A “Load Factor” may be a new concept to residential investors (single family or 2-4 units) as it is a phrase stolen from the commercial office space sector, but it applies across all sector. However, since the “Load Factor” can cause your building to loose rentable square footage thus impacting your asset income and investment value – it’s important for any real estate investor to understand. This article provides ways to analyze the financial feasibility of reducing the load factor in residential assets driven by the principle: Reducing Loan Factor = Increases Asset Value.
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What is Load Factor?
Load Factor is what I like to call “wasted” or “unused space”. It is that extra closet or a den that can be used for another purpose where the value utility is higher in that second purpose. The load factor in residential real estate comes in the forms of hallway, foyer, basements, attics, closets, and oversized rooms that provides limited utility to the end user (tenant or homeowner).
As a value investor, your goal is to improve investment value through financially feasible load factor reductions.
Load Factor Reduction Feasibility Analysis
How do you know if the wasted space you want to convert into another purpose is feasible change/conversion? I use the Rule of 24. The Rule of 24 states:
A value-add investment is feasible if its nominal cost is paid back within 24 months through improved net cashflow as a result of increased income or reduced expenses arising as a result of the value-add.
Reduction Feasibility Analysis-A Step by Step Guide
Step A: Locate wasted space by studying the asset floor plan. This is easier said than done as I am not a very spatially creative person. To help make my life and now hopefully yours easier, I go down the following list of questions as I review asset floor plans to locate potential wasted space:
- Can I convert that open area to rentable space by enclosing it?
- Can I increase the rent I get from that space by improving it?
- Can I increase the value by connecting it to an adjacent space?
Step B- Imagine what the space can be converted into within the flow of the floor plan. The important thing is that you do not add a bathroom in the middle of the hallway and say that has added value. You need to make sure that the conversion flows with the asset floor plan and is not awkward.
Step C- Is the conversion financially feasible?
To determine the answer to this question you will need to do some statistical analysis to determine the value of the converted space from both a cashflow and a value accretion perspective. To determine the asset value impact, review your MLS statistics to see what is the value accretion for adding a bedroom or a bathroom (typically the highest dollar value space point additions in my analysis) within your sub-market.
Below is a hypothetical table of the trailing 12 month median sale prices based on bedrooms for single family houses within a New Jersey sub-market:
|Median Sale Price||Delta|
Based on the example, the greatest money is made by adding an additional bedroom to a 2-bedroom property.
To determine the cashflow impact, you can use the same type of table to determine the trailing 12 month rental price by bedroom:
|Median Rent Price||Delta|
|4 Bedroom||$1,450.00||$ –|
Based on the example, the greatest cashflow growth happens by adding an additional bedroom to an 2 bedroom unit versus an 3 bedroom unit
Step D- Analysis Tests: The Rule of 24 & the Rule of 200
Rule of 24:
As indicated above, the rule of 24 states that any investment costs must be recouped within 24 months from the additional cashflow directly attributable to the value-add investment.
In the hypothetical example above if I added an additional bedroom to a 2 bedroom rental unit, I would accrete an additional $6,000 in cashflow over 24 months. To stick to the rule of 24, the cost for adding an additional bedroom must be less than $6,000 for the value add investment to be cashflow feasible.
Rule of 200:
When analyzing whether to install a new bedroom or bathroom especially for a flip investment, I usually base my decision on the Rule of 200. The rule of 200 states that:
I only invest in improvements/conversions that provide a 200%+ return on my investment dollars.
Using the rule of 200, I would spend no more than $16,666 to convert a 2 bedroom to a 3 bedroom asset in the example above if I was reviewing the load factor reduction analysis within the context of a flip investment strategy.
Six Ideas to Reduce Residential Load Factor
Residential just like commercial properties have unused space arising from lobbies, interior hallways,larger than necessary living rooms, and so forth. As a value investor your goal should be to reduce the load factor to as close to 0% as possible. Below are six ideas to help get the creative juices flowing when it comes to reducing load factor in residential assets :
- Converting enclosed patios in residential assets into bedrooms or storage rooms.
- Converting basements unit office or storage bins to increase rental and/or asset value.
- Adding partial or full floors into the roof space especially if the asset has a pitched roof.
- Converting overly large bedrooms into multiple bedrooms by putting up a wall,door and closet.
- Finish garage into office or storage location.
- Storage bins or closets under stairways.
Load Factor Reduction is a creative exercise that converts existing space to more profitable or valuable use within the guiding principles of the Rule of 24 or 200. What are other creative ways to reduce asset load factors; leave your suggestions below!