In Part 1 and Part 2 of Important Real Estate Terms we defined various terms that any commercial real estate investor needs to clearly understand in order to know how to invest wisely.  In this Blog we will discuss the very bottom line of investing – how to make money by buying (and financing) value added properties.

Part 1 of the Definition Blog discussed the difference between stabilized properties (where you pay what they are worth) and value-added properties (which you buy in order to increase their value and make money by doing so).  Another way of looking at this is to consider that in a stabilized property the investor looks at what it is today but, in a value-added property the investor looks at what the property could be.

Unless an investor is lucky enough to find a seller that is willing to sell their property at below its fair market value (not something that happens very often) the basic way to increase the value of a commercial income producing property is to increase its NOI (see Part 1 of Important Real Estate Terms for a definition of NOI).  The typical way an investor can increase a property’s NOI is to increase the property’s gross revenue.

How can an investor increase a property’s NOI?  Here are the most common ways

• Re-tenant the property.
• Rehabilitate the property.
• Reposition the property.
• Roll over the existing leases over time.
• Find a property where certain events will make this location a more desirable place to be.

To re-tenant a property the investor must figure out a way to do one or more of the following: Increase occupancy and/or raise current rents, get longer lease terms and increase tenant credit.  Rehabilitating a property means having sufficient access to capital to make capital improvements and/or make significant cosmetic improvements. Done properly, rehabilitating a property should attract better tenants and increase overall lease rates – all at a cost.  Rolling over existing leases means having the forethought to recognize that lease rates overall are going up and to work on changing the mix of tenants to find new tenants that will be willing to pay higher lease rates. Finding a property where events will make the location more desirable is self-explanatory.  An example might be found in the Cherry Creek area of Denver where massive development of new mixed-use projects are foreseeable in a relatively near-term time frame.

The other way to increase a property’s NOI is to decrease the expenses.  This is much more difficult than increasing the revenue as per above and carries the risk of having a long- term negative impact on any given property.

Although increasing a property’s NOI is a guaranteed method of increasing its value, it is important to be quite clear-eyed and realistic about the ability to succeed in doing this. Use your head, not your heart, in analyzing how to buy a property with the prospect of increasing its NOI.