Analyzing Income for Apartment Investing
In apartment investing analyzing income items that compose total income is important. Becoming good at analyzing income involves being competent at reading an income statement and rent roll. Good income analysis provides clues to how apartment operations are run. You’ll be able to build a story by the way revenues are collected, how income fluctuates over time and the types of revenue management is able to collect. There are two main sections of apartment income: rental income and other income. This article will describe the difference between both.
The common and highest revenue stream is rental income. It’s the rents your tenants pay and most important when analyzing income. When analyzing income from rents, expect a reduction by a certain amount of vacancy dependent on the local market and how well the property is operated.
On smaller properties it’s possible to keep vacancy very low or eliminate it by charging below market rents. This motivates tenants to stay for long periods of time as they can’t find lesser rents. I typically come across this from investors that own single family homes or smaller multifamily. They fear having vacancy and charge below market rents. They never raise rents to maximize their income; however, the expenses increase over time. Because income may not be in parity with expenses to effectively fund reserves and offset increasing expenses, over time there may be deferred maintenance. This especially affects larger capital expense items such roofs, HVAC systems, water heaters, etc.
On larger apartment complexes there’s usually vacancy. If a larger property operates at 100% occupancy, it may be that rents are extremely below market and it’s being managed by the owner to save management costs. This scenario provides a value-add opportunity to raise rents. This may also mean that since few tenants move out, the level of rehab may be higher. There may have been fewer opportunities to make improvements when tenants moved out.
When rental income is being effectively managed you may come across a lower amount of “loss to lease”. This is the difference between market rents and actual rent collected. Rent increases happen at the end of a lease term. Some tenants will be paying higher rents than others. If an existing tenant is paying $50 less than a new tenant because their lease hasn’t renewed, the $50 is considered loss to lease. An effective manager will increase rent at time of renewal and reduce the “loss to lease” amount.
A rent roll with lease dates shows if management is raising rents and generating income growth. If new tenants pay higher rents than existing tenants, than management is doing a good job of staying with the market and pricing correctly. When analyzing income check if existing tenants get periodic rent increases. If they are it’s a good sign that management is able to renew leases; therefore, practicing good tenant retention activities. In other words, tenants are satisfied to stay in their apartment and willing to pay more.
When analyzing income of a property, other income can involve a variety of revenue sources. Some will not apply depending on the market and property. Common sources of other income are the following:
- Utility Reimbursement Income
- Application Fees
- Laundry Income
- Pet Rent
- Security Deposit Reimbursement
- Parking Rent
- Storage Rent
- Appliance Rent
- Vending Machine Income
- Damage Fees
- Maintenance Fees
- Administrative Fees
Some items are dependent on their specific market and what the competition charges back to tenants. For example in California we rent refrigerators to tenants and create extra income. In the Texas and Indiana tenants expect refrigerators to be provided. Some markets are able to charge utilities back to tenants. Other markets include utilities to be competitive with other apartment complexes.
Utility Income can be the highest revenue source when analyzing income. It doesn’t apply in all markets, but where it does make sure its paid consistently. There are companies that provide R.U.B.S (Rent Utility Bill Systems) services. They calculate what a tenant owes based on the unit square footage or may install mechanisms to measure usage. Some owners charge a “utility allowance” – a set charge billed back to tenants.
Application fees are a small revenue source. If it’s steady or somewhat consistent from month to month, it’s a sign that your marketing is effective at bringing in prospective tenants. This will help you to raise rents over time.
Laundry income is a common item. The thing to know is if the property owns the machines or a vendor. If there’s a contract with a company, they provide the machines, maintenance and share the income. The typical split is 50% of the revenue when a contract exists. Make sure to review the contract in your due diligence. Most management companies prefer outsourcing the laundry to a vendor as it’s less work for staff to maintain and repair the machines.
Pet rent is a common item in larger complexes. This can give you an advantage against other locations that don’t allow pets. Be aware if insurance will not allow certain breeds. You may want to consider a size restriction. Notify tenants what their responsibilities are as a pet owner, especially to clean up for their pets. Enforce the rules so that issues with other tenants don’t come up. On our larger complexes we allow small pets with an extra pet deposit and pet rent.
At some locations we’ve been successful in renting garages, parking and storage. A particular complex with limited garages and parking, we’re able to charge extra for tenants that wanted a garage and extra to park inside the gated property. If tenants have extra cars and need extra parking, they can pay to park extra cars inside the complex or park on the street. This typically works were parking is limited and can be a good consistent source of extra revenue.
Damage fees are when tenants or their guests either deliberately or by accident damage the unit or anything on the complex. If this occurs the tenant must be responsible to pay for damages. They will adjust behavior and be careful in the future; otherwise, they will not value the rules and may not worry about causing damage in the future.
Maintenance fees can be when a tenant asks help to replace a light bulb, hang a shelf, get a key copy or any other type of special request from the tenant. This is not related to normal maintenance request to perform needed repairs.
Vending fees can be anything from a soda or snack machine to a laundry soap dispensing machine. It’s pretty much any money received from a vending machine.
Administrative fees can be anything from making extra lease copies for tenants, to performing special requests for tenants by management such as faxes.
Keep In Mind When Analyzing Income…
There may be other sources of income that are generated by different properties. The main thing to keep in mind is whether it’s something that adds value and can be received consistently or possibly increased.
apartment investing requires analyzing income that a property generates. Good income analysis helps to predict its value potential. You will get clarity on the story the number are conveying and how well the property is operating now and will be into the future.
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