The commercial real estate (CRE) industry is in a very uncertain time. With the collapse of two of the 30 largest U.S. banks in a 72-hour window, it has many CRE investors wondering what their next plan of action should be.
“There were already two things going against the real estate community — higher interest rates and lower valuations. Now there’s this,” said Anchin Block & Anchin partner Robert Gilman, co-leader of the accounting firm’s real estate group in a recent Bisnow article.
CRE investors and their property teams need to make long-term strategies that will be sustainable and increase the longevity of their buildings. Now is the time to put a major emphasis on net operating income (NOI) if properties want to have a lasting stay in the commercial real estate industry.
The risk of devalued assets
As interest rates rise, so do cap rates. Last year, CRE investors were looking at interest rates in the low 4%. Today, they’re facing 7-8% interest rates – or even higher. As a result, cap rates are also skyrocketing. And when that happens, the only way to maintain or increase your property’s value is through NOI growth.
Consider the following simple equations.
- Property value = NOI / Cap rate
- Cap rate = Interest rate on the loan + Risk premium
Let’s assume a risk premium of 5% and an interest rate of 4%. The cap rate would equal 9% (5% + 4%). Using this cap rate and a NOI of, say, $1 million, the equation would be:
- Property value = $1,000,000 / 0.09
- Property value = $11.1 million
Now, fast forward to today’s interest rates almost doubling. Let’s say we’re at the same risk premium of 5% with a loan interest rate of 7% today. The cap rate would now be 12% (5% + 7%). When we apply the same equation of Property value = NOI / Cap rate, the value for the same property today without NOI growth is now $8.3 million. That’s a 25% decrease in property value.
Focus on NOI even when building occupancy is low
Add skyrocketing interest rates, the recent banking collapses, and shifting workplaces keeping office spaces at low occupancy – it’s a recipe for uncertainty for CRE investors. The best way to plan for long-term success is to focus on NOI growth now.
CRE property management and streamlining building operations have never been more important. That’s because owners are competing for the best and highest quality tenants. For tenants to even consider leasing office spaces, the building needs to be high-quality and building operations need to be top notch. Tenants will not tolerate any lack of maintenance or upkeep, they’d rather stay home.
That means if you are struggling to increase occupancy levels at your buildings, you still need to maintain your buildings and have a record of it. Unkept buildings will likely cost you more in the end, since you’ll have to spend more to get building operations back up to speed when tenants return. So, the more you invest in efficient practices now, the less it will cost you, helping with your NOI growth.
In fact, a downcycle in occupancy and the market can actually help CRE teams to get building operations in order. When buildings aren’t fully occupied, less tenant requests come through. Now teams can focus on all the work they have been waiting to do while people aren’t in the buildings, instead of working around tenants.
With all this being said, it begs the question, “How do I mitigate the risks created by not knowing when my buildings will get back to full occupancy?”
You still need to ensure your buildings at least hold value. That starts with taking care of your buildings and maintaining equipment. And to attract the best tenants, you’ll need to prove what’s been done in the building. Tenants will want to know how you used the downtime. So, focus on building maintenance as your top opportunity for low occupancy.
How proptech can help with NOI growth
It’s understandable that property owners and operators are not looking to invest more while the commercial real estate industry is so unpredictable. However, the more you invest in efficient practices, the more it will save you in the long run. And software for commercial real estate is a top way to help property teams become more efficient.
With CRE technology, teams are able to fully connect their buildings and collect data to show what spaces are being used, which ones are not, if HVAC systems are running efficiently, and more. This information can bring down costs and increase NOI.
For instance, if your energy expenses continue to increase but your NOI is decreasing, your balance sheet suffers. And the No. 1 culprit of that challenge is HVAC.
Proptech can enable you to know who is in the building and when so you can adjust things like temperature based on building occupancy. For example, you can bring energy costs down with an intelligent HVAC optimization system that monitors your equipment and taps into artificial intelligence to help run your systems. Such a system allows for tighter control of HVAC set points. The result is using only the energy needed in the building based on occupancy. Additionally, when the building is occupied, you’ll get fewer temperature-related complaints, which means less time spent on work orders.
Proptech can also help property teams find new revenue sources. For example, one benefit of implementing a building communications system is that you can communicate with tenants at scale. So, once you’ve done the work to attract the best tenants, it’s time to continuously communicate with them and offer value-added services.
One property team used their building communications system to send out a mass message to tenants offering to clean their phones each night as a value-added service to the regular janitorial tasks. Each phone cleaning would cost 30 cents, and tenants could easily opt into the program via the software. That might not seem like a lot of added revenue, but when you consider this large, Class A building had 5,000 phones in it, that’s a new revenue opportunity of $1,500 a night. Let’s say there’s an average of 20 business days a month. That equals $30,000 in new revenue per month, or $360,000 per year. All because the property team could quickly send out a message to offer a service.
The evolution of the commercial real estate industry
While many things are still left up in the air for the CRE industry, one thing is for sure. CRE teams need to double down and focus their attention on increasing NOI, investing in the right property software, and settling in for what could be a long road ahead.
With Prism, commercial real estate’s most trusted and powerful operations platform, you can deliver the best experience for your tenants while increasing the NOI at your property. To learn more, schedule a personalized discovery session with an expert on our team to see how Prism can streamline all your most critical operational processes.
