How To Force Appreciation in Multifamily Properties?

28.01.22 11:03 AM By Christian Catron

        The term “forced appreciation” in real estate tends to be associated with simply renovating a property.  While renovating a multifamily property will certainly force appreciation, it is important to understand why, because renovations are one of many ways to force appreciation in multifamily real estate.

The key factor that drives multifamily property valuations is Net Operating Income (NOI). In equivalent market conditions, anything that increases NOI increases the value of the property. 

NOI is revenue minus operating expenses.  Here, operating expenses include property taxes and insurance, but not debt service (either principal or interest payments).  To determine the value of a property, divide the annual (or annualized) NOI by the local market cap rate.  So a property with an annual NOI of $100,000 in a market with a cap rate of 5.5% is valued at $1.818M.

As owners and investors, you of course want to see the value of your property increase, you want to force appreciation.  So, how can you make this happen?

There are two main levers you can pull in the pursuit of this: increasing revenue and managing expenses.  This can be a powerful way to expeditiously increase your returns.  Let’s look at a few ways to do each of these, then a case study to illustrate their combined effect in an apartment value-add scenario. 


Minimize Loss-to-Lease

        If you or your property manager have not pushed the issue, your asset could be renting for less than market value without you even investing in renovations.  You can increase revenue by proactively increasing rents as leases trade out.

Interior Renovations

        You get what you pay for, but you also get paid for the value you deliver.  Simply put, if you deliver a better product to your tenant by renovating your units, your asset will demand more in rent. 

There are of course some market nuances to this.  The demand must exist in your market for that kind of product.  However, if the market supports it, this will hold true.

Property and Exterior Renovations

        This goes hand-in-hand with interior renovations.  However, the revenue effects of exterior upgrades and added amenities can be harder to measure than interior renovations.  Nonetheless, the same concept holds true.  By adding, for example, fresh paint, upgraded landscaping, and a dog park, you make your property a more desirable place to live. This helps bolster the rent premiums you can expect from interior unit renovations.

Extra Services

        Depending on your property, market, and tenant base, you could be sitting on untapped sources of non-rental income.  Examples include: renting washer/dryers to tenants, installing and charging for covered parking, charging pet rent / pet fees, or contracting property-wide internet services that you arbitrage by paying $35 per month per unit and charge tenants $50 per month for.



        We cover this under expenses, but depending on how you go about this, the effects can be realized as either increased revenue or decreased expenses. For utilities that are individually metered, require that tenants place those utilities in their name (reducing expenses).  For those that are not individually metered, you have three options.  First (and best), you can implement a RUBS (Ratio Utility Billing System) program, that bills tenants back for a pro rata share of the utility cost each month.  Second, you can charge a flat fee on top of rent each month for utilities that are not individually metered.  Lastly, you can realize that your property is all-bills-paid and advertise it as such, likely increasing the rents the property will demand. 


        This varies from property to property but is always worth paying attention to.  At a certain point, it might be more cost effective to hire in-house maintenance personnel than contracting out everything.  You can also think about including maintenance-heavy items (i.e. boilers, roofs, HVAC systems) in your renovation budget, which can often be financed and reduce maintenance costs in the long term. 


        Let us take a look at the following example. You buy a 100-unit property at its current valuation, with a blended average market rent per unit of $1000 per month.  The property is stable at 95% occupancy but has a 5% loss-to lease (meaning $950 effective blended average rent per month).  The property has not been renovated in quite some time, and you realize the market rent for a renovated property of this type is $1200 per door.  The property only receives other income of $5,000 annually for miscellaneous charges accrued by the tenants.  Operating expenses are $500 per door per month ($6000 annually).  Utilities are paid by the property, not the tenant, but water/sewage and electricity are individually-metered. Lastly, the market cap rate for this asset is 5.5%.  So, the in-place trailing annual financials look like this:

  • Gross Market Rent: $1,200,000
    • Vacancy: ($60,000)
    • Loss-to-lease: ($60,000)
  • Effective Rental Income: $1,080,000
  • Other Income: $5,000
  • Net Effective Income: $1,085,000
  • Expenses: ($600,000)
  • NOI: $485,000
  • Market Cap Rate: 5.5%
  • Property Value:  $8,818,181

After you buy the property, you do the following to increase performance over the first two years:

  • Spend $1,000,000 in improvements:
    • $7000/door in interior renovations (including installing washer/dryer connections in units)
    • $300,000 to replace the boilers, HVAC systems, and install a dog park
  • Hire a new property manager that actively pushes rents up with new leases
  • Require that tenants put the water and electric bills in their name, saving you $75 per month per door. 

This results in your blended average rents being $1200 per door.  40 tenants are now renting washer/dryers from the property at $45 per month.  Your maintenance costs also decrease by $3,000 per month because of the new infrastructure. Now, your financials look like this:

  • Gross Market Rent: $1,440,000
    • Vacancy: ($60,000)
    • Loss-to-Lease: $0
  • Effective Rental Income: $1,380,000
  • Other Income: $26,600
  • Net Effective Income: $1,406,000
  • Expenses: ($564,000)
  • NOI:  $842,000
  • Market Cap Rate: 5.5%
  • Property Value:  $15,309,090

Now, in two years, you have increased the value of your property by 73.6%!  That’s some real appreciation!

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