BiggerPockets

Managing For Value – A Guide For The First Time Landlord (Part Two)

In Part One of this article, I discussed what I believe are some basic guidelines for managing your income property successfully. Now let's look at some specific steps you can take to optimize your return.

Buy Right

Your goal should be to manage the property for the greatest long-term gain. The value of a true income property (i.e., a commercial or larger residential property - not a single-family home or duplex) is directly related to its income stream. Hence, your best chance to maximize that gain is to grow the property's Net Operating Income. Doing so translates into at least two benefits: It's likely to help your year-to-year cash flow, but even more important, NOI is fundamental to the valuation of the property. Hence, by increasing the NOI you create equity.

One way to optimize the growth of the property's NOI is to buy it right. That's not code for "look for properties you can steal." It is not at all uncommon to find properties that earn below-market rents. This may happen because they have the kind of deferred maintenance discussed in Part One of this article, but it can also occur because the owner has simply not kept pace with the current market. Some landlords, especially those for whom real estate is a sideline, find it easier to renew the leases of good tenants at a nominal increase rather than demand market rents and take on the work and risk of finding new tenants.

When you locate such a property, you must not lose sight of the fact that you should purchase only if you can do so at a price that is very close to what its current income justifies. The seller will tell you that it should rent for more and therefore it is worth more. You could rephrase the seller's position as, "Do my job and assume my risk, but pay me as if I had done it myself." If you purchase a property with below-market rents at a price consistent with those rents, and then proceed to bring the rents up to market, you will almost always create additional equity.

Implement Management Improvements

Unless the property you buy is a text-book case of managerial perfection, you can generally enhance its revenue stream, and therefore its value, by making management improvements. Not to beat a fallen horse further, start by cleaning up the previous owner's deferred maintenance. After that, begin looking for ways to make the property more appealing to your pool of potential tenants. For example:

Common Areas - For apartment and office properties, make sure the hallways and stairways are clean and well-lighted. Some artwork on the walls and furniture or other decorative items in the halls creates a more welcoming and less institutional atmosphere. They convey that the owner cares about creating a quality environment.

Security - For better or worse, we've become a very security-conscious society. Don't take that concern for granted, but rather deal with it in a way that distinguishes your property from others with which it competes. The appropriate level of security varies a great deal from one type property of to another, but look for ways to improve whatever you have now. Exterior lighting, higher quality doors and door locks, controlled access to parking, and monitored fire and smoke detectors are just a few of the steps you can take.

Amenities - What do tenants really want? Can you wire the building for high-speed Internet access? Provide pooled secretarial and reception services for small office tenants? Pay for a series of newspaper ads promoting the businesses in your strip shopping center? Your goal is to maximize your income stream and to do so you need to distinguish yourself and your property from your competition. The numbers will add up quickly. Do the math:

Value = Net Operating Income / Capitalization Rate

Let's say that, in your market, the prevailing cap rate is 10%, that is, investors are buying properties for 10 times the NOI. You purchase such a property, make some of the management improvements suggested here and increase the Net Operating Income by $1,000 per month, or $12,000 per year.

Increase in Value = 12,000 / 0.10 = $120,000

By making management improvements, you created $120,000 in additional equity. Did you spend some time accomplishing this? Yes. Did you spend some money to make those improvements? Certainly. Did you spend $120,000? Not likely, probably not even close.

Some real estate entrepreneurs buy single-family homes with intention of "flipping" them quickly for a profit in a hot market and, in doing so, are often relying on economic forces beyond their control to create that profit. Those who invest in equities are also relying on outside economic forces as well as the competence and integrity of company management.

The bottom line with income-producing real estate is this: If you manage your property intelligently, ethically and responsibly with an eye toward providing the kind of quality environment that can command optimal rent, you can do something that you could seldom accomplish with a stock or bond investment or even with a flip. You can use your own initiative and skill to create value. In the most literal of terms, you can make money.

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