What Every Investor Should Know About Forcing Appreciation in Commercial Properties

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Oh yeah, real estate investors can use the force, too!

Especially those who own commercial properties that are valued-based on the net income they generate.

Here’s how forced appreciation in commercial properties works

If you can get your rental to generate a little more income, that income is divided by a capitalization rate, and that’s the value your property will appraise for. So you can force your value up by increasing your income stream.

That’s forced appreciation.

Different Kinds of Income Streams
But check it. Let’s look a little closer. While all income streams matter, some streams are better than others.

Related: Forced Appreciation in Buy & Holds: How to Create Your Own Great Deals

Let me illustrate: I’m known for chasing the dream of creating enough side income to cover my mortgage so my tenants’ rents are available for other things. (Listen to BP Podcast episode 11 to hear Josh laugh at me.) 🙂

Crazy goal, but I’ve kept the BP community updated, and now I’ve accomplished it. Woohoo!

Anyway, what’s interesting is that people (myself included) like to take the $1,750 extra side income and calculate the equity I’ve earned. It goes $1,750 x 12 / 0.10 cap rate = $210,000! Wow, I’m going to Cancun and going buy a Lamborghini like blogger Mark Ferguson!

But when I calm down, I realize that an appraiser is going to scrutinize my side income and see it could be transferred to a buyer.

In commercial real estate, like residential units comprised of 5 units or more, the buyer is paying for an income stream. They happily pay for lease agreements at market rate, but are less willing to pay for the revenue I generate from my bicycle sharing venture.

To get full credit, you need:

  1. Contractual agreements that can be transferred to a new owner
  2. A sufficient track record of side income streams

Growing Strong in “The Force”

We’re as all cash flow is good, but when it comes to using “the force,” not all streams are great. For example, income from my furniture rentals and bicycle sharing might be discounted. My corporate housing, Airbnb, furniture rental and payday rent income may be discounted. Lucas Hall’s contract with Zip Car and Roy N.‘s motorcycle/car garage storage income may be considered.

Related: Why Forced Appreciation Makes Multi Family Investing Better, Hands Down.

Now, I’m enjoying the cash flow. I like that my 8-unit is cash flowing like a typical 16-unit, but I’m doing the following to grow strong in “the force”:

  1. Keeping good records of side income and basing it on contracts whenever possible.
  2. Adding items that are closer to traditional, such as a storage unit.
  3. Adding items to knock out expenses like thermo preheating hot water to eliminate hot water expenses.

How about you? There is a wide array of tactics you can invest in to force your appreciation. Are the ones you’re choosing going to get a full capitalization rate?

Let me know with a comment!

About Author

Al Williamson

Al Williamson helps landlords increase their monthly income by sharing unique tips to save money. He is the author of Airbnb for Landlords, and he blogs at LeadingLandlord.com and is an active BP member.

24 Comments

  1. Roy N.

    Al,

    I was working on leasing a small section of one of my properties to the post office for a “super-mailbox”, but with the recent change in government, the plans to terminate door-to-door delivery have been put on hold.

    I am now working on a zoning clarification, which if successful, will allow me to sell advertising spots on a fence we have along a busy roadway.

  2. Jason Insalaco

    @AlWilliamson
    Great article Al!

    I highly recommend Al’s appearance on podcast 11. He is way ahead of the curve on value-add investing. Al develops income in surprising places that super serve his residents while filling his pockets and increasing his equity.

  3. Jerry W.

    Al, nice article. Things are getting tight around my neck of the woods due to falling oil prices and loss of jobs related to that. Maybe I need to open up some new streams of income. I had started a policy of charging when I let pets into rentals. I discontinued that policy when I had 5 rentals open up in November. I became afraid of extended vacancies during the worst winter months. It is bad enough to lose income streams, I did not want to be paying heating bills as well. Hopefully I can start it again this spring.

    • Al Williamson

      Hey Jerry, I know that feeling. I’ve been there as well.

      My go to move is to create saving for tenants by coordinating them where possible. This is easier with a multi, but if you have scattered SFH, try to work out a perk with a local restaurants or service provider that everyone uses. Some group discount, no matter how small, creates perceived value that keeps you looking better than the next landlord.

      For oil and gas, I know those workers value laundry service. If you could work something out…

      They also produce a lot of aluminum (beer cans) work something out (it’ll be small – but the symbolic gesture could give you an edge)

      Car washes, oil changes, etc. every other business in your area is feeling the same pitch. They should be motivated to try something.

      Think about a housing package that includes meaningful services. This will open you to a lot of revenue ideas that you might be blind to.

  4. Chris Newman

    Great article, Al! You’re a Rembrandt in a paint-by-number world. 🙂

    Note-Master Dave Van Horn does this value-adding, too: He once built four new garages behind a multi that he owned with a large lot and it paid off nicely. Looking for these side-income opportunities is now a big part of my new-acquisition deal analysis.

    From my own experience in renting out garages, the tenants have been great. No problems and timely rent payments, with no management required. The kind of people who rent garages are either making money or have something personal that they want to protect, such as a hot rod. In either case, they have the means and motivation to keep the rent paid, which can’t always be said for residential tenants.

