Most of us never think of an apartment building or storage facility as a business, but there are many ways a property can make serious cash by providing valuable services to tenants and communities.
Rental Income
Stating the obvious, rental income is the primary way a commercial property makes money. Collected rent is the majority of gross income for that month. After the mortgage and expenses are paid, the remainder is net operating income (NOI), or monthly profit. This is what is split among the partners and investors.
Let's say you're investing in a 250-unit apartment building. Rents average $1,000 per unit, for a total gross monthly income of $250,000. The mortgage is $75,000 and expenses (maintenance, repairs, utilities, management fees, and more) come out to $125,000.
$250,000 (gross income) - $75,000 (mortgage) - $125,000 (expenses) = $50,000 (NOI)
In a syndication, that $50,000 is split among all the partners and investors on a monthly basis.
Ancillary Income
Ancillary income is from the services and amenities, like a coin-operated laundromat within the building, vending machines, clubhouse rentals, reserved parking spaces, covered parking spaces, trash valet, shared Wi-Fi or cable, pet fees, and more. This is where apartment owners can get creative learning and responding to the residents’ needs and providing these valuable services and amenities.
Appreciation
When selling a single family home, the biggest factor determining the value of your home is connected to comps in the area. If the neighbor's home just sold for $575,000, your similar home is probably worth around the same amount despite putting in a crazy amount of upgrades. You'd be lucky to get more than $625,000, depending on the market.
Apartment buildings are not valued on comps, but rather, on the amount of income they generate: net operation income (NOI).
Let’s say you have a building that generates $20,000 per month in NOI. Your property manager increases the occupancy, brings rents up to market rates, and decrease expenses. Over the course of a year, you're able to increase the monthly NOI from $20,000 to $30,000. Not only is this extra income generated, this also drastically increased the value of the asset.
Every additional dollar of NOI adds about $120 to the value of the property applying the market cap rate:
$1 (additional NOI/month) x 12 months x 10 (10% cap rate) = $120 equity
Your $10,000 of extra monthly income multiplied by $120 = $1.2 million in equity, which you receive when refinancing or selling the property.
This is one reason commercial properties change hands fairly often. A new owner comes in, implements their business plan to improve the property, sells for a profit, and moves on to improve another property.
This is a case of spending money to make money, because renovations to the property, common areas, and the individual units add value by providing a cleaner, safer, overall better place to live. You’ll be able to charge more rent since people are willing to pay more to live in better conditions. Proud tenants will likely give positive referrals and reviews, and your street presence will be noticeable.
Increased rents and decreased vacancies lead to higher gross income, which increases the NOI, which leads to appreciation of property value. Renovations can both increase cash flow returns and increase equity.