There is a growing concern among professionals in the commercial real estate industry that we are nearing the end of the current market cycle. When rents soften in the market, it often falls to operations to deliver positive returns through expense reduction. In this article, we want to focus attention on the fact that finding ways to make even small improvements to operating expenses can result in surprisingly large increases in asset value.
The potential impact of OPEX reduction is often overlooked by asset managers who are focused on maximizing revenue and other financing opportunities to drive top line growth. The fact is, though, that very small percentage decreases in OPEX will translate into millions in value creation.
Take the following example:
Here we see that saving just $100k in expenses increases the property valuation by almost $1.5million. That is significant. Where else could you earn that ROI? This is simple math – the impact of the OPEX reduction is magnified by the cap rate. At any single Cap Rate, the relationship between OPEX reduction and value creation is linear. Where it gets interesting is when you look at how this multiplier changes across different cap rates.
In the above chart, each line represents the increase in asset value for a hypothetical property with $500k in revenue. This shows that even at higher Cap Rate levels OPEX savings is valuable. As an example, for a property valued using a 9% Cap Rate, lowering expenses by 80 basis points will produce an increase of $500k in value.
As we look at lower Cap Rates we see the relationship is always linear but the slope is continually increasing. Digging into this a little deeper uncovers an exponential relationship between Cap Rates and their multiplier effects on value creation.
The above chart shows the relationship between Cap Rate and the Asset Value Multiplier associated with each $ of OPEX reduction. A 1% decrease in OPEX can return 25 times each dollar of OPEX reduction in total asset value. This has a meaningful implication for all portfolios but is particularly significance for portfolios diversified across markets and/or asset classes. Class A assets with lower cap rates stand the most to gain, so transitioning properties down the cap rate ladder via capex projects will increase the value of OPEX savings.
Rearranging the mathematical relationship between asset values and revenues in this way can have a powerful impact on your approach to OPEX management. It shifts focus away from the market and empowers management to identify the properties where their time is best spent scrutinizing expenses.
Another takeaway is the importance of scrutinizing operating expenses regularly as a defensive measure against a market downturn. When rates increase and property values fall, the Cap Rate multiplier can offset these losses through OPEX reduction. OPEX reduction can also operate as a hedge against value destruction caused by a rate increase.
Leveraging Technology Unlocks OPEX Savings
Of course, everyone knows that there is value to be found within the operations side of your balance sheet. But until now it has been too costly to manage on a constant basis because the data needed to identify the highest potential points of savings is usually spread across disparate systems and locations. Monitoring it consistently takes energy away from higher-impact activities.
Investing in a reporting tool that can consolidate all the relevant information to provide a portfolio-wide perspective quickly pays for itself by highlighting immediate opportunities. The Waypoint platform provides real-time reports with standardized data so that you can pinpoint the areas where you can get the most “bang for your buck.” This allows you to instill effective operating expense management into every part of your CRE business. If you are interested in learning more about how this can work for your portfolio, contact us to set up a demo.