Creating Wealth vs earning it
While the majority of individuals work for money, others create it.
In the traditional sense, hours equal pay and most people work year after year to earn an income for their families. This is how the vast majority of workers create value. They offer up their time, in exchange for salary or hourly earnings. But while this feels and seems like a rule of our economic system, it’s simply not true. Trading time for resources is only one way in which value is created. The other isn’t necessarily attached to time on task, but is rather a factor of net income and asset performance.
Let me explain further
In business and investing, an asset’s value is a factor of the income it is able to generate. For example, if an asset is able to produce $24,000 in annual income and the market values the particular asset at 10 times it’s net income, the asset’s value will be equal to $240,000. Of course, different assets and businesses are valued differently than others. In multifamily real estate, a quick rule of thumb is a property is valued between 10-20 times its net income. That is, the income which is left over after all operating expenses are paid.
So based on this concept, how can value be created instead of earned?
The answer is rather simple. If value is based on a factor of net income, then as income is increased, so is the value of the asset. For example, this rule stands true in multifamily real estate. Unlike residential real estate, whose values are based on neighboring comparable properties, multifamily/commercial real estate’s value is based on a multiple of its annual net income. Increase the income, increase the value.
It is in this way, which wealth can literally be created. For example, if a multifamily owner were to add $2,000 ($24,000 per year) to the income of a property, the property would appreciate by $240,000 to $480,000. The exact amount, depends on the local market and how much investors are willing to pay for a particular stream of income.
So how can one increase cash flow/net operating income?
The answer is rather simple. Increase revenue and decrease expenses. On the revenue side, there a number of items which can create revenue and thus add to the overall valuation. For example, aside from rent increases, one could bill back utilities, add coin laundry, vending machines, storage, parking fees, etc. One of the most common strategies is to update units and increase rent. This is a fast and efficient way of increasing revenues.
On the expense side, there is also a bucket of items which can be tweaked, modified and changed. Some of the most common expenses include; Taxes, insurance, maintenance, management, utilities, landscaping, repair and security. Of course, there often more expenses, but these will vary depending on the specific property. Decreasing expenses can be accomplished by dissecting each of these items. For example, could you decrease insurance by switching carriers? Could you decrease utilities by installing LED lights and low flow plumbing attachments? Could you negotiate the management and maintenance fees?
Decreasing expenses is just as profitable/powerful as increasing revenue. After all, in both cases you are adding to the profitability and overall value of the property.
Repositioning a property
The process of maximizing a property’s operations (increasing revenue and decreasing expenses) is called repositioning. This is a strategy used by many investors to maximize value and create wealth. The success of a reposition, begins with finding a great deal. By approaching a deal with the end in mind, experienced investors pursue properties which are priced according to their current operations, but ripe for improvements.
In a recent deal, we acquired a 16 unit apartment complex in Goldendale, WA. This is a perfect example of repositioning a property and creating wealth vs earning it. Click here to learn more about this project.
Cadia Capital Group
Cadia Capital Group is committed to growing passive income and wealth through affordable housing assets. These include mobile home parks and affordable apartment communities. If you are an accredited investor and interested in connecting with us, please complete the form below.