Buying income producing apartment buildings is one of the greatest wealth building strategies for real estate investors. Real estate offers investors the ability to acquire ownership with minimal cash down and benefit from the massive leverage effect which increases profits by using OPM (other peopleâ€™s money). Apartment buildings are on the one most viable investment vehicles and should be considered as an effective strategy to build real estate wealth.
In this article, we will discuss several steps included in the process of buying an apartment building. Letâ€™s roll up the sleeves and have some fun!
Step 1 â€“ Master the Basic Formulas
Before you set out to buy your first apartment building, itâ€™s extremely important for you to have a solid understanding of the basic terminology, mathematical formulas, and financing strategies used in the apartment investment industry. Having a firm foundation in place will greatly improve your chances for success. Visit your local book store and browse the real estate section for books on apartment investing.
Step 2 â€“ Locate Multiple Properties
Probably the most challenging task with apartment investing is locating the right property that offers solid financial benefits. These sound investments are sought by many active real estate investors. Assuming youâ€™re a novice investor seeking to buy your first apartment building, itâ€™s wise if you conduct your search within your local community and/or nearby neighborhood. Keeping your search within close proximity of your home base will allow you to monitor your investment more closely. Start the search by browsing the local newspapers under the classified section. This is one of best sources for active apartment listings, but it also captures the most eyes and leads to more competition. Nonetheless, itâ€™s a great start. In addition, search other online ads such as LoopNet.com and cityfeet.com that offer a great selection of apartment buildings for sale. Contact a local real estate broker to assist you with your search. If you decide to go this route, look to work with a well respected and experienced â€œbuyerâ€™sâ€ broker. Moreover, browse through your list of contacts and begin asking friends and family members if they know of any accountants, attorneys, bankers, etc. who may know of local apartment building owners. The goal is to start expanding your network and quickly informing others that youâ€™re actively looking to buy apartment buildings. You will be surprised at just how many contacts this strategy will generate. Post an ad in the local newspapers classified section under titled â€œWanted â€“ Apartment Buildings.â€
Perhaps the best and most profitable search strategy is locating â€œoff-marketâ€ properties owned by motivated sellers. â€œOff Marketâ€ properties are not officially on the market for sale. This strategy is generally implemented by the more experienced investors. It commands the most time, energy and effort, but also is one of the most profitable strategies if executed correctly. The major benefit of this search strategy is that you will be dealing directly with the owner and bypassing the brokerage community which will show the same property to 100 other active investors. Just imagine, 100 investors bidding on the same property that you want to buy! A mass marketed property generates a hyper competitive bidding environment (as it should) which leads to higher offer prices. High prices translate to lower returns because you will be forced to invest much more equity.
Stay focused and work hard and smart at becoming an expert at locating â€œoff-marketâ€ deals because its one of the quickest ways to build real estate wealth.
Step 3 â€“ Conduct a Detailed Market Survey
Now that you have located several apartment buildings for sale, its time to conduct an in-depth market analysis in order to fully understand the market rental rates, occupancy rates and each propertyâ€™s position in the marketplace. The first step will be for you to locate the top 3 to 5 competing apartment properties in the neighborhood that are of similar size (total units) and vintage (year built). Once you have identified the rent comparables, contact each property directly and conduct a market survey. Ask each property the following questions:
ï What is the age of the property?
ï What year was the property built?
ïHow many units does the property contain?
ï What is the current occupancy rate?
ï What has the occupancy rate averaged over the last 12 months?
ï What is the monthly rent for each different floor plan?
ï Are you offering any rental concessions (free rent)?
ï If so, what type of concessions are you offering for each floor?
ï Do the individual units offer full size washer and dryer sets in the unit? Stackable sets? Or, washer and dryer connections?
ï Does the community offer any outdoor amenities? If so, what are they?
Survey the properties, collect the information, enter the data into an excel spreadsheet, and analyze it thoroughly.
Itâ€™s very important that you pay particular attention to the â€œnet effectiveâ€ rents vs. â€œquoted marketâ€ rents. For example, if you survey rental comparable #1 and they quote a market rent of $500 per month for a one-bedroom/one-bathroom floor plan, but they offer a potential resident one-month free on a signed 12-month lease; the real â€œnet effectiveâ€ rent is $458 per month not $500 per month. The formula for determining the net effective rent is as follows: $500 per month divided by a 12 month lease equals $41.67 in discounts per month that the new resident receives over the length of their lease term. Another way to calculate this is to simply take one month free over a 12 month lease as follows (1 month/12 months=8.33%X$500=$458). Basically a tenant will be paying for 11 months but that cost is spread over a 12 month lease term. You got the idea now, right? Excellent!
Complete the net effective rent exercise for each individual floor plan at each property surveyed. This will take a little time getting use to, but as you call more properties and complete more exercises it will become second nature. The most important thing to remember is that you are now performing a more sophisticated level of analysis and this will give you a competitive advantage in the marketplace. It will also greatly benefit you once you start your underwriting process as you will be able to more accurately forecast cash flows and investment returns. The last thing you want to do as a serious investor is to overpay for a property based on inflated numbers.
Study the competitionâ€™s product, site layout, interior and exterior amenity package, asking rental rates, specials/concessions (free rent offered), and net effective rental rates, and occupancy rates in order to â€œfully understandâ€ your subjectâ€™s position in the marketplace.
Step 4 â€“ Analyze Operating Statements
After you have completed your market study, start analyzing the subject propertyâ€™s operating statements and rent rolls. Itâ€™s best if you are able to obtain several years of historical data. This will allow you to properly evaluate the historical financial performance and stability of the income stream you will be buying. If youâ€™re talking directly with an owner of the apartment building, request operating statements in a trailing 12 month (called T-12) format. One of the main benefits of this format is that it provides you with â€œdetailed monthlyâ€ figures so that you can analyze each monthâ€™s operations in further detail.
A T-12 format will also allow you to detect any â€œone-time anomaliesâ€ either in revenue collected or expenses incurred. For example, letâ€™s assume you are analyzing a 30-unit apartment building and the listing broker provided you with a year-to-date (YTD) operating statement ending June 2007 (six months of operating data). Many novice investors would annualize the operating statementâ€™s data and capitalize the net operating income to determine a purchase price. Letâ€™s analyze this scenario one step further. â€œWHAT IFâ€ the other income line item was reported at $20,000? If you were to annualize that amount, you would be valuing the property on the basis that it generates $40,000 per year in other income (cable revenue sharing, late fee, non-sufficient fund fees, month-to-month fees, carport rent, storage rent, etc.).
Now, letâ€™s assume that you requested operating statements in a trailing 12 month format vs. a year-to-date format. Because of the monthly breakdown, you were able to identify that in the month of April, the owner reported revenue of $15,000 which was solely attributed to a â€œone-time eventâ€ for renewing a 10 year cable contract. Itâ€™s very common practice for cable providers to provide apartment landlords an upfront bonus for renewing long term contracts. If an investor were to pay the seller for this $30,000 one-time event revenue stream using an 8.0% cap rate, the implied value would be $375,000. Basically, an investor would have overpaid by $375,000!
Donâ€™t be fooled into believing just because a year-to-date operating statement reports a specific amount of revenue the property actually generates that amount each year. Be certain to request operating statements in a trailing 12 month format so you can easily analyze operations on month-by-month basis. This is an absolute must do!
Smart apartment investing requires patience, thoroughness, and a very detailed oriented mindset when analyzing the rental competition and operating statements. Make it a fundamental rule to ask the important questions and never invest a penny until you fully understand the complete story for each investment under consideration.
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