In this article, we will kick off 2020 by exploring the hidden killers of NOI for apartment buildings.
But first, a quick review: the NOI (or net operating income) is what buyers use to determine the maximum price they would pay for an apartment building. The higher the NOI, the higher the price, as per this formula:
Gross Income (Rent + Ancillary) – All Expenses = Net Operating Income.
It is basically the cash in the owner’s pocket at the end of the day.
NOI is “normalized” by buyers, especially the sophisticated ones, therefore private-ownership savings may not be applicable to boost NOI.
For example, an owner who takes care of his own janitorial will not have that expense removed from the calculation of NOI by any purchaser; rather this expense will be included at market rates or, at the buyers’ standard operating expense rate in the case of sophisticated buyers.
In today’s market, what are some of the expenses that could seriously hurt NOI?
We have seen this go up quite a bit in the last year or so, mostly because of the replacement cost which is part of any standard insurance (should building need to be reconstructed, and founded in the reality that construction costs have risen substantially over the last five years).
Shopping around ahead of your policy renewal is key.
Here are some numbers for perspective: One of our clients was able to reduce the insurance bill from $18,000 to approximately $10,000 per annum ahead of renewal by switching insurance companies. Total value-add: $160,000 increase in asset value!
There are still insurance companies out there that will surprise with a much lower rate and when it comes to selling or refinancing, a few thousand dollars in expenses will make a huge difference in returns/loan available.
Ancillary revenue miss
Many times an apartment building owner does not maximize the potential for additional revenues such as parking, storage and other features.
We had a client who did not have parking agreements with the tenants and was charging the same amount for indoor and outdoor parking, losing $30 per spot per month in potential revenue.
Based on our calculation for the NOI impact, this translated as an approximate $600,000 in building value!
This was great news for the buyer, but what’s surprising is the ownership group did not even realize the impact was going to be “significant” on what they considered a minor variance.
Retail revenue miss, or not actualized
Having a retail component in an apartment building completely changes the underwriting of the asset.
Key differentiator is the inability to obtain a CMHC-insured loan; however, even leaving this aspect aside, not actualizing retail revenue can render the building unsellable (or sellable only at a significant discount).
Even if you have “enough” revenue from the apartments, do not keep the retail empty if you are planning to sell or refinance in the next 12 months.
High expenses from old equipment
You might be on the fence on whether to spend thousands of dollars on a new furnace, but how much asset value are you losing by keeping your existing one?
As energy costs seem to approach infinity, your NOI will reflect heat loss from an inefficient furnace, old windows and an improper roof.
A hard winter will have a significant impact for the asset value the following year as buyers typically review expenses for the last six to 12 months in their underwriting.
A market underwriting of your building can help identify missed revenue sources and other NOI killers.
Remember, before accepting a direct offer:
* Ask about the buyer’s track record of closing transactions;
* Request to see proof of funds for down payment (assume 30-40 per cent of price);
* Re-evaluate conditions and delays;
* Find out if the buyer needs to raise money to make the deal happen;
* Clarify if the buyer can renege on the deal without consequence, after your selling power was “on hold” during their conditional period;
* Know that if your offer falls through, this will raise a question mark in the minds of other buyers and potentially impact the sellability of the asset.
We only work with proven buyers, who generally can put forward offers that are not conditional on financing.
Baron Realty specializes in matching buyers and sellers of apartment buildings. Ramona works in partnership with Mikael Kurkdjian and a team of real estate professionals to bring the best boutique-brokerage services to the apartment transactional space in Ontario and Quebec. [email protected]