorithm to determine the monthly rental price for a specific property. It uses public property data and similar local properties listed for rent as part of the algorithm. The Rental Zestimate is generally an excellent tool, but like all computer models, it has some weaknesses, and it is important to try other sites to compare their numbers.
Del Val Property Management: Zillow is by far the largest real estate site, but many other online tools can help you discover the rental price for your property. For example, my company, Del Val Realty & Property Management, has a tool for landlords to determine the rental fee at https://www.delvalproperty.com/philadelphia-property-management. Like Zillow, you go to our website and enter the address. Then, provide some basic information like the number of beds, bathrooms, square footage, and if it is single or multi-family. From that input, you get a much more detailed six or seven page Rental Property Analysis Report, showing the estimated rental price and many other key facts.
Other sites: Several sites offer rental price estimates, such as Avail.com, redfin.com, and Realtor.com, which can produce a rental estimate for your property.
Look at all these sites and compare them to what rents you are charging to see if you can increase rents.
2) Minimize vacancies: Actively market your property to reduce vacancy times. If you have a tenant that moves out every 24 months and it takes 60 days to find a new tenant, you have lost 8.3% of your income. Doing a better job and renting the property in 30 days reduces that vacancy by 4.1%. This is a huge difference in NOI and the value of your property.
3) Late fees and other fees: Implement a late fee policy to encourage timely rent payments and add revenue to your property. Also, consider charging fees such as pet fees, lease renewal fees, lease administrative fees, technology fees for online rent payments, and parking or storage locker fees. You can add laundry or vending machines to generate extra revenue if you have space. All these fees can contribute to extra rental income and an improved NOI.
4) Bi-monthly Rent: Consider offering your tenants bi-weekly rent. Many tenants get paid every two weeks, and it would make their life easier if they could pay their rent with each paycheck. So, if you have a tenant that pays $2,000 per month, your total rent is $24,000 ($2,000 times 12 payments). Now offer your tenant an option to pay $1,000 every two weeks. This results in a total rent of $26,000 per year ($1,000 times 26 payments). This is a $2,000 increase in your annual NOI.
Managing Operating Expenses
Controlling expenses is equally important in improving NOI. Here are a few tactics to consider:
1) Regular maintenance: Prioritize preventive maintenance to avoid costly repairs in the long run. Timely repairs and upkeep can extend the lifespan of your property and reduce overall maintenance expenses.
2) Have the Tenant Do Minor Maintenance: Can your tenant do minor maintenance such as cutting the grass in a small yard, putting out the trash, spreading salt when it snows, or even replacing light bulbs or cleaning hallways. Yes, you might have to pay them a small amount, but it is a much cheaper option than doing it yourself or having maintenance professionals do these services.
3) Shift Utility Cost to the Tenant: One of the errors we see landlords make is paying for some or all the property's utilities. Moving the utilities' cost over to the tenant can boost the NOI. These can include the utilities we all think about, such as gas, electricity, and water, but other charges, such as sewer, trash and condo fees, can be shifted to the tenant.
4) Choose Your Landlord Insurance Carefully: Another important cost reduction measure for landlords is to talk to your insurance agent and review the amount and type of insurance you have. You may have insurance you may not need, or you have too much insurance, and it is worth a conversation to look for some cost-saving ideas. Even compare your insurance against online insurance providers.
5) Long-term vendor Contracts: If you have vendors doing lawn or snow removal or other services on a one-year service agreement, consider moving them to a three agreement with a reduced cost. Vendors love long-term contracts and will discount their fees by 5% or 10% in exchange for the long-term agreement.
6) Improve the Energy Efficiency of Your Investment Property
- Install Low-Flow Faucets: Switching to low-flow faucets and other fixtures means that your tenants will use less water, and you will end up with smaller water bills. According to studies by Water Scrooge, the average property owner overpays on water expenses by approximately $500 per unit per year.
- Install a Programmable Thermostat: Whether a single thermostat controls all the units in the building or tenants have access to thermostats in their apartments, switching to programmable models can help to cut heating and cooling bills.
- Clean the Furnace/HVAC: Cleaning the filters in the property's furnace or HVAC system has several benefits, including lowering heating costs. The filter in the furnace can get full of dust and debris. When it is clogged, the furnace must work harder to produce the same level of heating, meaning it uses more energy.
- Upgrade to More Energy-Efficient Appliances: It might seem smart to keep old appliances to save the cost of buying new ones. But it can be wiser to purchase new, energy-efficient appliances for your rentals that save money and make your properties more appealing to tenants.
- Install Motion-Activated Lights: As a landlord, you ensure the property's common areas are well-lit and safe. Installing motion-activated lights is one way to keep those areas lit up and reduce energy bills. When someone approaches the exterior door or the yard of the apartment building, the light will switch on. When no one's around, it will switch off again. You can also install motion-sensor lights in the interior hallways so that the lights are not burning 24 hours a day.
7) Appeal Your Property Taxes: Taxes are often one of the largest expenses any property owner must cover. Many property owners need to realize that you can appeal your property taxes, especially if they have increased dramatically over the last few years. Therefore, it may be wise to hire a tax appeal expert.
The Role of Property Management in Improving NOI
A professional property management company, such as Del Val Realty & Property Management ("Del Val"), can be crucial in maximizing NOI and overall investment returns.
Here is how we can help:
- Market rent analysis: Del Val has in-depth knowledge of the local rental markets and can conduct thorough market research to determine the optimal rental rates for your property. We can offer strategies to increase rent for existing tenants and vacant units.
- Tenant screening: Del Val employs rigorous tenant screening processes to find reliable and responsible tenants. We can minimize vacancies and ensure consistent rental income by placing qualified tenants who pay rent on time and take care of the property.
- Efficient operations: Del Val manages various operational aspects, including property maintenance, repairs, and emergencies. We have established relationships with vendors and contractors, allowing us to negotiate competitive rates for maintenance services. We can promptly address maintenance issues, reduce expenses, and satisfy tenants.
- Financial management: Del Val maintains accurate financial records, including rent collection, expense tracking, and budgeting. We provide detailed financial reports, allowing you to monitor the performance of your investment and make informed decisions to improve NOI.
Case Study: Maximizing NOI with Professional Property Management
Del Val Realty & Property Management ("Del Val") took over the property management duties for a group of 47 rental units in Philadelphia and New Jersey in 4 separate buildings as of August 2015.
The buildings had extensive collection and deferred maintenance issues when we took over, with an occupancy rate of 81% and over $150,000 in unpaid rent.
Del Val took over and upgraded the vacant units with paint, carpet, and other improvements. We also spent considerable time and effort to get all the buildings up to code from local townships and state regulators. We cleaned up the exterior areas and did extensive trash from basements and storage areas.
We then increased the rent from $75 to $125 on any rented units. We also gave the existing tenants a new 2-year lease with rent increases every three months to bring the rent up to market rates. We also increased rent at each lease anniversary.
The results over three years showed that the net operating income has more than doubled from $114,000 to $270,000. This resulted from the occupancy percentage going from 81% to 98% and increasing the average rent by over $120 per unit during the last three years.
The improved net operating income has more than doubled the value of buildings to the owners.
The Path Forward
Improving your rental property's NOI requires a strategic approach focusing on increasing income and reducing costs. You can significantly enhance your NOI and maximize investment returns by implementing market-aligned rent pricing, efficient property management, and improvements.
If you want to unlock the full potential of your rental properties in Philadelphia, consider partnering with a professional property management company like Del Val Realty & Property Management. Our expertise and comprehensive services will help you achieve higher NOI and navigate real estate investment challenges more effectively.