We’re now over halfway of going through the 7 different profit centers associated with rental properties. In my last post, I discussed Instant Equity. In this post, I’m going to explain Forced Equity and how it can add significant income to your next rental property.

Forced Equity: performing minor (or major) renovations to increase the value of the property.

This kind of equity can be increased in a personal home as well as rental properties. Most often in personal homes, forced equity happens just before putting the property on the market to sell. It increases the value of the property and makes it more appealing for new buyers.

In rental properties, forced equity is a great idea to implement at any time during ownership. Yes, it’s more common to invest money into the property just before selling it so it attracts buyers and top dollar. However, these renos can also increase monthly rents.

Once a tenant moves out, a paint job is standard to give the place a fresh look. It also covers up dents and scratches that new potential tenants won’t appreciate. It may be time to replace vanities, bath tub and light fixtures. Good lighting can make a big difference in a rental unit. If the unit has carpet, it can be a good idea to replace with a laminate flooring alternative. It looks nicer and easier to keep clean.

It’s also important to take care of the exterior of the property. This includes landscaping. A property that has good curb appeal will attract a steady stream of tenant interest, which means you can set a higher standard for tenants living in your building. Exterior paint generally fades, so it’s important to re-paint the exterior every couple years or so.

Larger renovations obviously can do more wonders for a building. Things become outdated. It’s normal. Potential tenants don’t want to see appliances that are rusty and clearly 15 years old. Out with the old and in with the new! It can be expensive to change out all appliances in a multifamily building at the same time. Even changing them all out of one unit can be costly, but think about the bigger picture: higher rents, attracts better tenants, and they are more energy efficient which will reduce your expenses and increase cash flow.

Replacing old furnaces with a boiler system is another costly upgrade, but one that can save you a LOT of money in heating expenses. This type of upgrade doesn’t do anything for attracting tenants, but it does big things for your bottom line.

All of these upgrades, big or small, are types of forced equity. They can have immediate impacts like increased monthly rents or reducing expenses, or they can increase the market value of the building when it’s time to sell. Commercial multifamily properties are unique in that the amount of revenue they generate directly affects their market value. So if it’s possible to increase the rents through minor renovations here and there, the overall market value of the property also increases. It’s not necessary to spend tens of thousands of dollars to increase the market value of a property.

So how EXACTLY is the forced equity received? It’s a good idea to take before and after photos of renovation projects. These can be used to show appraisers what you’ve done to improve the property. Once noticeable renovations are completed, you can prepare a little presentation showcasing the improvements you’ve done to the property – inside and out. Give this package to an appraiser and have them conduct a new appraisal for the property. This costs money and is generally not done in the first few years of ownership. When it comes time to re-finance or sell the property though, that is when an appraisal is good to have so you know how much your property is worth.

In terms of re-financing, if I bought a property for $500,000 and completed upgrades mentioned above, and an appraiser says my property is now worth $550,000, then I just “earned” $50,000 of additional equity. The value of my property increased by $50,000. I can now access up to 80% of that equity from my lender in a home equity line of credit (HELOC). I can now also increase the listing price of my property if it’s time to sell, which will lead to more profits.

In summary: a little bit of elbow grease can go a long way in rental properties, especially larger multifamily properties. The improvements and upgrades can immediately increase rents, lower expenses and increase the overall market value of the property and thus, increasing profits.

If you’ve ever done these kind of upgrades before and saw a large ROI because of it, or you’re interested in doing something like this with me, send me a quick message to mark@perryinvestments.ca and we can talk!

Cheers to profits!

Mark