    I haven’t run all the numbers, but the Steelmaster-type pre-fab all-steel quonset buildings look like a good way to go: Easy construction, zero maintenance (with little to go wrong) and they should last about forever. With solid tenants and solid buildings, “the Force” should be strong with this one.

    • Al Williamson

      Chris, you sound like a Next Gen Landlord. Welcome to the club.

      Yes, I know about Dave’s garages. He is inspirational and a Side Income Jedi.

      Prefab buildings/garages are perfect! I always have heard that the numbers work out nicely, especially if financed.

      Yep, you should figure side income in your deals after your numbers work in the traditional manner. It’s a wonderful way to help you do more with less.

      Thanks for reading and commenting.

  5. Matt McCourry

    Al,

    Extremely insightful, I currently have a duplex thats a student rental, out back it has three enclosed, attached spaces for tenant storage. None of my tenants will pay the extra for storage, would it be a stretch to think I could rent out the spaces to other students that are not my tenants? Are there any laws I need to be aware of that would affect this kind of agreement?

    Thanks for the great article!

    -Matt

    • Al Williamson

      Hi Matt.
      Your duplex isn’t appraised solely on net operating income. You’re not able to use the force.
      However, you can enjoy the cash flow of renting those storage units to others.

      Grab a lease agreement from your local mini storage company and read up on your local lien laws.
      Renting storage doesn’t fall under landlord-tenant laws – you’re dealing with a new beast where you can lock out a non-paying tenant.

      So, by all means, DO NOT rent those units to your residential tenants. You’re far better off renting them to non residents in my opinion (as long as there’s separate access).

  6. Ben Leybovich

    Al, you are creative as hell!

    Though, I must say that your thoughts triggered a response. I’ll publish tomorrow 🙂

    For now, here’s the deal. To a large extent the value of forced appreciation is in the eye of the beholder. in other words, you can get capitalized value if the buyer agrees 🙂

    Double edged sword…as most things

  7. Brian Burke

    Good article, Al. I’m a partial believer in forced appreciation. I say “partial” for a similar reason as Ben pointed out. Additional income, no matter how you get it, is a great thing because it is just that–additional income. As an owner of income property, the more income you can get the better.

    The confusion arises when you try to connect that additional income to an exit value by capitalizing the income. Mainstream income such as market-rate fee income (late, NSF, pet, application, etc), additional rent income (upgraded units, view premiums, storage closets, carport/garage/parking), utility reimbursements, laundry/vending etc can usually translate directly to a capitalized value if the income stream is consistent and proven. Unorthodox revenue streams are a coin toss…some buyers may give you some value for that income, other buyers, not so much or at all.

    Expense reduction is a similar situation. Reducing some expenses will give you no additional value if your buyer knows how much it costs THEM to run a property. They’ll use their own expense matrix regardless of your expenses. Exceptions are with service contracts (because they are what they are, negotiating good prices will result in added value) and utilities. Installing water saving plumbing fixtures comes at a price but water savings can add to the value in excess of cost in some cases. I’m doing something similar–I have a climate-controlled self storage facility and I’m installing solar. This will drop my electric bill from $1,000/mo to $60/mo which will add $150K in capitalized value for an $85K investment, almost doubling my money. And it gets better–in 10 years my bills will still be $60/mo but they would likely have been $1,500 by then, which means that by the time I sell the added value will likely be in excess of $230K.

  8. Mark Gaines

    Thank you so much for your article. I own a government leased commercial office building. The cash flow has been great from the start. My whole focus has always been on increasing income and decreasing expenses. It is really that simple. But the multiplier is the key when you go to sell. Thank you for your insight, I always look to learn from others.

  9. robbie j.

    Mr. Williamson,

    Your article brought to mind the realization that as RE owners and managers we need to be as innovative, creative and resourceful as possible to capitalize on our assets!! Thanks for the reminder and I look forward to studying these areas more closely!

  10. steve g.

    great post… Appreciation is a big part of the investment picture for instance , example: Many homes in the city of San Francisco are several million dollars in today’s market, but back in the 1960s, the same property was worth about the cost of the car you are currently driving (probably even less!). Throughout the years, the area became more popular and the demand that ensued caused the real estate prices in the city to grow exponentially compared to where they were a few decades ago. People that were lucky enough to recognize this, or who were just in the right place at the right time and continued to live in their home have realized an investment return in the 1000’s of percent. Now that’s what appreciation is all about.

    1 would want to look at the appreciation value ,but its only part of the picture.

    • I – Income
    • D – Depreciation
    • E – Expenses
    • A – Appreciation
    • L – Leverage

    these are all areas to be considered when buying or evaluating a property.

  11. steve g.

    Does it even generate income?

    Leverage – A lot of people refer to this as “OPM” (other people’s money). This is when you are using a small amount of your money to control a much more expensive asset. You are essentially leveraging your down payment and gaining control of an asset that you would normally not be able to purchase without the loan itself.

    positive cash flow , does your subject property deliver positive cash flow? can it easily be made to produce a positive cash flow? what will be needed to gain this positive cash flow.

  12. Peter Mckernan

    Hello Al,

    This is a great strategy! It shows that getting down to the nuts and bolts can create more cashflow, which is what everyone wants in life! If there are more upside to a property that the seller does not see (what you are talking about), then it makes the buy that much more. Some properties are not used for their fullest potential, that is why I like this post so much! Thank you for sharing!

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