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5 Reasons Why Bigger is Better with Apartment Building Investing

by Michael Blank on March 17, 2014 · 15 comments

  
Bigger is Better with Apartment Building

When I bought my 12-unit apartment building in Washington DC I was overwhelmed by its size and complexity. Sure, I had flipped about 30 houses and analyzed about a hundred apartment deals in Texas several years before, so I wasn’t a complete newbie, but having a building like this actually under contract was quite a different thing entirely.

Interestingly, three weeks into due diligence, my comfort level not only expanded but I began to wish that the building was bigger. As I was going down my due diligence check list, I realized that a 12 unit was about as much work as a building twice its size.

Related: How I Bought a 12-Unit Apartment Building with No Money Down (And How it Nearly Bankrupted Me…)

Here are 5 reasons why bigger is, indeed, better when it comes to apartment building investing

Reason # 1: A Much Better Buying Experience

With my 12-unit, I was dealing with an emotional seller who managed the building herself and kept utterly incomplete records. She had hired a residential real estate agent who was completely overwhelmed with the sales process of a commercial real estate building. As a result, the entire experience was stressful, the deal nearly fell apart, and it took 4 months to close.

Contrast this with the experience involving the purchase of a 44-unit building, for example. The larger the building, the more professional everyone tends to be. The commercial real estate brokers guide everyone through the entire process. The property is managed by a professional property management company that produces financial reports that are readily available, extensive, and detailed. The seller tends to be less emotional and actually make business decisions you can relate to.

Reason # 2: Economies of Scale.

The larger the building, the less stuff costs on a per unit basis. For example, the property management fee for my 12-unit is 8% but for a 44 unit, that same fee may very well be 5%. Other expenses, like trash or insurance start to decrease as a percentage of income the larger the building. In other words, the larger the building, the lower you can get your expenses.

Reason # 3: Less closing costs

And speaking of expenses, for my dinky 12 unit, my closing costs were 8.5% of the purchase price! That’s because a lot of the closing costs are almost like fixed costs. For example, the loan doc prep costs are normally about the same (or differ only slightly) based on the purchase price. Your appraisal will cost at least $2,500, even for a small building, but will only go up slightly for a much larger building. Your SEC attorney will normally charge you the same for preparing legal documents for a $500,000 building or a $2M building. For a much larger building (say, around $2M), the estimated closing costs are about 4.5% all in. It’s like shopping on black Friday: the more you spend, the more you save!

Reason # 4: Better financing

Loans under $1M are harder to get, have higher interest rates, and almost always require a personal guarantee. On the other hand, loans above $2M are much easier to get, have a lower interest rate, and are often non-recourse for stabilized assets, which means you don’t need to personally guarantee them. That alone is enough incentive for me to go after bigger deals!

Related: How to Get Apartment Building Financing Even if You Don’t Qualify

Reason # 5: Bigger Pockets, I mean Profits -;)

And finally, the bigger the building, the bigger the numbers become. Do I want $1,000 of cash flow per month or $10,000? Wouldn’t I be able to achieve my financial goals faster if I did bigger deals?

If my goal is to get to 100 units (or whatever), wouldn’t it be better to do one or two bigger deals than ten smaller ones?

The answer is of course, “YES!” but, there is one HUGE challenge you need to overcome first:

Getting Over Your Biggest Obstacle: Yourself

Will I have to work a little harder to do a bigger deal? Well, maybe a little. I may have to work hard for longer until I get that bigger deal. But I can tell you you’re going to work ten times harder if you go after 10 smaller deals.

The other obstacle I constantly have to get over is my own mind. Certainly I’m comfortable now with a 12-unit and also with the idea of a 24-unit. But what about a 75 unit? I’m constantly striving to expand my own comfort zone by analyzing and looking at larger deals and visualizing myself closing such a deal.

Raising More Money

Then there’s the issue of money, or the lack of it. For bigger deals you will need more money, possibly more money than you have yourself.

The answer, of course, is to raise money from private individuals, and I’ve been writing about this extensively on the Bigger Pockets and also on my own blog. Once you arm yourself with a little bit of knowledge and confidence, there is no reason why EVERYONE shouldn’t be able to raise money to do bigger deals.

Bigger is most certainly better with regards to investing in apartment buildings. Let this sink in and then transform your buy and hold investing strategy. Skip the single family rentals and duplexes and imagine instead a much bigger building. Then go for it.

What do you think about the idea that “bigger is better” and what have your successes and struggles been in this regard?

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{ 15 comments… read them below or add one }

Michael mcewen March 17, 2014 at 8:32 am

Geez I wish I lived in the US. Australia = 4% yield, and way over priced.

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Michael Blank March 17, 2014 at 9:00 am

Michael – I wished I lived in Australia right now … warmer (today is the 3rd snow storm this winter which is highly unusual in Northern Virginia ! -;)

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Michael mcewen March 20, 2014 at 8:00 pm

I guess that’s a point to consider lol.

