As real estate investors, we know that the value of commercial buildings is determined by dividing its Net Operating Income (NOI) by its Capitalization Rate (Cap Rate). By definition, Value = NOI / Cap Rate. In other words, the property’s value is greatly magnified by relatively small increases in Net Operating Income. To illustrate, for a given Cap Rate (say 6%), every extra dollar in NOI increases the property’s value by $16.67 (=$1.00/0.006). In low Cap Rate areas like San Diego, that means there’s a huge opportunity to increase your building’s value dramatically!
Factors Affecting NOI
There are a number of obvious things one may do to positively affect the NOI of a property: raise rents, cure vacancy, decrease expenses. Well, what do you do if your building is 100% occupied at above market rents, and the property is so efficiently managed that you can’t think of a way to decrease expenses? Should you accept the status quo and simply keep up the good work? You could, but where’s the fun in that? You would be overlooking the unlimited number of ways to optimize not only your property’s NOI, but your returns as well.
Let’s look at an example of one creative way to decrease expenses. Several municipalities in Southern California offer rebates for installing water saving devices-every thing from highly efficient toilets and washing machines to new irrigation controllers and synthetic turf. These rebates make it much more affordable to install water saving technologies that not only help conserve water, but save money as well.
Operation Green Flush
Currently, there is a $100 rebate offered for replacing each 3.5gpf (gallons per flush) or greater toilet with an approved High Efficiency toilet (1.6 gpf or less) in the San Diego area. With high-efficiency toilets going as low as $128 at Home Depot, the rebate almost completely offsets the toilet’s cost. But the rebate is simply icing on the cake. Let’s see how performing this upgrade can not only save hundreds of thousands of gallons of water, but put tens of thousands of dollars in your pocket and substantially increase the value of your property.
To illustrate, we will examine how “Operation Green Flush” could increase the value of one of my company’s current investment projects, a property with 75 units. This particular property has sixty-five 2-Bedroom/2-Bath units and ten 1-Bedroom/1-Bath units; that means there are a total of 140 inefficient toilets to be replaced. According to the “Save Water, Save a Buck” website, the average water savings is 38 gallons per day per toilet when replacing the 3.5gpf variety with a High Efficiency one. Assuming we upgrade 140 such toilets, we would save 1,941,800 gallons of water per year. If the water company charges $2.6458/HCF (1 HCF = 748.05 gal), then our water cost savings would come to $6,868 annually [(1,941,800 gal ÷ 748.05 gal/HCF) * $2.6458/HCF]. With future water prices almost certain to go up, you have created a hedge against expense inflation. More importantly, however, you have added an extra $114,467 (=$6868/6%Cap) in building value! When it comes to commercial income properties, it pays to go green.
Other Creative Ideas
Replacing inefficient toilets is just one example. Imagine all of the other ways you could increase the value of a property by employing other water-saving techniques: efficient washers, fixing hidden leaks, installing synthetic turf…and we haven’t even begun to talk about how conventional ways of optimizing NOI can affect property values! If you have any questions about what you’ve read here or you would like to know how else we plan to increase the value of the 75-unit property in question, feel free to contact me today.
Photo Credit: Matti Mattila