thinking about these things as investments, not expenses, and proposing them to the owner in that way.
RETURN ON INVESTMENT (ROI)
Sticking with our HVAC repair-or-replace decision, let us
consider the next type of investment analysis, Return on Investment (ROI). This is a cousin of the payback period. ROI is
a measure of the return on the original investment, expressed
as a percentage.
HERE’S THE FORMULA:
Here, we would take the total revenue (savings in our case), subtract the initial cost and divide by that initial cost factor. We
said that the savings were projected to be $700 per year. Let’s
say that over the projected useful life of the new unit ( 15 years),
we will save approximately $10,500.
USING OUR COST OF $8,500, WE END UP
This investment would produce an ROI of 23. 53 percent on our
initial investment. Now how does that stack up against the repair decision in which there is no return on investment? In fairness, the owner would have to hold the property for all 15 years
to realize the full return on his investment. And the unit would
have to work well for the entire 15 years without having to put
a lot of money into it (normal maintenance). But all investment
decisions are made on a set of reasonable projections.
ROI (and again, you should know that) and propose these types
of projects as “investments” rather than “expenses,” you will get
a better outcome, I guarantee.
The last type of investment analysis that we will discuss is the
cap rate. This is an abbreviation of the term capitalization rate,
to this as cap rate analysis.
The cap rate is the ratio of net operating income (NOI) to the
value of an asset. Most owners use cap rates to compare two or
more proposed investments. The one with the higher cap rate
is the one that provides the investor with the higher potential
return (all else being equal).
In our case, it is the ratio of the projected savings from the
previous assumptions about the savings per year ($700) and
the cost ($8,500) of our proposed investment, THE CAP RATE
ANALYSIS IS AS FOLLOWS:
If the owner or owner’s asset manager considers any investment
that has a cap rate of 8 percent or higher to be favorable, then
yes,;this;would;pass;that;test.;You;need;to;find;out;what;the;min-imum cap rate threshold for this owner is before presenting this
investment for consideration.
USE THE LANGUAGE OF FINANCE
methods of investment analysis presented here are new. For others, the terms are familiar but they have not used these types of
analyses when seeking the property owner’s approval for such
For CPMs and CPM Candidates who have taken IREM’s
course, Budgeting, Cash Flow and Reporting For Investment Real Estate
(FIN402), these terms, concepts and methods are familiar and
applicable ways of presenting proposed projects.
For property managers with ambitions to move into an asset
management role in the future, understanding and using these
concepts is a must. In such a role, you will be analyzing and
and more complex analytical tools on a regular basis. And then
you will welcome this kind of perspective coming from those
not just collecting rents and cleaning buildings (a very unfortunate but all too common perception of what we do).
The next time you need to get the owner’s approval for a large
projected repair or replacement project, think about it in terms
of an “investment,” not an expense. Consider not only the immediate cost of the proposed investment but the cost over the
projected life of the item (known as life cycle costing) and the
return on investment from savings over time.
Jeff Lapin, CPM ( firstname.lastname@example.org)
is vice president of property management at
Coastal Partners, LLC, AMO, in Rocklin, Calif.
ROI = TOTAL REVENUE – TOTAL COST OTAL COST x 100
ROI = $10,500 - $8,500 $8,500 x 100
$700 / $8,500 = 8.24 Cap Rate =