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Maximize Your Future Potential Income
By eric | November 7, 2007
When you are buying and holding property it makes sense to want to maximize your cash flow. After all, you want to reap an annual return for years to come, and the higher the better. To do that you’ll want your property at 100 percent occupancy; even if it means some of your rents are slightly below market.
However, when you are planning to sell your property, you want your rental rates to be at the market rate in the area. This is because the value of the property will be based upon not necessarily the current income, but the future potential income of the property. Sometimes there is a very big difference between the two. When you are selling your property, you want to demonstrate the highest future potential income for the property, not the highest actual income, because remember, as explained in Chapter 7, the actual income is the wholesale price, potential income is the retail price. As the seller, you want to sell at as close to retail as possible, even at the expense of occupancy!
Let me explain: No buyer will buy your property with the assumption that it will be 100 percent occupied forever. If they do, please have them e-mail me immediately, I have swampland I’d like to show them. Rather, buyers must understand there will always be a vacancy component in the analysis, which could be as low as 2 percent and I have seen it as high as 20 percent. Regardless of the number, the point I’m trying to make is that when you are selling your property it is not always to your benefit to be at 100 percent occupancy. When I’m buying a property, 100 percent occupancy to me means that the rents are too low or the seller is trying to pull one over on me.
To maximize your sale price, you are better off having your market rents high and creating some vacancy.
Let me give you an example. If your twenty-unit property was 100 percent occupied and the rents were an average of $35 lower per unit when compared to the market rents in the area, you would be losing $700 in rent per month (assuming again you were at 100percent occupancy). You’ve left $8,400 in annual cash flow for the next buyer ($700 per month multiplied by 12 months). This short fall goes straight to the bottom line, and remembers the bottom line determines the ultimate value of the property. Going back to our formula for calculating the offer price of a property, you know that the offer price equals the net operating income divided by the capitalization rate. Using a conservative capitalization rate of 10 percent, divided into the $8,400 in cash flow left on the table, you would experience an $84,000 reduction in your purchase price. Just from having your rents $35 per unit too low!
As I mentioned before, buyers will assume there will be some vacancy, so they will assign a 5-7 percent vacancy rate on your property even if it is currently 100 percent occupied or not.
You can see how impossible it becomes to get top dollar for your property if your rents are below-market. Sometimes it is difficult to have all the rents in line with the market, but you should at least have some of them at that level. If you do not have one unit with rents at market and your buyer read this book, you’ll find yourself on the other side of the valuation discussion we outlined in Chapter 7. That’s not a good place to be. At that point, your only alternatives will be to sell your property low, or hold on to it and prepare it for sale by increasing your rents and therefore the future operation’s performance potential.
Your team members can help you update your market rent information. Management company and broker contacts will be particularly helpful. I must emphasize, however, that to be successful in this business, you need to know this information on an ongoing basis. You can see from the example above how quickly a small $35
rent difference can result in loss of cash flow and loss of value. This is a business you’ll want to stay on top of.
Now that you know the importance of maximizing the future potential income of the property, you’re probably wondering how you accomplish it. There are two ways:
- You re-rent vacancies at the market rent (retail).
- You renew your current resident leases at the market rent (retail).
Don’t be alarmed if these actions create vacancies and turnover. In some cases they will. But remember, you are not managing to maximize cash flow here. You are managing the property for sale and that means you want to demonstrate the property’s highest potential income. You can only do that by demonstrating your rental units can command rents at the market level. The more units you can move to market level rents, the smaller the gap between wholesale and retail. The smaller the gap, the easier it will be for you to get a retail price for your property.
Possibly related posts: (automatically generated)
Maximize Your Future Potential Income
- To Sell or Not to Sell
- Working with a Buyer's Agent
- Thirty-two Techniques For Acquiring Real Estate When You Don’t Have Cash (29-32)
- More Private Financing Techniques (7-10)
- Partners - A Good Thing or a Bad Idea
- Thirty-two Techniques for Acquiring Real Estate When You Don’t Have Cash (13-16)
- Tenant Selection
- Techniques For Negotiating The most Advantageous Private Financing (8-11)
- Due Diligence: The Easter Egg Hunt
- Supply and Demand
Topics: Broker, Company, Dollar, Market, Property, Rental, Residential, Sale | 6 Comments »
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