How Real Estate Funds Can Improve Operating Performance

In today’s real estate landscape, many funds are facing significant headwinds. From rising interest rates to softening demand in certain asset classes, delivering successful returns for investors is more challenging today than at perhaps any point in recent memory.

But while fund managers can’t control factors like interest rates, other variables can be actively managed. Regardless of the configuration of a fund’s debt structure, improving the net operating income, or NOI, of every property in their portfolio should be a key focus.

Many firms are exploring creative new ways to improve NOI, but the basic tenets of good management still hold true. Here’s an overview of the steps real estate funds can take to improve the operating performance of the assets that make up their portfolio.

At James Moore, our real estate tax and accounting professionals work with a diverse range of real estate funds, from small funds operating multifamily assets to large commercial real estate funds. Contact us today to learn more about our accounting and advisory services for real estate funds. 

NOI: The Driver of Value in Commercial Real Estate

In the real estate industry, one of the primary drivers of an asset’s value is the net operating income (NOI) it produces. NOI is similar to EBITDA, a metric commonly used for non-real estate businesses which measures profitability before interest, taxes, depreciation and amortization.

NOI offers real estate investors a way to directly compare properties, independent of the capital structure under which the property is operated. It measures operating performance and is calculated by subtracting the operating expenses of the property from its rental income.

In principle, improving NOI seems fairly straightforward: Funds can either raise rents, decrease operational expenses, or both. In practice, however, it’s much more complex. And in today’s high interest rate market, many real estate funds are embracing more creative ways to grow the NOI of the assets they manage.

Improving NOI

As noted above, real estate funds essentially have two levers that they can pull to improve the NOI of an asset: increasing rental income or reducing expenses. But as with anything, success lies in execution.

Below, we share a few strategies that we’re seeing real estate funds adopt to improve the NOIs of the assets they manage.

Increasing Rents

Rental income is the primary driver of NOI. Funds commonly increase rents in one of two ways: raising them to be in line with market rates, or adding value to their properties that enable them to charge more.

Regardless of what type of real estate a fund owns, it must understand the market in which that property is located. If your fund owns multifamily properties, identify comparable properties and the effective rents your local competitors are charging. If you operate commercial real estate (CRE), have a broker complete a lease analysis to ensure you’re charging market-rate rents.

Aligning leases with market rates can significantly boost NOI, especially since there’s no impact on operational expenses. The moment a tenant signs a long-term lease for rent higher than previous rates, your property grows significantly more valuable.

Raising rents can also be achieved by pursuing value-add strategies. By improving the quality of the asset, property owners unlock the ability to charge higher rents. As you explore whether this is an attractive strategy for your fund, consider the long-term return on investment. Weigh the cost of performing renovations or adding new amenities with the potential increase in rents that will result to determine the rate of return of your investment.

Today, some real estate funds are experimenting with innovative value-add strategies. This might involve significantly reconfiguring assets — for example, changing the layout of an office building from one large office to several smaller offices. In some cities, real estate funds are going even further, changing the use of properties from commercial to residential. Studies estimate that over 55,000 new housing units will be repurposed from commercial office space in 2024.

While not every fund needs to take such a radical approach, novel ideas such as these could prove effective. In an environment as tough as today’s real estate markets, they’re certainly worthy of consideration.

Managing Expenses

Alongside increasing rents, real estate funds can also drive improvements to NOI by optimizing the operational expenses associated with managing a property. This process typically starts by benchmarking the various elements of your cost structure to identify potential areas of overspending.

This analysis may, for example, reveal that the property management fees or insurance premiums for a particular property are higher than the standard rates in a local market. Property taxes are another area where some real estate funds may be able to decrease expenses. Working with a property tax consultant to challenge the valuations made by local governments may result in a successful appeal that reduces property tax expenses.

Learn More: How Sky-High Insurance Premiums Affect Your Real Estate Fund

Real estate funds should also closely monitor their repair and maintenance costs. If you find that your fund continues to face repair costs on systems that routinely fail, determine whether it would be better to replace the system rather than continue making regular repairs. This is especially true for funds that hold older assets with many components approaching the end of their useful lives.

Partner with James Moore: Experienced Real Estate CPAs

While NOI is a crucial metric, it’s far from the only performance metric that illustrates the operating performance of a real estate fund. Because NOI doesn’t take into account capital structures or tax strategies, it’s not the best way to understand the returns of a fund or measure the cash flow an asset provides for investors.

Take a more holistic view of the performance of the various assets within your fund by embracing more sophisticated real estate accounting with the James Moore real estate team. Our professionals work closely with real estate funds on a wide range of engagements, from consulting on fund design and structure to helping fund managers navigate the complexities of real estate tax strategy.

Contact James Moore today to learn more about our accounting, consulting, and tax services for real estate funds.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.