Lots of people wonder how to take an underperforming multifamily property and make it shine like it’s new again.
That’s a course of action that can create the most favorable returns and why one of our main strategies for multifamily investing is pursuing value add deals.
These are deals where through a combination of strategic renovations and leasing to more desirable tenants you can significantly boost the property’s net operating income and subsequently, its value.
That’s great, but it feels to me that there aren’t enough people asking how to make a “good” or “okay” property into a “great” one.
Unfortunately, it seems that a lot of investors feel a sense of complacency once their properties are stabilized.
In our 5 Steps to Asset Manage like a Pro for Multifamily Investments and 5 Tips for Working with the Right Property Management Company articles, we took a deep dive into the topics of property and asset management to give you a game plan for operational excellence for your multifamily investments.
In today’s article, we’re going to focus on three operational habits that can easily go overlooked when everything seems to be going “okay,” but can add up to massive increases in your NOI if implemented properly.
Maybe you and your team overcame some major issues that you inherited from the previous owner and are feeling pretty satisfied.
I would say that you’re wrong to drop your guard just yet, as this is the time to push the property a little bit further and realize its true cash-flowing potential. Otherwise, you’re simply leaving money on the table.
The idea here is to cut down on operational waste by avoiding spending more money in order to achieve the same results you could get for less.
It should be the case that, after several months of review and implementation of these strategies, the property is a tightly-run ship with minimal waste and strong NOI growth.
The thing everyone needs to keep in mind is that pretty much every property has room for growth.
It’s simply a matter of taking the time to go through every line of the property’s income and expenses and see where improvements can be made.
A skilled operator can see patterns of mismanagement simply by reviewing income and expenses and it’s important to identify the hallmarks of mismanagement so you can respond to them directly.
Remember that every property is unique and you need to separate property-specific concerns from more general problems that come as a result of management decisions.
Paying close attention during your due diligence phase and into your ownership is critical in parsing what problems are inherent to a particular property as opposed to something you and your team could improve.
Here are three commonly overlooked examples of areas that you can improve through your asset management practices:
1. Leasing Rates vs Effective Rental Rate:
This is a topic that you don’t see brought up all that often by the real estate investing community online, but is very important in higher levels of asset and property management.
Your effective rental rate is simply the average weighted rent for the property.
It’s important that you and your property manager pay close attention to the relationship between the going rental rate you are offering for new leases as opposed to the building’s effective rental rate.
To give you an example, you could have a property management company that’s boasting to you that they’ve had 100% occupancy for three months in a row now.
That sounds incredible, you might be thinking, but there may be issues lurking beneath the surface. In order to see them, you need to be comparing your leasing rate with your effective rent.
Let’s say that for this example, the leasing rate and effective rent are equal at $700. That sounds pretty good, right?
You’re at 100% occupancy and have brought your rents all in line with each other! Actually, this is a sign of mismanagement.
Stability is one of the most important things when managing multifamily properties, but it needs to work in tandem with a strategy to drive income growth over time.
If your leasing rate and your effective rent are equal, it implies you aren’t driving any additional growth in the property.
If you’re leasing at $500, at 100% occupancy, and your effective rent is also $500, it means you aren’t driving any growth in the property.
The fact that you’re able to consistently rent the property out at full occupancy suggests there is room for growth.
Essentially, you’ve allowed the property to become stagnant.
You’re leaving money on the table by not attempting to raise the leasing rate and seeing at what point occupancy drops off.
There is no growth coming in the imminent future, either, as you’re continuing to lease units for the same rate as your effective rent.
That makes it seem like 100% occupancy is a bad thing!
Well, not exactly.
Obviously that is one of our primary goals as property owners and investors, but it’s all about looking at the details.
If we were looking at a situation where the property was 100% occupied, but the leasing rate for new units as they become available was a couple percentage points higher than the effective rent, we’re in pretty good shape.
This demonstrates both stability and growth simultaneously, which is the ideal situation as a property owner.
A tip that can help you keep your leasing rent a healthy level above your effective rent is being a little more aggressive in pushing the new rental rates during times of high occupancy.
This allows you to take advantage of the high occupancy to test the market a bit and realize your property’s full potential.
A good rule of thumb is that your leasing rates should be around 1-4% above the effective rent for a stabilized building.
2. Service Contracts:
In the realm of expenses, the place where we see the most inefficiencies is in service contracts.
Due to the recurring nature of the contracts, something about them tends to lead property owners to “setting and forgetting,” which leads to lots of unnecessary expenses over the long term.
Sometimes you might wonder what the hell these previous owners were even doing when you get down into the details of each expense.
Just keep in mind that many property owners purchased in a different time and they have a far lower cost basis.
This essentially leads to a situation where these property owners have never faced the requisite amount of pressure to improve their operational practices.
They were already making money, so things simply went overlooked and undone.
Service contracts seem to be one area that suffer disproportionately from this.
One of the first things you need to do during your due diligence phase is to pore through the property’s financial statements line by line.
Identifying small expense infficiencies can add up to big cumulative savings. While you need to review all line items, pay particular attention to service contracts.
Why does the property need three phone lines, for example, when there are only two on-site staff in the office at any given time?
Another common example you will run into are pest control contracts that are serviced monthly for properties with no ongoing pest issues.
It’s important to have preventative pest control measures in place, but monthly service is typically overkill.
This could be changed to quarterly for properties without any severe issues and can provide some large savings to the property owner.
