Growth of our Capital
For us and our investors, investing in Commercial Multifamily Assets is a long-term investment plan.
This is not a “get rich quick” approach. Although growth in the value of our properties can occur in fast-growing markets or when purchased and managed well, we are planning for the asset to grow over long periods of time, two to five years or longer.
We are in this business with a deliberate, long-term wealth building objective for ourselves and our investors. We want better returns, better than many other asset classes over the long term.
APPRECIATION is one of the biggest forces for growth in our properties. It comes in many forms.
One of the forms of appreciation is simply Market Appreciation, the steady increase in values over time. But, we do not simply have to wait for the market to give us this growth or appreciation. We can actually control a great deal of the appreciation our properties experience.
Another form is Forced Appreciation, by which we mean wisely managing the asset, resulting in an increase in the Net Operating Income (NOI). We force the income to go up and/or the expenses to go down. Since this asset class, as compared with single-family homes, is valued by its Net Operating Income (NOI) rather than the comparable sales in the neighborhood, when we increase the Net Operating Income, we force the value to increase as well, and exponentially so.
A $1 increase in NOI per year will result in perhaps a $10 increase in the value of the property. Or, to put it another way, a $100,000 increase in NOI per year could result in something like a $1 million increase in the property’s market value. So, if we have 100 units and are able to bring up below-market rents $100 per month, or approximately $1000 per year, this would be a $100,000 increase in NOI per year and a corresponding $1 million increase in the value of the property.
Forcing appreciation is a form of leverage in multifamily assets. A small increase in Net Operating Income can have the effect of a significant appreciation in the value of the property. Another form of forced appreciation is physically doing something -- such a improving signage or lighting or fresh paint -- that increases the value of the property. These actions on our part will often reduce turnover, increase occupancy, or allow us to raise rents, and thus leverage the increased NOI, forcing appreciation.
We have looked at Market or Passive Appreciation (letting the market do what it does) and Forced Appreciation (managing so that the Net Operating Income increases). Now, let’s look at Found and Phased Appreciation.
Found Appreciation. This is a result of our skill in locating and negotiating a great purchase of an asset. Found appreciation is the equity in the property in the property when we buy it or the terms when we purchase the property that will build equity.
An example of found appreciation in everyday-life would be if we purchase a set of antique toys at an auction for $5 each and sell them for $50 each on eBay over the next couple of weeks, without doing anything other than getting a good deal on the purchase.
Through careful research and understanding of the market and the properties we locate, we build in significant equity or found appreciation upon purchase. In other words, we buy below market value. The difference between the market value and what we acquire the asset for is the found appreciation. We plan on having a good cushion of equity as soon as we close on a property as a way of mitigating the risks which are not under our control.
Phased Appreciation is another force we can apply to the value of a property, particularly if it has land available for adding another income stream, such as storage units or a retail or office center. Say we spend, $100,000 in new phases or added opportunities and the added income streams increase the value by $400,000. This is phased appreciation, adding something that wasn't there at the time of purpose and increasing the income stream or value of the property with this new phase of development
However we do it, we apply our knowledge and skill to grow our assets, producing appreciation or growth of our investments. If our investors want to participate in the appreciation of the assets, we can provide the ways for them to do this.
PAYDOWN OF PRINCIPAL is a second way we grow the value of our assets. We use appropriate, but significant leverage to purchase our multi-family properties. We borrow money from the “banks,” often with agency funding from Freddy Mac or Fannie Mae.
Each month we make a payment on these long-term loans. Part of the payment is an interest expense and part is the paydown of the principal owed. In effect, our residents are paying off our loans for us. In the early years of the 30-year, 5% loan of $4 million, the amount of principal is not much, about $50,000. By year 5, the loan will be reduced by $300,000. By year 10, $700,000.
This paydown of principal increases the equity we have in the property, should we work a refinancing event and harvest the equity. This principal paydown is another wealth builder.