You may have heard that you should increase your NOI. Today, I’m going to show you how. I will also define NOI and DSCR in case you’re wondering, “oh, yeah? What’s that?”
First, I’ll admit I was leaving money on the table for years. I own a single-family home that also has a detached shop on the property. At first, we didn’t take the time to rent the detached shop. While the main house rented for $2,400 per month, the detached shop sat empty or maybe a few of our spare tools were locked inside.
At the beginning of 2020, we rented the detached shop for $500 per month, adding $6,000 in annual cash flow.
Now, you may be thinking, “Great! But none of my houses have a detached shop.”
Here is something every investor can do to increase their NOI. I own a duplex in Indiana. It is actually the first out-of-state property I have ever bought, and I still own it today. When I first bought the duplex, I used a local insurance agent. He quoted me $1,300 annual insurance, so I assumed that was market rate and that was that. A year later, I took the time to shop around. I was able to bring it down to $700 per year. That increased my annual cash flow by +$600.
Do you call around to compare insurance quotes?
Once you own a few rentals, the crucial next step is to increase the NOI (Net Operating Income). NOI is the money the rental property produces before paying your mortgage and before income taxes.
How do you calculate the NOI? The calculation is net rental income (gross rents – vacancy + other income) – net operating expenses (property taxes + insurance + landlord paid utilities + repairs and maintenance + capital expenditures + management).
Increasing the NOI accomplishes two very important things: increases the value of your property and increases the cash flow you earn. Both are really important as we invest in real estate.
There are two simple ways to improve your Net Operating Income:
- Reduce your expenses
- Increase your income
It’s the same simple logic we use to increase your savings.
Here are five ways to reduce expenses on your property:
- Reduce Landlord paid utility costs
- Maintain a high occupancy rate
- Shop insurance rates
- Tenant proof units with hardier finishes (less maintenance)
- Contest property tax rates
Here are four ways to increase income on your property:
- Rent rate increases
- Charge for pet rent
- Charge for premium parking
- Charge for storage
You may be asking, “Why does NOI matter?” Aside from increasing your profits (hello extra cash in your pocket!), mortgage lenders use the NOI to determine a property’s debt-service coverage ratio (DSCR) with multi-family properties (2+ units). Lenders use the DSCR to determine how much they will lend on a property.
For example, if the NOI is $140,000 per year, and total debt service is $100,000 per year. The debt service coverage ratio (DSCR) for this property would be $140,000 / $100,000, which equals 1.40. The NOI covers debt service 1.4 times.
They will often use 1.25 – 1.4 (meaning 25% – 40% more income than annual debt). We see this get even tighter with the current economic situation.
At the beginning of 2019, I bought an eight-plex in Clarksville, Tennessee. When I purchased the property, the total monthly rents were $4,930. With a focus on maintaining our occupancy rate while increasing the income, we could bring the rents up to $5,270. This increased the NOI by $4,080 per year. Applying a cap rate of 6.5%, the property has increased in value by $62,769.
Sarah ended up self-managing, bringing 8% for property management down to 0%.
I’m not the only one able to increase NOI. Sarah owns a duplex in Kansas City that she bought as an owner-occupied property. Before purchasing the property, she used our Deal Analysis Calculator. She calculated 8% for property management, assuming she would eventually hire a company to manage it. A trusted property manager also told Sarah market rent was $850 per unit. Knowing that, this deal made sense and she got it under contract. She used our free Due Diligence checklist and successfully closed on the property.
To her surprise, she rented out the bottom unit for $985 per month instead of $850! Then, she got a roommate who pays her $625 per month. Sarah initially thought she would have $10,200 in rental income, but in reality, she was bringing in $19,320 in her first year. An unexpected increase of $9,120. Not to mention, she ended up self-managing, bringing 8% for property management down to 0%.
What is one way you can increase income on your property? What are two ways you can reduce expenses on your property?
Next week, I’ll show you five ways to reduce the expense of landlord-paid utilities.