When Bob Murray joined KSI Management as president roughly one year ago, he had a pretty clear agenda: to grow the company, in part by tapping new sources of revenue.
Ancillary income is a key part of his strategy. “Whether you're managing high-end luxury units or the lowest of the low-income tax credit units, ancillary income is the only remaining uncharted field for additional, needed revenue,” says Murray. KSI is a Centreville, Va.-based company with 10,000 units.
Turns out KSI isn't alone. It's been tough in recent years to charge extra for any additional products or services, let alone raise the rent. In fact, experts say apartment owners have been absorbing additional costs and at times offering incentives to keep occupancies up. But as the nation continues its slow emergence from a less-than-stellar economic cycle, building owners are looking to find new ways to charge their renters for add-on products and services.
“For the past three years the market has been so mushy in almost every area—except South Florida and Southern California—that owners haven't paid much attention to ancillary income,” says Linwood Thompson, managing director of the national multihousing group of the brokerage firm Marcus & Millichap. In certain markets today, however, things are starting to tighten up, and owners will need to start thinking about ancillary sources again, he says.
So regional apartment firms and REITs alike are actively mining relationships with third parties that will provide products and services to residents while boosting multifamily companies' revenues. The spectrum of current and potential partners includes telephone and cable companies, washer and dryer vendors, cell phone companies that need real estate for antennas, and banks that operate automated teller machines.
It's clear that ancillary revenue shouldn't be overlooked. It can translate into higher values for properties that are sold, particularly in strong markets when sellers have the leverage to build ancillary revenue into their asking prices.
“If a market is a little tighter and buyers have to fight against each other, now they'll pay not only for ancillary income, but they will also pay for income they think they can get in the first 12 months of ownership,” says Thompson.
The availability and sophistication of ancillary income sources can directly impact a property's value as reflected in its cap rate, experts say. “If you're buying a 250-unit property that has an old infrastructure based on demand and residents' preferences, you would discount that property” by 25 to 50 basis points on its cap rate, says David Cardwell, vice president of capital markets and technology at the National Multi Housing Council in Washington, D.C.
The good news: Opportunities to develop ancillary income sources through services such as high-speed Internet appear to be on the rise. NMHC, for instance, found a 10 percent to 15 percent penetration rate of high-speed Internet access in suburban garden style apartments in 2000, says Cardwell. Today, based on anecdotal and other analyses, that figure is more in the range of 30 percent to 35 percent. “The revenue stream is increasing as demand for high-speed Internet is increasing,” Cardwell says.
Feel the Power One of the most cutting-edge technologies being targeted as an ancillary revenue stream is powerline broadband or powerline Internet, which uses the electricity infrastructure to provide Internet access. Whatever you call it, the technology's underlying concept is simple: It allows a user to plug a computer into any outlet that's “powerline” enabled to access the Internet.
KSI is strongly considering offering powerline services to tenants this year, says Murray. “The best economic model is to put it in a high-rise because you'd only need to buy and install one ‘box,'” or hardware device, Murray explains, at a cost of $7,000 to $9,000 per device.
Murray contends that once renters become familiar and comfortable with the powerline concept, they'll realize its advantages. While most broadband services cost about $40 per month, Murray says, KSI expects to appeal to renters by undercutting that cost by $5 to $10 per month to offer Internet service to its residents for $30 to $35 monthly. It's a price savings for residents that still turns a profit for the company.
Powerline technology also is significantly less expensive than rewiring a building with the cable required for broadband access and is a viable alternative to wireless. NMHC estimates it can cost $150 to $350 per unit to rewire an existing building, a factor that is causing more companies to look at powerline, says Cardwell.
Ring, Ring If companies such as KSI are able to blaze the trail of developing powerline as a strong revenue source, that may replace the fees from telephone or cable companies for high-speed Internet access. But using the approach that KSI plans, a multifamily company would be able to ensure the revenue stream continues indefinitely, rather than relying on the cable companies to supply those extra dollars.
For those firms that rely on telephone and cable companies in their ancillary income programs, there are encouraging signs: Telecom providers are becoming increasingly receptive—and creative—when it comes to structuring compensation for apartment property owners. “There is a much greater willingness than a few years ago on behalf of telecom providers, particularly the cable companies, to share some a mount of revenue with the owner/manager to assist in marketing their services to residents,” notes Christopher Hanback, partner at Holland & Knight, a Washington, D.C.-based law firm that represents multifamily owners, developers, and managers. “The franchise providers worry that another carrier will get in a building and reduce penetration,” Hanback explains.
