Last week we were talking to a friend of ours about our property management business and what makes 45 Main special. Our friend is a graphic designer by trade, although she is moderately familiar with real estate and is a homeowner herself. She nodded enthusiastically as we told her about our commitment to customer service and consistent communication, of which the industry is not known for. When we mentioned “Performance,” her face furrowed and it was obvious she had to think about that more carefully.
One of our main values as a company is Performance. This may sound vague and a bit wishy-washy, but performance is one of the most important things you need to consider when owning a property. Absolutely, positively, no other way around it, performance is what will make or break your investment.
To fully explain what we mean by performance, it will be helpful to use a simplified example to illustrate what this looks like. Let’s look at two different properties, both triplexes that are located in close-in Portland neighborhoods, both places owned by two different, yet very happy property owners.
The two owners are John and Amelia. They purchased both properties at the same time for the same price of $400,000. For example sake, the properties are exactly the same in style, condition, and desirability.
At the time of purchase, both properties were fully rented received $1,000 per unit in rent per month. John believes the secret to real estate investing is low vacancy and happy tenants. He vows that as long as the tenants pay rent on time then he won’t raise rents on them.
John feels like his place is decent enough and he decides not to do much repair at the time of purchase. Each month he receives three rent checks totaling $3,000. After expenses such as taxes, insurance, garbage, management, and maintenance, he pockets $1,950. At the end of the first year John is able to make $21,450.
Amelia, on the other hand, decides that she wants her place to shine. She makes the decision to invest in painting each unit and putting in new appliances because she feels like she could get more rent per unit if she did. She spent $5,000 per unit for a total of $15,000. She lost a month worth of rental income doing the work, but was able to quickly rent up all the units at $1,500 per unit after completion. Applying the same expense ratios as John, Amelia pockets $2,925 each month, and at the end of the year has $17,175 to show for it. This is several thousand dollars short of John’s return.
Both John and Amelia feel like they have made wise investments. All of their tenants have decided to renew their leases and there isn’t any major repairs needed in the first or second year. It seems like everyone has made out just fine, right?
Breaking down the approach
John’s behind. He received a higher cash flow in the first year because he chose to forgo updating the place and keep the current tenants in place. However, at the end of year two he decided to get an appraisal. The value was determined based upon his Net Operating Income, which reflected a value of $425,500.
Amelia, on the other hand, has much more competitive rents and receives more cash flow in the second year. The value of her property—applying all the same expense ratios, capitalization rates, etc—at the end of year two is a whooping $638,000. That is over a $200,000 difference
Performance does not just look at one metric. It is not just about good tenants or minimal repairs. It is about making the property competitive to the market. This is not rocket science, but it does require an in-depth understanding of what is going on in the neighborhood, what renters are looking for, and how each decision you make as a landlord effects your bottom line. If you don’t have the knowledge or experience to this, then I highly recommend getting a property manager to guide you through this process. In this example, it was the difference of Amelia force appreciating her property value up $238,000 in two years. A small investment for a big reward.