SS178: Why is Rent Growth Crucial to Multifamily Investor Returns?

SS178 Why is Rent Growth Crucial to Multifamily Investor Returns

There are a number of important factors to consider when assessing the value of multifamily assets. In this episode, Charles discusses rent growth and its importance to investor returns.

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Talking Points:

  • Years back, I had a property manager of mine tell me that you need to raise rents every year, even if it is only 1% or 2%. I didn’t think too much of it at the time; I was pretty naïve in my 20s, and my thoughts were around the fact that if my insurance goes up $250 that year and I increase 1 tenant’s rent from $1,000 to $1,020 a month, that will pretty much cover it, which is true but then, many years later, I realized the real reason behind this piece of advice, which is a significant increase in property values.
  • You might have heard index and mutual fund investors discuss expense ratios with different funds and their importance to your lifetime return. For example, if you invest $10k in 2 different funds, one with a 0.5% expense ratio and one with a 2.5% expense ratio. Both earn a consistent 10% annual return before fees; after 20 years, the one with the 0.5% expense ratio will be worth $64,000, while the one with the 2.5% expense ratio will be worth $51,000. In other words, the lower expense ratio will be worth 24% more.
    • This compound effect is also the basis for the annual rent increase strategy. Annual rent increases or lower fees (in the fund example) over a long period of time create dramatically higher returns.
  • This rent increase strategy is heightened when we evaluate larger apartment complexes. This is mainly because commercial multifamily properties (apartment complexes with 5 or more units) are valued by their net operating income. We can exponentially increase the property’s value for every dollar we increase the net operating income by.
    • For a simple real estate example, if you own an apartment building with 20 apartments rented at $1,000 per month. Everything is identical except for the annual rent increase, and I assume a 5% cap rate.
    • If you increase rents by 1% a year, after 5 years, your property will be worth $240,000 more than it was at the beginning of year 1 BUT, if you increase rents by 2% a year, after 5 years, it will be worth $500,000 more than the beginning of year 1.
    • This is a greatly simplified example, and different rent increases may affect property expenses differently, which I have left out. However, it shows how important rent increases are to a property’s overall valuation.
  • Why is this important?
  1. If you currently own rental properties, you should raise rents yearly, even if it is a minimal increase. It is much easier to raise rents by a couple of percent a year than by 10% every 3-4 years.
  2. When you are underwriting properties, be careful what you estimate as your annual rent increase assumptions.
  3. When reviewing another investor’s underwriting, especially if you are deciding whether to invest, review their assumptions in-depth. A 1% difference between proposed and actual rents can greatly impact the property’s value over a 5-7-year hold.

Transcript:

Charles:
Are you missing out on maximizing your investor returns by overlooking the importance of rent growth in the multifamily sector?

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing why is rent growth crucial to multi-family investor returns? So years back, I had a property manager of mine tell me that you need to raise rents every year, even if it’s only 1% or 2%, and I didn’t think too much of it at the time. I was pretty naive in my twenties and my thoughts around rent increases were pretty much, if my insurance goes up by $250 that year and I increase a one tenant’s rent from $1,000 to 1,020 a month, that will pretty much cover it, which is true. But then many years later, I realized the real reason behind that piece of advice, which is a significant increase in property values.

Charles:
So you might have heard index and mutual fund investors discuss expense ratios with different funds and their importance to your lifetime return. For example, if you invest $10,000 in two different funds, one with a half percent expense ratio and one with a two and a half percent expense ratio, and both earn a consistent 10% annual return before fees after 20 years, the one with a half percent expense ratio will be worth a $64,000, while the one with a two and a half percent expense ratio will be worth $51,000. In other words, the lower expense ratio fund will be worth 24% more. Now, this compound effect is also the basis for the annual rent increase strategy. Annual rent increases are lower fees in the fund. Example over a long period of time create dramatically higher returns. Now, this rent increase strategy is heightened when we evaluate larger apartment complexes.

Charles:
And this is mainly because commercial multifamily properties. So apartment complexes with five or more units are valued by their net operating income, and we can exponentially increase the properties value for every dollar. We increase the net operating income by. So for a simple real estate example, if you own an apartment building with 20 apartments rented at $1,000 per month, everything is identical except for the annual rent increase and I’m assuming a 5% cap rate for this property. An example, if you increase rent by 1% a year after five years, your property will be worth $240,000 more than it was at the beginning of year one. But if you increase rent by 2% a year after five years, it’ll be worth $500,000 more than the beginning of year one. Now, this is a greatly simplified example and different rent increases may affect property expenses differently, which I’ve left out.

Charles:
However, it shows how important rent increases are to the property’s overall valuation. So why is this important? Well, number one, if you currently own rental properties, you should raise rents yearly. Even if it is a minimal increase, it’s much easier to raise rents by a couple percent a year than by 10% every three to four years, and it’s also easier for your tenants. Number two, when you’re underwriting properties, be careful what you estimate as your annual rent increase assumptions. And number three, when you’re reviewing another investor’s underwriting, especially if you’re deciding whether to invest, review their assumptions in depth, a 1% difference between proposed and actual rent can greatly impact the property’s value over a five to 70-year-old. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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