Like many apartment firms, AIMCO, a Denver-based REIT with roughly 275,000 units, strikes marketing relationships with telecom providers to market their services. Typically, there is an ongoing revenue-sharing arrangement based on the number of residents that subscribe, explains Don Baumann, a vice president at AIMCO. While some arrangements are flat rate and some are structured with incentives (i.e., higher fees for higher sign-up rates), revenue sharing starts at a low of 6 percent and ranges as high as 12 percent to 14 percent, he adds. AIMCO realized $20 million in ancillary income in 2004, Baumann adds, and expects that figure to grow in 2005.
When it comes to cable companies, there are some similarities in the relationships, Baumann says, though cable providers will sweeten the pot for property owners that invest in the cable infrastructure in their buildings so that the cable companies themselves don't need to incur those costs. In AIMCO's case, however, the company typically looks to the cable companies to shoulder that infrastructure investment.
As the lines between cable and telecom companies increasingly blur, renters are beginning to prefer providers who offer many services—and the appeal of writing just one check for cable, phone, and Internet access. And apartment firms can't overlook that preference. “Single-product providers aren't really producing [revenue] for us,” says Chris Acker, manager of ancillary services at Forest City Residential Management, a Cleveland-based firm with more than 30,000 apartment units. “They want a single provider and a single bill,” Acker says. Ancillary revenue represents slightly more than $1 million per year at Forest City.
Wash and Dry Another tried and true source of revenue is laundry facilities, whether they are in-unit washers and dryers available for monthly rental fees or common-area laundry facilities.
AIMCO, for example, capitalizes on its size and clout to put out “power bids” that bundle 30 or 40 communities together to obtain the most favorable arrangement for laundry facilities in common areas. The cut for building owners can be quite healthy. “Laundry varies from a low of 50 percent to highs of 75 percent to 80 percent” of gross revenue from the machines, which are owned, maintained, and managed by the outside vendor, AIMCO's Baumann explains.
KSI Management currently provides washers and dryers in its top-of-the-line units as part of the monthly rent but will increasingly look to charge for that amenity in other classes of apartments. “In the next two years, we hope to be able to provide rental equipment in every unit that has washer/dryer hookups available,” Murray says, and KSI may charge about $50 per month for the service. That will, however, continue to exclude the company's top-of-the-line units, where the laundry facilities will remain included in the overall package.
Water submetering is another opportunity. Julian LeCraw & Co., an Atlanta-based firm that manages 8,400 units, currently submeters the water at only a fraction of its properties—a statistic it wants to change. One of its 2005 objectives is to get most or all properties set up so tenants will foot the bill for their water usage, says Todd Jackovich, vice president, ancillary service.
The water recovery effort is part of a broader strategy at Julian LeCraw to significantly step up its ancillary income, Jackovich says. “In the last two years, we haven't had anybody focused in this role. That's [why] my position was created, to increase this revenue. Our biggest push is water and sewer billing.”
Similarly, Essex Property Trust, a West Coast REIT with nearly 22,000 units, is looking to what it calls “utility recovery.” The company is looking to recover its costs through one of two methods: submetering for actual water usage or billing based on an allocation method that factors in square footage of units and occupant count, explains Karen Erlandson, the company's ancillary income manager.
Erlandson said a couple of factors drive the need for metering water usage: a broad-based water shortage and a need to manage the behavior of renters. “Conservation is definitely a big part of it,” she says. “I think it's a national crisis—in California for sure—but we're going to run out of water.” Rising costs are also acute, she notes. “It's proven that when renters have to pay for water, they tend to conserve.”
Cell Phones and Cash Of course, there are other money-making ideas, too: reserved parking spots, clubhouse rentals, fitness center fees. But not everything works.
Two sources of ancillary revenue get mixed reviews from multifamily firms: cell phone towers on building rooftops and automated teller machines, or ATMs. While cell phone towers once represented a healthy revenue stream, that has begun to diminish—and will do so even more—amid broad consolidation among the big cell phone services companies. “With some of these mergers, not as many sites are needed when both companies can use the same sites,” says AIMCO's Baumann.
ATMs have been installed on a limited basis on KSI properties and “so far look really good,” says Murray, whose company earns a commission on transactions. Others were less enthusiastic. Forest City's Acker suggested ATMs will fare best in locations that have retail space alongside apartment units.
While there's less than universal agreement on the best potential sources of ancillary income, it's clear the need to develop and deliver new revenue is being felt at the highest levels of the nation's apartment firms.
– Tom Smith is a freelancer in Williamsville, N.Y.