May 27, 2021
How to Increase Your Multifamily Cap Rate
One of the most important critical tasks in managing a multifamily property is assessing and improving its profitability. In this post, we break down how to calculate your property’s cap rate and strategies for improving it.
What Is a Cap Rate?
Cap rate (short for capitalization rate) is a metric used to compare and assess real estate investments. For multifamily property owners and investors, cap rates are used to evaluate both the profitability of potential investments and the performance of their current properties against the market.
What constitutes a “good” cap rate varies depending on region, market trends and the economy. A general guideline is that 4-10% is a reasonable return.
How to Calculate Cap Rate
The formula for calculating a property’s cap rate is fairly straightforward:
- Capitalization Rate = Net Operating Income / Current Value
However, that formula actually contains Net Operating Income (NOI), a separate value you’ll need to calculate:
- Net Operating Income = Total Income – Operating Expenses
If you combine the two formulas, you get:
- Capitalization Rate = (Total Income – Operating Expenses) / Current Value
Suppose, for example, your property has a current value of $400k, a gross income of $50k and operating expenses of $26k. Inputting those values into the cap rate formula would yield:
- Cap Rate = ($50k – $26k) / $400k = 6%.
How to Increase Your Cap Rate
Mathematically speaking, the best way to increase your Cap rate is to increase your NOI. Based on the equation for NOI, we can see there are two possible approaches.
Increase Total Income
Increasing property income is the primary objective of every owner. And there are strategies you can do to drive more revenue. Decreasing vacancies, mitigating tenant turnover and investing in tenant satisfaction are all ways to keep your units occupied and generating revenue.
However, the amount of direct control you can exert on property income is limited. For example, you can only increase rent so much before it makes your property less competitive with the market, which in turn increases vacancies and decreases revenue.
Because of this, many multifamily owners find that the easiest way to increase their NOI and cap rate is to optimize operating expenses.
Decrease Operating Expenses
There are number of expenses that go into running a multifamily property. These include:
- Maintenance & repairs
- Property management software
- Rental listing fees
- Property taxes
However, one of the biggest expenses for most rental properties – and perhaps the most difficult to manage – is utilities.
The burden of including public utility services in rent – which can add up to tens to hundreds of thousands of dollars per year – can quickly diminish net operating income. As a result, more and more landlords are turning to utility billing.
How to Reduce Your Utility Expenses
To decrease their operating expenses, many property owners are using utility billing to charge tenants for their utility usage separate from rent. This is because utility billing enables property owners to eliminate tens of thousands of dollars from their annual operating expenses, which increases the property’s cap rate.
But there’s a catch. The increase in your cap rate is directly correlated to two more metrics:
- Billing Rate = Utility Expenses Billed to Tenants / Property’s Total Expenses
- Collection Rate = Utility Payments Collected From Tenants / Utility Expenses Billed to Tenants
The higher these numbers are, the more significant the improvement to your cap rate.
To maximize these values, along with your cap rate and bottom line, you’ll need to implement an effective utility billing system.
There are two methods for accomplishing this.
Utility submetering allows property owners to allocate utility costs fairly among tenants by measuring each unit’s true consumption of water, gas and electricity.
You can do this by installing a meter between the master meter for the property and each tenant’s unit. This provides accurate data for every tenant’s consumption for every utility. And with precise consumption data, you can bill back tenants for exactly what they consume.
RUBS, short for ratio utility billing system, is a billing method that proportionally allocates utility costs to tenants. It’s used to bill tenants for water, gas, electric, trash, cable and other services. RUBS is perfect for commercial properties that can’t use submetering either for technical or practical reasons.
Your property’s cap rate is a key metric for assessing its profitability and performance. There are a number of ways to increase your cap rate, but utility billing is one of the most cost-effective and scalable. For help implementing a utility billing system, many property owners turn to a utility billing company.