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Sharon Tzib March 17, 2014 at 9:23 am

I definitely agree with you that bigger is better, however, you’re right, getting the money and the experience is the challenge. Most investors will not fund a deal with a novice apartment syndicator. I think one or two smaller apartment deals actually serves a great purpose – kind of on the job training – to be able to move into something bigger and then have the experience those investors want to see so you can ramp up more quickly. Great food for thought.

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Michael Blank March 17, 2014 at 9:33 am

Sharon – you’re right that track record matters, especially as the asset gets bigger. What I’m arguing is that people should re-consider their stepping stones, i.e. it may not be necessary to have a bunch of single family house or duplex rentals — go right for that 10+ unit building. I’ve found it interesting that no one in the apartment building investing world cared that I flipped 30 houses and owned restaurants. So why distract yourself with house rentals or duplexes?

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Sharon Tzib March 17, 2014 at 9:36 am

I hear ya, MIchael, and I think you make some great points :)

Thanks!

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LC Chase March 17, 2014 at 12:09 pm

Great advice Mike. A track record will help but as I have acquired larger and larger assets, no one cared about much other that THIS INVESTMENT we are discussing. What is can do for them, what money they can make and what is the risk.

Keep up the great postings!

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Adrian Tilley March 17, 2014 at 9:54 am

Michael,
At what point do you think it’s worth the trouble to syndicate and involve an SEC lawyer? It seems like a 12 unit might not justify it. Or is there another reason for that person?

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Michael Blank March 17, 2014 at 10:51 am

An excellent question Adrian. In fact, I got the same question like three times this week, so it looks like that’s a good reason to write my next post on this subject! Paying the legal fees for a private placement memorandum essentially protects you if a deal goes bad. The short answer is, a lot depends on your risk tolerance which is related to the size of the deal and the make-up of your investors.

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Adrian Tilley March 17, 2014 at 11:09 am

I’d love to see the article. Please discuss which risks are mitigated and how those risks are mitigated.

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Michael March 17, 2014 at 11:47 am

I do believe that bigger IS better. Its the same paperwork and bureaucracy for as big a return as you would want it to be.

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Michael Blank March 17, 2014 at 12:37 pm

Yup

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Leonid March 17, 2014 at 2:24 pm

Great discussion,
These are the questions I had on my mind.
I do have experience with 25 units that are dispersed in 3 to 5 unit properties .. and am wondering if 25 units apt building will reduce the management demands or reduce em.

I am also thinking that common sense logic of soft entry into the apartment building space, maybe common .. but not the best .. especially if its out of town management situation.

30 units building is a small portion of any management co. income .. and one has to rely on such mgmt. co for everything .. there is not enough of economy of scale to hire a couple, he is a handyman, she is a gatekeeper to manage vacancies and tenants interaction.

In this setup you have 2 people who ‘s most likely 100% of the income and a free or bargain basement apt rent depends on success of your property operation .. call me selfish, and thirsty for attention :-) .. but I take this any time of the day vs. PM co, were you are 3% of their income.

The question is what is the minimum number of units to reach that kind of level .. and is it wise to ump from 25 dispersed units to a 100 in one building?

.. Any thoughts?

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Jonathan Twombly March 20, 2014 at 9:22 am

Michael, that was a great post, and I agree with all that you wrote. I think it’s also appropriate to point out that there is a great economy of scale to be had in terms of your own efforts. If you’re dealing with banks and dealing with investors anyway, then it is much more time-efficient for you to buy as large a property as you can handle financially and psychologically. In other words, in terms of time and headache, the investment is the same whether you are buying 12 units or 44 units. And the bigger you get, the more bang you get for everything you discussed, whether it’s management fees, purchasing power for supplies, or amortizing the cost of your legal fees. The only expense that I can see that is great is due diligence — it will just take you (or someone you hire) longer to do the lease audit, walk-through, and building inspection if the property is bigger. But these are small pieces of your overall cost, so they should not discourage you from taking on bigger projects. In fact, now that I am doing 100-unit deals, I am looking forward anxiously to the day when I can put together the capital to do 200-unit deals, for just this reason.

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Shaun March 25, 2014 at 7:31 am

Great article showing these benefits.
Big buildings are intimidating for people because they are, well BIG!
Most people can wrap their heads around singles and small multi families. Once you start talking 10, 30, 75, 100+ units people have to adjust their mindset and push past that hurdle, which do point out well.
My guess is to why there is little weight given to someone getting into apartments after doing well in small residential is that not many make the jump. I’ll guess that the majority that get into that space and have success stay in that basic business and continue that success.
Not right or wrong since everyone is different but my hypothesis as why it is not at all a natural stepping stone.

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