Tuesday, March 26, 2013

Magic of rental increases

Often it is viewed as a negative when a tenant moves out.  There can be a silver lining, when you own an apartment building.  The increase in rent can reap huge dividends, but be aware, that a decrease in rent is also potentially damaging.

EXAMPLE
Recently, a tenant gave notice that they are moving out.  They were paying $663 for an apartment.  The current market rent for the space is $895.  That means, monthly, there will be an increase of $232, which over a year is $2784.  A nice little bonus in rental income. 

The real magic happens when you consider that apartment buildings are sold on a cap rate basis.  In Ottawa, most cap rates are now in the 4 or 5% range, so for conservative analysis, let's use 6%.

$2784 divided by 6% = $46,400

What this simple calculation tells you, is that your apartment building is now worth $46,400 more, because of the higher rental amount.  On the other hand, if you owned the building and dropped your rent from $895 to $663, the value of your building has dropped..

In income real estate, it is important to remember that what properties in the area have sold for is only somewhat important (for establishing the cap rate), the most important aspect is keeping your rents high and your expenses low, to create maximum NET OPERATING INCOME.

1 comment:

  1. Now imagine the annual 2.9% rental increase on your building. If you have a monthly rental income of $4500 and you make the rental increase, it raises your monthly income a mere $130.50, which over a year is $1566.

    The amazing part, is that this translates (with a 6% cap) to an increase in the value of your building of $26,100.

    Small increases make huge difference, make sure you always do your annual increase!

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