The Impact of Leasing Strategy on Property Value
By Joseph Root
Some investors need to sell a property to raise capital for another purpose, so they might list the apartment building for sale at a price that reflects it current conditions. Other investors have an opportunity to plan for a sale well in advance, thus enabling them and their property manager to make improvements to optimize the sale price of the building. At the end of this article, you will have a few tips that you can use to improve the value of your apartment building, whether you are interested in selling or not.
Leasing is the key to owning rental property. The income of the property is determined by the leases that are in place. That lease income is used to pay the property’s operating expenses, the mortgage, and to hopefully provide cash flow to the owner. In general, we see two types of leasing strategies: 1) Keep rents below market so that the property never has a vacancy; 2) Increase rent as much as possible each year in order to maximize cash flow for the owner.
· 12 unit property with 2 bedroom units
· Market rent is $1, 500 per month for a 2 bedroom unit of similar quality
· Owner A has long term tenants and does not increase the rent when leases are up for renewal. Owner A has average rent of $1,400.
· Owner B gives a rent increase to the residents each year when their leases renew. Owner B has average rent of $1, 500
We are going to use a valuation metric called the Gross Rent Multiplier (GRM) to illustrate the impact. The GRM is used to value property by multiplying the gross annual rent by the prevailing GRM in the market to determine the property value. A market GRM varies by neighborhood and property type, but for the purposes of this analysis we are going to use a GRM of 10.
This chart illustrates that a 7% increase in average monthly rent per unit results in an increased property valuation of $144,000. The key takeaway for property investors who prefer to keep units occupied by offering below market rents is that this strategy should be re-evaluated if a sale is on the horizon. The Real Estate Agents and Property Managers at Root Realty are happy to discuss your property and how this and other techniques can optimize the value of your real estate investment.