Increasing owner value in real estate investments requires consideration and understanding of various factors related to the investment. Premico’s Finance Manager Rami Sinnelä delves into this complexity in his blog.
“A cynic is a man who knows the price of everything, and the value of nothing.” – Oscar Wilde
Before discussing how to increase owner value, it’s important to define what owner value means in the context of real estate investment and how it is generated. Real estate valuation can be approached through the income method, where the market value of a property is determined by calculating the present value of its cash flows and residual value. Owner value is generated when the invested capital yields more than its required return. The required return can be an alternative risk-free rate, such as government bonds, plus a risk premium, which typically increases based on the perceived riskiness of the investment.
According to these principles, owner value in real estate investment is created when the sum of the property’s cash flows and residual value exceeds the total returns of a so-called risk-free investment. Cash flows refer to rental income from the property minus operating expenses, while the residual value is the expected selling price of the property at the end of the investment period. Rental income is influenced by the rental level, and income is only generated from leased spaces. Incorrectly set rental levels can lead to prolonged vacancies, resulting in no positive cash flow. Conversely, a too low rental level translates to lower owner value. Determining the rental level and leasing the property require knowledge of the area and the market, as well as physically presenting the property to potential tenants. It’s crucial to choose the right tenants, and once a good tenant is selected, maintaining the lease relationship during the rental period is essential.
Operating expenses and repair investments are crucial in shaping cash flow
Operating expenses are another variable in cash flow formation. Property maintenance is not free and requires management. There are several service providers to choose from, and it’s essential to select a good one while keeping the cost reasonable. Cutting corners in property management can affect its condition, which in turn lowers rental levels. Also, if property management is neglected, the residual value is low. Therefore, technical maintenance of the property must be managed professionally.
Repair investments also affect the residual value of the property. What is the technical lifespan of the sewage system? Should the pipes be completely replaced or can they be relined? Over-repairing is not advisable as it eats into cash flow, so technical knowledge in planning repairs is beneficial. When implementing larger projects, experience in construction management helps to keep the project on schedule, within budget, and achieving the desired outcome.
Understanding property types and the impact of energy efficiency on increasing owner value
Real estate investment involves capital commitment to the property, but real estate investment classes differ. Hotel and residential properties are completely different types and operate on different principles. Especially hotel construction requires special expertise. Once the real estate investment class is chosen, the location of the property should be considered, as well as whether to build new or acquire an existing property. In the case of an existing property, increasing owner value can be pursued through renovation, refurbishment, or possibly changing the intended use.
Whether building new or renovating old, promoting energy efficiency reduces carbon dioxide emissions, reduces energy consumption, produces cost savings, and positively impacts owner value. EU energy and climate policy aims to reduce energy consumption, so in addition to lower operating costs, the residual value of the property in an energy-efficient property is expected to be better due to increasing political regulation. In addition to the economic aspect, improving energy efficiency contributes to the UN’s sustainable development goals, making it an investment in the future.
The importance of expertise in increasing owner value
The quote at the beginning of the article refers to the idea that something may have more value than its cost. It may be that Wilde did not refer to real estate investment, but the same idea can be applied to owner value. The management of a property by professionals or a construction project guided by experts ultimately reflects on the property’s cash flows and residual value, so it is wise to have an experienced partner in these matters. At Premico, we understand the entire life cycle of a property, and our services range from real estate investment to construction and rental housing. We develop, renew, and build a better life for people and the environment. And we create owner value.
Rami Sinnelä
Finance Manager, Premico
+358405963969
rami.sinnela@premico.fi