We’ve been able to realize savings of up to 15% of the original line item by sensibly re-negotiating contracts like these.
Remember that you’re not trying to push down the hourly rate of their services.
You don’t want to just hire the cheapest company in the name of savings; you still want quality services.
It’s usually more a matter of strategically shifting the scale of their services. As mentioned earlier, it’s all a matter of each property’s unique circumstances and crafting a strategy that fits.
Another contract item that should get some immediate attention are your trash contracts.
Maybe you’re really proud of how immaculate your property is, but, of the four total dumpsters on your property, two of them are pretty much empty at any given time.
know right there that you could likely be achieving those same clean results you’re proud of for a far lower price.
Again, this is mostly driven by the scale of work performed, rather than somehow forcing people to charge you below the market rate for their services.
There’s only so much you can do about how expensive a service is, but you can be sensible about how MUCH of that service is needed.
Trash contracts are a particularly noteworthy example of inflated service contracts where we have been able to realize savings of up to 25% as opposed to the previous owner.
Every expense line item matters, but service contracts tend to be one of the areas where you get the most immediate bang for your buck in addressing.
3. Property Manager Performance and Being Willing to Fire Them:
The first thing you’ll do upon assuming ownership of a new property is to begin working in earnest with your property management company to implement your business plan.
It’s critical that you select a company that has robust pre-existing property management systems in place, has key relationships in the asset’s sub-market, and possess a similar approach and philosophy to management as you and your team.
Staffing is the most important feature of each property and you should try to get an impression of your property management company’s staff prior to assuming ownership.
Are they efficient, open to change, and good at execution?
Unfortunately, there’s only so much information that can be gathered through an interview, and it behooves you to continue your assessment of the company even once you assume ownership and begin working together.
While it’s tough to do, if you’re not watching over the management’s shoulder, you’re not going to be able to put pressure on them or decide it’s time to fire them if they’re under performing.
This includes both lowering the expenses for the property and increasing the income, as I’m sure all of you know by now.
For expenses, the property management company should be taking all of those service contracts we mentioned earlier and putting them out to all of the reputable service providers in the area to bid on.
They should then be comparing the prices and scope for each company’s bid in order to compare them apples-to-apples.
Remember that a properly executed business plan and competent management should be able to have an impact on expenses within your first month of ownership.
As we’ve been discussing contract services, just use those for an example. If the property manager put each contract out to bid and you’ve secured a lower-priced contract for several services, you’ll see an immediate impact.
On the income side of things, it typically takes some time to see which changes have been effective and how your property is performing in relation to the sub-market as a whole.
You need to plan for anywhere from 6-18 months to both stabilize and optimize a property.
The length of this period will obviously be impacted by the degree of changes needed to optimize the property.
If the positive changes you are hoping for are materializing more slowly than that, the largest factor is often staffing.
That’s why it’s critical that you are extremely hands on with your property management company.
As we discussed in our 5 Steps to Asset Manage like a Pro for Multifamily Investments article, this entails monitoring and communication on a weekly, monthly and quarterly basis.
You need to be speaking directly to both the leadership and the boots on the ground to make sure the strategies you’re directing them to implement are being implemented properly.
The first month of new ownership requires you to be actively involved on a daily basis to make sure positive changes are being implemented.
During this period you need conduct constant follow ups with the property management staff. Many issues will need daily attention.
During these initial months, in addition to the manual focus you give your property manager, you need to keep your eyes on the property financials.
If your strategies for raising income and lowering expenses are being implemented, that should be reflected in the financials for the property.
Let’s say you re-negotiated a trash contract, like we discussed in #2. Moving forward, you know the rate of your new re-negotiated trash contract and you will be watching each month to assure your billed amount is the same as the negotiated amount.
If it comes in higher one month, you’re going to need an explanation. It’s watching over these line items like a hawk that allows all of these seemingly small differences to collaboratively boost your NOI significantly.
Make sure to interview each member of the property staff to look for any weak links. For better or worse, the composition of the staff is the number one factor in determining if a property will be mismanaged.
When vetting the staff, ask them due diligence and financial questions.
Focus on their decision making and how it affects the property’s financial situation.
Then, keep a close eye on them – don’t just take their word for it. For physical changes to the property, it’s good to also include multiple in-person visits to assess proper implementation.
What’s the end result of all this monitoring?
Hopefully, it results in a property manager that knocks it out of the park with the increased focus you’ve provided, but we’re not always so lucky.
The other side of this equation is being willing to bite the bullet and fire an incompetent property manager.
If the staff for the property aren’t getting the job done, a common mistake is procrastinating and giving them too many chances.
You need to be willing to fire and part ways with staff that aren’t implementing your business plan properly.
Waiting too long has a compounding negative effect and only serves to harm you and your investors.
Whatever changes you make to your property operations, you need to follow up on them to observe the real impact (or lack thereof).
It’s only through implementing changes, observing them, tweaking, and repeating the process, that you can truly bring your property to its full potential.
You need to be willing and able to adjust and optimize and then quantify how those changes flow into the property’s financial statements.
Remember that small changes can add up big if there are enough of them.
When you’re managing a portfolio with many properties and you implement these changes across your entire portfolio, these little changes can add up to hundreds of thousands or millions in added income.
That’s why you truly can’t overlook the need for optimizing each property. If it seems too tedious for you, you’re simply in the wrong business!