You're about to discover what most people will never know about how to invest in apartments...successfully. The vast majority of advice on apartment investing is wrong! You'll learn the right way to invest in apartments here:
6 Steps to Regret
Most google searches for how to invest in apartments will lead you to blogs and videos with these 6 basics steps:
- Find a good property
- Get it under contract
- Do your inspections
- Get bank financing
- Hire a local and good property manager
- Close the deal
These six steps seem reasonable, but they are wrong. They are missing a key component. By following these steps you will overpay for the property, have limited cash flow, and if you try to resell the property you will lose money. All this equals regret.
4 Types of Apartment Investors
Apartment investors fall into at least one of these four categories. And knowing which category you are in is important because each one requires a different skill set. If you just follow a generic script, you won’t be successful because each type of investor requires a different strategy.
- Builder: The builder purchases an apartment building, renovates, and then stabilizes the property. After the property is stabilized, the Builder seasons the net operating income. This will be nine to twelve months of great cash flow, showing a lender that the higher NOI now equates to increased property value. The next move is to refinance, doing a cash out refi, pulling out the down payment and then repeating the process. The Builder is keeping the property and using the equity to buy another property, building up their portfolio. Discover more about the Builder investor in this video: Passive Income for Busy Professionals
- Holder: The Holder buys an apartment, upgrades and renovates to stabilize the asset, and then instead of seasoning the NOI, holds the property for long term cash flow. Learn more about the Holder investor here: Why Invest in Apartments Over Single Family Rentals
- Exchanger: The Exchanger purchases, renovates and stabilizes the apartment, increasing the cash flow and property value, and then sells the property to do a 1031 Exchange. A 1031 Exchange allows you to defer all the capital gains from the sale of a property if you buy an equal or larger property. You can roll the cash over to a larger and larger property. Learn, step by step, with a case study, how to do a 1031 Tax Deferred Exchange: 1031 Exchange Case Study
- Syndicator: The Syndicator purchases their apartment with investors. They renovate and stabilize the property and season the NOI to force the appreciation. However they exit the property by selling it, paying back the investors a healthy return, and then repeat the process. Get the basics on Syndication here: Basics of Real Estate Syndication and a real world example of a syndicated deal in my video Beginner Buys $5M 66-Unit Apartment Deal.
How to Invest in Apartments Successfully
The missing key component to the basic steps is knowing how to evaluate a deal and calculate the numbers. This is the key to investing in apartments successfully. Using an example deal of a 24 unit apartment in the Midwest, I will demonstrate how the typical seller or agent would present a deal. Then using the same example, I will show you how we at Commercial Property Advisors evaluate the same deal.
24 Unit Apartment Deal – Seller/Agent Calculations
Income: $230,400/year (each unit renting for $800/month x 24 units x 12 months)
Expenses: $69,120 – Sellers and agents generally set expenses as 30% of the total income
NOI: $161,280 – To calculate the NOI subtract expenses from the income
Market Cap Rate: 6% - Divide the market cap rate into your NOI to get the property value. $161,280 divided by 6%.
Property Value: $2,688,000
This is how a seller/agent will determine the list price for the apartment and they will list it for $2.688 million.
24 Unit Apartment Deal – CPA Calculations
This is how we teach our students to evaluated a deal to ensure that they don't overpay and purchase commercial properties that cash flow. Here are our calculations for the same property.
Income: $218,880 - Our projected income is lower than what the seller is proposing because they haven’t accounted for vacancies. All 24 units will not be occupied 100% of the time. To calculate for potential vacancies take off 5% from $230,000, which drops the income to $218,880.
Expenses: $96,000 - Our expenses are higher. The seller or the agent will say expenses are 30%. However, we know from owning properties all over the country for the last twenty years that property expenses are much higher. Expenses for this apartment will be about $4,000 per unit, multiplied by 24 is $96,000 for the year.
NOI: $122,880 - The increase in expenses drops the NOI to $122,880. You can see the difference the numbers make in the NOI and subsequently in cash flow.
Market Cap Rate: 6% - $122,880 divided by 6%,
Property Value: $2,000,048 - There is a $600,000 difference between the sellers evaluation of the deal and our evaluation. If an investor believed the sellers numbers, they would overpay by a half a million dollars. Do you see why you can't follow the generic script? You must follow wisdom and experience. This property is worth $2,048,000, not $2,688,00.
Proforma (Projected Performance)
Another consideration when evaluating a deal is the proforma, or what the property could do in terms of rents based upon your research. Sometimes the brochure or a seller will tell you how well the property performs. Don't believe them. Do your own research and find out what it can do. We teach our Protégé Students how to get this data. This is important because we base our offer and pursue a deal not only on the current numbers but also on how well the property can perform in the future. Here’s an example Proforma using the same 24 unit apartment, based on our calculations, not the sellers.
The seller hasn’t raised the rents in five years. Remember the rents are currently $800 a month. After doing renovations and based on our research in this area, we can raise the rents on all 24 units $150. $950 x 24 units minus 5% vacancy is $259,920.
Projected Income: $259,920
Projected NOI: $163,920.
Cap Rate: 6%
Projected Property Value: $2,732,000
If you spend a couple years working to increase the rents, you can increase the property value to 2.732 million. But if you bought it for $2.688 million, all that work was for what? You overpaid. You can see now that knowing how to evaluate a deal correctly is key and this process comes from experience.
Another way to look at the three apartment examples is as the past, present, and future. The seller's calculations are the past, or what they have reported in the last 12 months in terms of income and expenses. Our evaluation of the property is the present. How the property will perform based on 20 years of Commercial Property Advisors experience. If you want to invest in apartments successfully, this is what to base your offer on.
The Proforma is the future and again, you base your proforma on our evaluation of the property, not the sellers. Every commercial property needs to have a future and this is our bread and butter. Our business model is to buy a property, fix it up, stabilize it, season the NOI, make it worth a lot more money, and then do a cash out refi or purchase something larger. This strategy is only possible if you know what the future looks like.
3 Tips to Invest in Apartments Successfully
- Verify the Past, Present and the Future: Do not rely on the agent or seller to verify the numbers. You need to verify the numbers. It's a skill you need to have. And if you can't calculate the past, present, and future, don't do the deal. It is as simple as that. Remember, you will overpay for the property, have limited cash flow, and if you try to resell the property you will lose money. All this equals regret.
- Have a Goal: If you want to invest in the apartments successfully, your first goal is to buy a property that's priced under market. That takes skill and it’s what we teach our students to do. Your second goal is to buy a property with rent upside potential. If you raise the rents, you can force your appreciation and that opens up a lot of options for you. Your third goal is to be in a good neighborhood. You know the saying, “you can fix a property, but you can't fix a location”. So those are the three goals: priced under market, the ability to raise the rents and a good location.
- Know Who You Are: You need to know what type of an apartment investor you are. Are you going to be the Builder, or the Holder? Or are you going to be the Exchanger or the Syndicate? Know who you are and master the skills and strategies you need to be successful.
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