Jonathan Cronin explains why net operating income matters most in multifamily real estate. NOI drives property valuation through cap rates, and increasing it exponentially raises what your property is worth. He covers how value-add strategies work to boost NOI and returns.
Let's take this off Market property. $200,000 is what the net operating income is for this property. Okay, we're going to buy this property. Let's say that we're able to buy it at, you know, off market, direct from seller. It's a value add property and needs a couple of things. We're going to buy this property at a 7.5% cap rate. So we go in, the owner says, Yeah, I got $200,000 in net operating income. And we say, I'd like to buy it at 7.5% cap rate. That comes to 2.67 million with a $200,000 purchase price. I would imagine that it would be somewhere in the neighborhood of, I would imagine that it would be somewhere in the neighborhood of, you know, 50 to 100 units, something like that. So let's imagine that with our 5,200 units, we're able to increase the rent by a nominal amount. Let's say that we're able to increase the, the rent by $100 a month per unit. This is our purchase. And over the course of a year or two, we increase the net operating income by $60,000. And now our net operating income is 260,000. Okay. The reason that if we increase the rent by 60,000 that our net operating income goes up by 60,000 is that when you do a rental increase, the vast majority of your rent goes directly to your net operating income because your expenses are already covered for the most part. It won't be 100%, but it'll be like over 90% of rental increases or increased revenue go to your bottom line. The other way that you increase your net operating income is by decreasing expenses. So if you're going in, we could say we increased rent a little bit, but we also operated the property more efficiently. Maybe we, we didn't pay the property manager quite as much. Maybe we renegotiated our landscaping contract, something like that. So we improved our net take home pay for this property by $60,000 per year. So trying to keep it a nominal example, a very moderate sort of exaggerate, not exaggerated scenario here. And so if we bought it off market at 7.5%, a lot of times what I see I'm buying a property off market is that I can buy it at a little bit higher cap rate because I'm the only person at the auction, so to speak, I'm the only person dealing with the seller. And so just like if you go to an auction and you're the only one there and you bid, you get best deal because there's nobody to drive the price up in an auction. So with brokers, even if it's an off market property, if it's with a broker, that broker is going to send it out to their entire network. When I was a broker, I might have 200 people or more on my email list sending it out to all of them. So yeah, it's off market in the sense it's not on LoopNet, but it's not off market in the sense that you're the only one looking at it. When you go direct to seller, which is what we teach, that's where you get the best deals. It saves the seller some money on brokerage fees, commissions. And so we're able to buy at better than market cap rates directly from the seller. However, when we go to sell that property, we want as many people at that auction as we possibly can. We want that property on LoopNet, we want it on Crexi, we want it everywhere it'll go, right? And so we will often buy properties at a 7.5% cap rate, 8.5% cap rate, whatever. And then when we take it to market, we'll, we'll sell it at a better cap rate because there's just more people at the auction, there are more people showing up. There's thousands of people looking at a loop net. Not only that, when we go to sell it, we're taking great pictures, we've got clean financials. The property has been improved through capital expenditures and other improvements. So it's just a cleaner property that's advertised well, it's marketed well, and it's more compelling to like a turnkey investor who's not interested in how you add. They're interested in buying the property and collecting the cash flow. So we will take that property from a 7.5% cap rate where we purchased it, and we'll sell it at a 6% cap rate. Now when we do that, we take that $260,000 and we divide it by our 6% cap rate and now the 260,000 divided by 6%. Now our value is 4.3 million. Now who would be happy with almost $2 million profit in a year? That's not a bad year. So what we've done is we bought a property at 7.5% cap rate, we increased the net operating income nominal nominally by $60,000 per year, and we took it from a higher off market cap rate to a lower on market cap rate and we went from 2.67 million to 4.3 million. It's not a bad day's work. Now this is the reason that this is so dramatic is the exponential impact. So this is like a dollar profit. So this is how people get rich in multi family. This is how one deal, yeah, almost a two million dollar profit. This is how one deal ends up changing your life. Now remember, this is a, this is a two million dollar profit at the very least because we still get to keep this number, right? We owned it for a year and we made $260,000 over the course of that year. That's net income that comes back to us. This is just your, your profit from the capital gains from the improvement in the value of the capital of property of the asset going from 2.67 to 4.3. But we still get to keep the income as well. So again, this is how people are changing their lives through multifamily real estate investing is because the, the value, the increase in value is exponential. It's exponential because you've got two numbers. You've got your net operating income and you've got your cap rate that you're dividing it by. So a couple of interesting things to keep in mind for every $1. So let's take $1, this is $1 per year and we're going to say $1 divided by 6%. So here, let me, let me expand this out a little bit. One dollar, not a hundred dollars, not a thousand dollars is one dollar per year. Okay, If I increase my net operating income on this property by $1 in a year, how much do you think that impacts my value at a 6% cap rate? It impacts my value by $17. I don't know if you can see that. My value, the value of my property goes for every $1 of net operating income that I increase the property in a year. So that's $1 divided by 12. What is that? $1 divided by 12? That's $0.08 a month. To get up to the point that I have earned a dollar per year in net operating income. So the most important element when we're doing value add, real estate investing number one by far is your net operating income. Because by increasing your net operating income by one single dollar, you have increased the value of your property by 17. So it's the 17x. You're people saying 10x. You know, you got a 10x your, your value, 10x your life. We're increasing by 17 times for every $1 that we earn in that operating income. That's why as property owners. And as investors, we have to be obsessive about our net operating income. Okay. So when we're looking at properties, the most important number is not cap rates. What's behind the cap rate is the net operating income. That is, hands down, the most important number.
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