Real estate investors’ life blood is slam dunk knowledge of neighborhood rents. If they don’t know, or worse, think they do and are wrong, not much good happens. In fact, mistakes in what an income property can realistically produce in, ah, income, can lead to what Grandpa used to call unintended consequences. He liked to sugar coat bad news whenever possible.
Monday’s post talked about discovering rents/vacancy rates for a property in a neighborhood. Let’s add to that today by fillin’ in some potential comparative flaws.
By having the rents reliably documented in a given neighborhood, you’ve established a solid baseline from which you can now make informed decisions. Still, if you don’t include the following, you’re not outa the woods yet, and could still find yourself scratchin’ your head after the fact.
What’d he say?
Let’s say you’ve established rents for 2/2 bath units with 800-900 square feet. Operation clipboard yielded bunches of info on this unit. You have 14 to compare. The range of rents however, have you a little confused. Why is there a difference from low to high of over 15%?
I dunno, let’s look at the replay Coach.
Here’s what you’ll no doubt discover. The units rentin’ for $1,000 look the same as the ones goin’ for $1,175 — from the outside — especially to the dufus who just drove by. But the latter have 2 full baths instead of 1.5, and their kitchens sport dishwashers, which aren’t in the cheaper unit. If you’re a tenant and can afford the extra $175, are you gonna grab the bigger second bathroom plus a dishwasher to boot? If there’s estrogen in the equation you are. Oh, and did I neglect mentioning the granite tiled kitchen countertops? Bingo.
Knowing these differences is crucial to understanding the various neighborhood rents — anywhere. This goes for differences in parking too — both in quantity, quality, and location. One building offers 2 off street spaces per unit, the other just 1. Then there’s covered vs uncovered. Does the property you’re thinkin’ of buying have garages? Woo hoo! Garages are the gold standard.
One unit has a wall air conditioner and a wall heater, the other central heat and air. How’s the floor plan? Women especially are sensitive to what I’ve termed ‘I Love Lucy’ kitchens and floor plans in general. All these things, and the list is loooonger, affect the ultimate price for which you’ll be able to rent any particular unit in any neighborhood.
This is how more experienced real estate investors add value. They accomplish it by addressing what’s known as functional obsolescence. You know, a carport turned into a garage. An I Love Lucy kitchen quickly/cheaply morphed into the 21st century. Forced air heat & a/c added, especially in areas where they’re either expected or the weather dictates. One of my all time favorites was when a client, back in the late 90′s called up all excited, breathlessly tellin’ me about a great find he’d made on a couple fourplexes on separate but contiguous lots. When I asked what made them so good, he said the price was way lower than what I’d sold him months ago just around the corner.
I smiled. Knew exactly the units to which he was referring.
I said, ‘Hey Mike, before ya go off halfcocked, go out there again and check to see how many gas and electric meters there are for each fourplex.’ Yer catchin’ the drift here, aren’t ya? 
Of course the prices were way below everything else. The owner paid all the power and gas for his tenants. In a 6% capitalization market, that meant a price reduction of at least $80,000 or so.
Oh. Never mind. It’s always the little things, isn’t it?
The central concept here is to understand what makes one unit more valuable to a tenant than the one across the street. The amateur drives by, quickly checks Craig’s List, or worse, asks the agent who sold them their home, what the rents should be. The pro looks at units, judges them if you will, much the same way a farmer looks at livestock at an auction. In other words, he wants to know exactly what he’s gettin’ for his money.
And the congregations said…..Duh.
If you were eyein’ a fourplex, and your personal operation clipboard showed that $30,000 would raise the rents on each unit by $200 monthly, what would ya do? Well, it depends, you answer cagily. Fair enough. Let’s say you can buy it for the market capitalization rate of 6% in that area. Now would ya do it? Would ya?
I’ll be puttin’ the real life answer in the comments section no later than end of day Thursday. I’d love to see what you come up with and your reasoning.
Meanwhile, back at the BawldRanch, where the heck have ya been? You can find me by clickin’ on the Contact BawldGuy doohicky. I love talkin’ with new folks. It’s like a fix. That’s ‘cuz I’m like, addicted to this stuff. Have a good one.
Related posts:
- Figuring Out Rents And Vacancy Rates In A Neighborhood
- How To Get The Real Scoop On Rents OR They Call It INCOME Property
- My Buddy Brian Brady At The ‘Q’ — Already On the Move to A Different Neighborhood
- Real Esate, The Media, Reality, And The Greenest Grass In Your Neighborhood
- Real Estate Interest Rates To Rise…Oops!
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$200 x 4 x 12 = $9,600. Subtract out even your worst case vacancy and expenses and divide the result by 0.06. Say $4,800/0.06. This one’s a no brainer. And you might reduce your actual vacancy if you bring the property up to the standard of its competition.
There’s that cheesecake again.
Yummy. I really appreciate you posting this series of posts as they are very helpful.
A I — Observation. Would you agree that by improving the property your operating expenses would have no reason to increase? Vacancy rate should, of course, be applied to new income, though your thought on a potential drop in vacancy rate has been my experience almost universally.
Thanks
Joshua — Yeah, I love that cheesecake shot. Glad you like these posts.
You may increase your operating expenses somewhat to service and maintain the improvements, but not in the same ratio as your other expenses. From your perspective as the current owner, most of the rent increase is gravy on your plate, in keeping with your food theme.
However, potential buyers of your 4-plex may not be as detailed in their analysis. No seasoned investor really trusts the operating statements provided by sellers and their agents. The potential buyers will likely slap a GRM or calculate the NOI on a property using the more generic ratios they have found to be accurate in their experience. You probably won’t recover 100 percent of your newly added NOI in the value, at least not immediately.
A I — Wouldn’t disagree with you there.
However, whenever we enter new region, we do our own boots on the ground ‘operation clipboard’ for operating expenses — strictly by line item.
The final number is the final number, regardless of the % vs GSI.
Thanks again. You add to the conversation.
That’s exactly my point. You would apply the ratios from your survey as the buyer’s representative. The seller, who just did the improvements, would not benefit from a lower blended OER or a lower vacancy rate.
My experience is that experienced small unit investor buyers tend to discount new improvements as shiny objects meant to attract (distract) buyers. They have seen too much lipstick on too many pigs.
Since I am for reasons that escape me considered semi-pro I waited until someone mentioned “vacancies.” I’ll see those vacancies and raise with “turnover rate.” Nothing kills more or faster than rapid turnover. I take that back, an undisclosed pet can come close. Anyway, that is a directly manageable aspect. A few percent lower monthly for the right renter can pay dividends if you can convince them that it is in their best interests to stay a long time on similar terms. I found asking high median rents and telling them I was loathe to raise rents was a great technique.
Ditto the lipstick comments A.I.
A I — Was agreeing with you on expenses.
Those who insist on applying rote %’s to income property numbers often miss out on great deals.
In my experience that happens a lot when you have a self anointed ‘expert’ represented by the same agent who sold them their home.
The blind leadin’ the blind.
Robert — When you’ve cured functional obsolescence, the property is now often among the elite in the neighborhood as far as amenities. Experience shows longer tenant occupancy when unit is reasonably updated, while also attracting higher rents.