How to Increase Investment Value by Reducing Expenses

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Real Estate “Value-Add Investing” is a proposition wherein you buy properties at or below market value and still increase their value by 20%+ by identifying and exploiting value add improvement centers that the seller was not able to tap. In the last article I wrote, we discussed how to increase the value of your investment through rental income growth techniques. This article we will look into the flip side of the equation and see how you increase your investment value through expense compression.

The value add formula to determine the feasibility of executing any value add strategy is the same as the last article. Lets just review it once again:

Feasible Strategy = Value Add Increase/Savings > Cost to Make the Increase Happen

The formula from the perspective of expense reduction relates to how much money is saved in comparison to the upfront cost to reduce or remove the expense category.

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What Expenses to Reduce?

Every property has operating expenses that directly impact the property’s net operating income. Typically operating expenses combine to total approximately 55% of a properties gross income. Hence reducing operating expenses is a great way to increase property net operating income and its associated resale value. That is the big picture that you should keep in mind as you go after and identify expense reduction centers.

Operating expenses typically fall into one of two categories: verifiable or non-verifiable expenses. Verifiable expenses are those that you will incur on a repeat basis and it can be verified by a third party i.e. property tax, utilities. The expense compression value add strategy surrounds reducing verifiable expenses since when you go to sell the investment property; the prospective buyer will only give you credit for this category of expense reduction.

Major Verifiable Expense Sources

The main center of verifiable operating expense is property taxes and working to reduce that expense will help you increase cash flow and in turns asset value.

Expense Center – Property Taxes

Property taxes are usually a property biggest expense and highest percentage of your fixed operating expenses.  As an investor you need to make sure that the property taxes are accurate by ascertaining your assessment-to-value ratio is not out of sync to the town’s average.

Steps below will help you verify and take action to appeal your property taxes:

Step A:  Request your property assessment card by calling the tax office or you can use online tax services where you can look up property tax description  and assessment.

Step B: Once you get your property card, scrutinize the property description by looking up the description codes with the assessor office. Make sure that your property description is accurate as a low paying employee or an intern at the assessment company usually fills out the description and they can make mistakes. If your property is incorrectly described to have extra square footage or stories then you should file an appeal with the assessor immediately.

Step C: Determine your town’s average assessment-to-value ratio and see if your ratio is higher or lower than the towns average. Most towns publish their average assessment-to-value ratio but if yours doesn’t then you can back into the ratio by locating properties like yours in your surrounding neighborhood and checking their assessments. Determine each properties assessment-to-value ratio by dividing the assessment to the respective property value. If your property’s ratio is higher than the average then you would have a case to appeal your taxes.

Step D: If your ratio is higher than the towns or neighborhood average then you should consider pursuing a tax appeal only if it passes the Tax Appeal Payback Rule test.

Tax Appeal Payback Rule

The goal of a value add investor is to only spend money that you know you can get back in under 24 months through expense savings thereby yielding higher net annual cash flow.

Tax Appeal Rule in Action

  • Current Taxes: $10,000
  • Appealed Taxes: $8,000
  • Probability of Success: 80%
  • Potential Cost Savings per Year: ($10,000-$8,000)*.80 = $1,600
  • Maximum Capital Commitment: No more than $3,000 (two years worth of tax savings would amount to $3,200 so the cost to achieve that savings should be less than the 24 month payback rule).

As long as your property appeal potential passes the payback rule test then you should consider appealing your property taxes. You can pursue your tax appeal either professionally or pro-se.

The best bet is to approach the assessment pro-se and to do so by setting up a meeting with the tax assessor and explaining the reasons and showing the comps associated with why you think the value is too high. Speaking directly with the assessor is the best and cheapest way to go and any savings gained will definitely pass your payback rule test. If you have no success with the tax assessor and you still feel your value is too high then you should consider filing a tax appeal through the help of a professional organization. Just make sure to not agree to spend more than your potential savings gained.

Expense compression value add strategies can be a add value when you cannot increase rental income or ancillary income at a income investment. The goal is to gain additional positive cash flow to help increase the market value of your investment asset. What other expense centers would you want to review to help increase the property net operating income? Leave your answers in the comments below.

Happy Investing!

Photo: ·BigGolf·

About Author

Ankit Duggal

Ankit Duggal(G+) is the Investment Director of a New Jersey Income Operating & Consulting Company . Ankit is a seasoned value investor who enjoys achieving a zen through surfing, hot yoga, and snowboarding.

10 Comments

  1. Taxes are usually pretty in line with values in my market, and typically adjust after an arms length transaction. So I’m not sure if I can find much savings there – especially on SFHs. What other categories can you find savings on?

    I’m thinking repairs, maintenance, and property mgmt. If you can do this or run this yourself, you certainly can come in below the 55% OpEx level. What types of materials and finishes will help minimize on-going maintenance yet not break the bank up front?

