Professional commercial real estate investors consider apartments their businesses, and that the best way to optimize their business performance is through NOI (Net Operating Income) optimization.
There are three principal avenues to optimize your NOI:
- Increase Revenue
- Decrease Expenses
- Improve Rentability
Increasing Your Revenue
It goes without saying that increasing revenue is a straightforward way to increase NOI. There are several ways to increase revenue, but the most common and effective way is to raise rent.
Rental revenue usually makes up ~90% of your total income, and typically provides the most opportunity for increasing your revenue. Still, a couple things need to be in place before you can raise rents.
First, you must make sure you are in a market that has steady population and economic growth. Without jobs, you won’t have renters; and you need renters looking for housing to justify increased rental prices.
Second, your submarket must have income levels that support the increased rental fees. If you price yourself out of your renter base, you will face higher vacancies, which offset any benefits of increased rental income.
All of this research must be done before you purchase an apartment complex.
Increasing rental revenue is a straightforward way to optimize NOI and maximize appreciation.
As part of our due diligence process, we spend hours analyzing markets, submarkets, and neighborhoods to make sure they have the characteristics necessary to grow rental income. Then we match a project’s current rents with what the market will support to decide if there is room to increase rent and drive appreciation.
After we examine market and submarket rents, we take a further step in our analysis to review competing properties nearby. We review their floor plans, amenities, rental rates, and other details to evaluate whether we can create a competitive advantage by improving individual units (e.g., updating the kitchen with new appliances) or updating amenities (e.g., fitness center, pool, picnic areas).
If our analysis shows that improving the property will put us in a position to increase rents, we solicit feedback from our property management team, asking for their analysis on rent growth in the market. If they agree with our assessment of investment potential, we feel comfortable forecasting that growth in our pro-forma.
There are additional ways to increase your rental income in an apartment investment. You can look to charge for services like valet trash, or even install covered parking for an upcharge. As with rent increases, you must ensure your market and submarket can support this service, and that renters are willing to pay for it.
Decreasing Your Expenses
While increasing revenue is the most effective way to increase NOI, professional apartment managers understand there are other options available to maximize profitability. After all, with approximately 50% of your revenue getting absorbed by expenses, there will be areas to examine when you are looking to increase cost savings.
Let’s discuss a few prime candidates for cost-cutting, as well as areas to avoid.
One of your largest expenses is property taxes. While every state has its own tax code and each county has its own tax rate, it is more than common that a new assessment can lead to an inflated tax bill.
In these cases, it is incumbent upon the operator to appeal their assessment in court and apply for relief. As a matter of practice, we appeal every one of our tax bills each year to ensure we’re not overpaying property tax. Another area where experienced operators look to trim costs is in landscaping and similar contracts (e.g., exterminating, trash collection).
If you have more than one property in a market, you have opportunities to achieve economies of scale across multiple properties that allow all your investments to enjoy a price break while you enjoy an increase to your NOI.
With nearly 50% of revenue absorbed by expenses, you have to examine where you can increase your cost savings.
Marketing is another area where savings can be found across your portfolio. By cross-marketing your properties, you can give potential renters more options by sending them to a sister property within the same market that has the floorplan or move-in date they want. This practice should increase occupancy across your portfolio, and reduce the amount of money you need to spend on advertising.
You might come across some expense items that appear as easy targets to redline, such as salaries and wages, but these are not the first place to start in expense reduction. While salaries and wages are pretty large items on your expense ledger, it is important to not be “penny wise and dollar foolish” in this area. A strong leasing agent or competent maintenance technician is worthy of a slightly higher salary if they are keeping your apartments occupied at market rent, or keeping your apartments in good repair.
While revenue growth is a surefire way to optimize NOI, expense management must also be a focus, as every dollar saved goes straight to your bottom line.
Improving Your Rentability
Rentability is the practice of making your apartment complex more appealing to current and future renters.
An apartment complex with strong rentability has low vacancy compared to its competition. Renters stay in their apartments longer and are willing to pay higher rents to do so. And, because apartments become available less frequently, you can charge a premium for new renters.
How do you make your apartments more rentable? And what practices should you avoid?
First, take a hard look at your competition. And, are there amenities they’re offering (either for free or for a premium) that you are not? Are there amenities that you can offer that your competition isn’t?
You should also look beyond new amenities and services and make sure existing features are appealing to your current and potential renters. Does your pool furniture or gym equipment need to be updated? Is the landscaping well maintained? These simple upgrades can make a big difference as potential renters often pay attention to these particular amenities when deciding where to rent.
An apartment complex with strong rentability has low vacancy with renters willing to pay higher rents to stay in their apartments longer.
It is also important to remember that a key component of rentability is customer service. Your leasing agents should be polite and professional at all times. Maintenance requests should be handled promptly and competently. If renters see their residence being cared for and maintained by professionals, they will be more inclined to stay, increasing your rentability.
One thing you should avoid (if possible) is reducing rent in order to increase your occupancy. The practice of “buying occupancy” is often a short-sighted practice that decreases potential long-term revenue.
Improving your rentability should result in increased revenue and decreased expenses, growing your overall apartment investment’s value while increasing your cash flow.
Optimizing Your Investment
Combining these three approaches can help you optimize your apartment investment by optimizing your NOI.