Optech Insights 2022: Solving 3 Common Owner NOI IssuesArticle
Few things are as important to multifamily owners and operators as NOI (net operating income). Owners are fiercely concerned with things that cause their properties to lose money. If a multifamily investment is leaking funds, there’s a fair chance it’s associated with one of three issues. Each is detailed below. Look at the list, consider your assets, and determine if you're in one of these common predicaments. Recommended solutions for all three are also included.
1. Bad Debt
Though there are more than two forms of bad debt in multifamily, resident default and vacant units represent the vast majority of it.
Near the end of 2021, rent debt in the U.S. was estimated at more than $20 billion. Covid lockdowns and related government mandates forced the number of renters defaulting on leases to record heights. Now, in the aftermath, inflation and other economic hardships add even more pressure. Countless multifamily owners in America are shedding dollars via resident default.
Rental income lost from vacancy during resident turnover adds up incredibly fast. The money clock starts ticking the moment a unit is vacated, not to mention the costs associated with cleaning, repair, advertising, and administration. These things together average between $1,000-5,000 per unit. Looking at this through a portfolio-wide lens shows a picture of hundreds of thousands, perhaps even millions, of dollars a year depending on portfolio size.
Many owners are getting creative with tech solutions to protect their properties against the impact of defaulting residents and vacant units. One of these solutions is implementing flexible rent payments. By integrating with third parties like Flex, Zego, and Till, owners allow residents to customize when and how they pay rent each month. They can break it into two installments, for example, and align their rent payment with their paychecks. Owners receive rent on the first of the month and the resident pays it back on a schedule that’s suitable to them. This method is rising in popularity as more owners discover it maximizes NOI by reducing delinquency, eliminating resident’s financial burdens, and lowering bad debt.
Another modern solution protecting owners against bad debt is lease insurance. Instead of requiring residents to pay a large security deposit upfront (which many cannot afford in today’s economic climate), they pay a small monthly fee instead. This eliminates a significant barrier and is proven to attract potential residents and lift administrative burden associated with collecting security deposits. It’s also a great marketing tool, setting the community apart with solutions residents love and appreciate. Some providers include LeaseLock, Obligo, and Jetty.
Lastly, experts advise not discounting tried and true methods of keeping residents around and avoiding bad debt, some of which include:
Choosing renters wisely (background checks)
Maintaining constant communication (reminders, notifications, follow-up)
Incentivizing on-time payment (gift cards, rent discounts, cleaning services)
2. Utility Mishaps
Less rare than you may think, mishandled utilities create serious financial losses for owners, as well as disgruntled residents. Three of the most common utility mistakes made by owners are under-billing, over-billing, and when utilities are included in the rent.
This is when owners fail to carry over master-meter rate increases to resident bills. Under-billing also occurs when CADs (common area deductions) are too high or when services like fire, emergency medical, stormwater charges, and other legally billable fees aren’t charged back to the resident. Communities that are submetered are usually where these situations spring up.
A lot of these circumstances seem trivial, but losses that appear small add up fast. Consider an owner who’s under-billing residents only $5 each month in a community with 300 units. At year’s end, that’s $18,000 lost. If you’re over-billing more than $5 and have more than 300 units, the problem is magnified.
This happens when owners charge residents too much because they aren’t subtracting non-billable expenses (like CADs) from the master-meter bill amount. It also happens when owners rationalize increasing renter’s residential rates after receiving a lower commercial utility rate, or when owners intentionally charge residents service fees higher than the legal limit.
Where under-billing is almost always the result of oversight, over-billing is usually the result of intentional action. Owners who over-bill their residents are attempting to profit from utility sales, when in reality they’re putting themselves in jeopardy. This practice is nearly guaranteed to result in residents filing complaints with the PUC (Public Utility Commission), bad PR, or both.
Including Utilities In Rent
There are pros and cons when it comes to including utilities in rent. Sure, owners can charge premiums, it’s easier for residents, and there are tax advantages. But when you include utilities in the rent, premiums appear higher to prospects, residents have no incentive to conserve, and rising rates almost always cut into profitability. When you assume liability for paying these bills, you take on big expenses that you can’t control. You put yourself at the mercy of utility companies and resident’s usage habits. And if your rental rates don’t cover the utility expenses at the end of the year, you have to pay that difference.
Owners often avoid losing utility-related NOI by integrating with a third party billing company. (A number of options are discussed here). This takes the burden off the resident and simplifies the process. But remember that even third parties can make mistakes, which is why owners should perform their own internal audit to ensure everything is as it should be. It’s not difficult and mostly involves familiarizing yourself with your state’s utility rules, collecting billing data, and building a spreadsheet to graph the relevant data. It’s easier than it sounds. Click here for a simple walkthrough. Once you have a system like this place, you can easily and periodically crosscheck resident billing amounts with master-meter charges, and you’ll know you’re not losing money.
3. Loss to Lease
This term refers to the difference between actual rent and market rent. Actual rent is the monthly dollar amount an owner is charging their residents (also called in-place rent). Market rent is the rent premium that an owner could be charging their residents based on submarket data. If an owner is charging their residents less than current market rent, that owner is experiencing loss to lease. Owners don’t usually incur out-of-pocket losses in these instances. Rather, they represent lost revenue opportunities. If an owner doesn’t raise rent premiums when their submarkets rises, they’re leaving money on the table.
Loss to lease results in property devaluation. Consider an owner’s failure to enhance amenities, upgrade exterior and interior spaces, renovate where necessary, or one who engages in poor property management practices. All these things put an owner at a disadvantage compared to competitors in their submarket.
To an owner, loss to lease is certainly negative. But when an investor discovers a loss to lease item on a property’s operating statement, it’s viewed in a positive light. Why? Because an investor can score a fast win and add value quickly by closing the loss to lease gap.
First of all, how do you know if your property has loss to lease? Gather three numbers: how many units in your property, actual rent, and market rent. Let’s say your numbers are 150, $1,800, and $2,000 respectively. Multiply the number of units by the annual rent. Then multiply that number by 12 months and you have your annual market rent. In this example, it comes out to $3,240,000. Now, do the same equation with the market rent. The difference between the two numbers is your loss to lease, which in this case is $360,000. That’s a lot of money.
To avoid this, you need to close that gap by raising rent premiums to market rate. You also need to justify this by investing in management, maintenance, and improvements. Remember that all these things increase the value of the property. Closing the actual rent/market gap in the above example would increase that property’s value from over $10 million to over $13 million, assuming a 6% market cap rate.
Raising rent to market rates across a whole property is a gradual process. As a unit comes up for renewal, the rent for that unit can then be raised. It often takes large multifamily communities more than a year to complete this process.
Investing in multifamily is a worthwhile endeavor that takes constant vigilance and observation to succeed. It is well within every owner's power to avoid bad debt, utility mishaps, loss to lease, and other things that eat away at NOI. Making wise decisions that prevent and fix these issues requires knowledge, foresight, and learning from mistakes, including those made by others.
Contact Dwelo today and learn how smart community systems increase NOI and help owners avoid the challenges discussed above.
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