    • Ankit Duggal

      Bill

      Other areas to save money are as follows:

      1) Electricity charges- see some of my ideas in my response to Al comment
      2) Water- make sure that your meter is being read correctly and that you install water savings flushes, valves and faucets throughout the house. The water savings will also save your sewer costs as in NJ your sewer cost is based on your water usage bill.
      3) The way to minimize expense from the maintenance equation is to complete annual clean up and repairs to the following asset system:

      a. Heating Boiler Servicing
      b. Roof Inspection and Patch up
      c. Gutter cleaning
      d. Windows closing properly with no additional air seeping through
      e. Repricing your maintenance contracts with vendors such as landscaper, snow removal
      f. Pest Control treatment
      g. Sewer line flush

      Those are some of my ideas that I work off. Hope that helps

      Ankit

  2. Ankit

    Great article.

    I might add that expense reduction just like increasing income can increase the equity of a commercial property. Its a value 10 play. You take the annual savings multiply by 10 and the answer is how much equity was created by the expense reduction.

    Paul

  3. Loving this series. I’m running a similar series on my home blog.

    Just for the heck of it, I wanted to find something controversial to point out. I found two things:

    1) I found it interesting that you focused on verifiable expenses. That’s a new paradigm to me. Thanks for sharing that framework (I’m going to steal it)/ I agree that property taxes makes up a large portion of your annual expenses but “long tail” miscellaneous and varying reoccurring expenses are important too. If you can do something non-verifiable to save $100 shouldn’t you jump on it?

    Obvious answer. My point is that the areas we analyze for expense reductions should never be reduced to one category. That only reduces innovations.

    2) Property taxes can be challenged when values are increasing as well as decreasing. When values are increasing, an owner should push back saying their property is inferior and doesn’t deserve to be valued so high. This is a new way of thinking for most; but no matter how you slice it, reducing “increases” is what savvy owners should focus on.

    • Ankit Duggal

      Sorry Al for the delayed response but usually Fall is busy with deal sourcing and new acquisitions. So here are my thoughts back to your points raised:

      1) You are welcome to creatively borrow it and I hope your readers and followers find the idea useful. Getting to the heart of your question: if you could save a $100 in non-verifiable expense shouldn’t you jump on it? Simple answer is Hella Yea its a $100 a month! But when it comes time to sell your asset just realize that the buyer will not pay you an additional $12,000 in value (assuming a 10 Cap rate market) at the time of his purchase offer as the expense not verifiable.

      Expense reductions should go into other areas as well rather than just verifiable expenses. The other types that I would recommend are as follows:

      1) Hallway and basement lights to be put on sensor switch that turns on and off in the presence of people entering and exiting the location

      2) Lower wattage bulbs to help reduce the utility cost

      3) Changing your building energy provider to a Virdian or another energy wholesaler if it saves you and/or your tenant even $10 a month in the utility bill.

      4) Annually checking on your property insulation especially within the attic area to help conserve heating costs especially if you pay for the common area heat bills

      Those items highlighted above are other centers that will make a difference to your cash flow line but may not get the credit from the end buyer at the time of resale valuation.

  4. I bought a distressed property in 2010 for $60k. The local tax assessor try to say it was “worth” $187k because “we all know that real estate will go up” ( (in CA tax base is calculated on market value at time of purchase).

    Anyhow, after reading the tax assessors manual (twice!) and numerous hours of research and a few rather detailed…er… “discussions” with the head of the local head tax assessor I filed an appeal for a hearing with tax appeals board (read the handbook for the members of the appeals board too –AND made sure that the tax assessor knew I was going to be there in person, even though I live 800 miles away).
    I happened to be assigned the first hearing of the day. The tax assessor apparently deciding that it was better to accept $60k as a tax base on my property than to start the day by having to explain to the board why his assessor had decided worth 300% of the sale price (in fact, $20k more than it had sold for at the height of the bubble, and the house had suffered significant damage while vacant for a year).
    Anyway, score 1 for “the little guy” and fighting back.
    (as a note, the tax assessor IS a decent guy — his assessor just got too over-ambitous).

    • Ankit Duggal

      Yes job. Sometimes the little guy does win with the right amount of research though! A great story as the right amount of research and education as you approach an issue will make you better at navigating unknown waters such as tax appeal. Thanks for the share

  5. Hey Ankit,

    I really enjoyed this and the previous article.
    The very analytic approach appeals to me being a former scientist that also has a math degree. 🙂

    Looking forward to more insights.
    I have not ventured into commercial properties yet but I do want to move in that direction in the near future so this stuff is great!

  6. Jonathan Gregori

    Hey Ankit,

    Quick question, what if you want to appeal but the card shows less square footage then you actually have. Will that open up a bigger can of worms? I live in a 30 year old neighborhood but my house was built in 2011, the other neighborhoods within in a mile radius are very new and huge houses, so I am trying to figure out how I could appeal. Any advice. Would me showing they were wrong on square footage be helpful or harmful because they show less square footage?

    I am looking more closely at this because I will be renting this home out in a few months and I have till the end of this month to appeal. Here is more info on my house.

    Here are the past tax years. I probably should of done it sooner. When I bought the house in 2011 I paid $164,000 and I refinanced in 2013 and the appraisal was $183,000. Do you think I even have a shot? Any advice would be much appreciated. Thanks for your time!

    2016* $181,222.00
    2015 $176,148.00
    2014 $167,879.00
    2013 $164,189.00
    2012 $159,464.00

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