Recently I was asked how we create value in apartment buildings, for us and our co-investors/limited partners who co-own these assets.
The short answer is: by higher rents, usually due to improvements to the asset, but on occasion with little or any investments. So if the rent goes up by 3% the asset value goes up by 3%, too, more or less.
The math on a simple example of a 20 unit building very similar to an asset we recently acquired in Red Deer, AB:
Current Rent = $240,000 / year in rent minus 40% expenses divided over a 6% CAP rate = $2.4M or $120,000/unit (more or less).
Value increase of 3% or $7200 – 40% expenses (or so) divided over a 6% CAP rate = $72,000 (more or less) or $3600/suite or 3%.
Thus, value goes up 3% also, as expenses (in time) will go up too (i.e. property taxes, utilities, management fees, R&M, insurance)
The real money however is made by investing into a vacant suite, or the overall asset, by getting 10% to 40% rent increases as tenants move out. Let’s say you invest $12,000 into a 2BR unit to make it real nice. Rent goes up 20% to $1200 (often far more than that actually). Then the unit increases by 20% in value, by $24,000 ! That is a very good ROI on the $12,000 invested. Often you can raise rents with minimal investments, say a paint job and new carpet for maybe $2500. Sometimes no $s are required, and sometimes a major investment as everything incl. drywall (not so dry often in that case) has to be removed and that is easily $10-$15,000 on a 2BR of 850-900 sq ft.
Repeat for massive wealth creation !
It works faster in less rent controlled areas like SK or AB as rents can be raised by any level to market within a year usually, but it also works in NB, NL, PQ, BC and ON, but slower and usually only on turnover as we have proven in assets we own in Abbotsford, BC or Sudbury, ON !!
We then unlock the additional value from the asset by re-financing it, as we have done many times, or by selling it.
So, a 20% increase in value, combined with an investment of perhaps 30% down (and the rest a mortgage) is a very powerful wealth creation vehicle as this would equate to a 66.67% cash-on-cash return (plus mortgage paydown plus cash-flow).