Investing, in my opinion, should be treated like a business.
It requires a product which produces an income or cash flow larger then the expenditures necessary to sell the product. Therefore, it should produce a profit for the manager or business owner.

Unfortunately, many investors are actually not investors at all in the business sense of the word. They are in fact speculators. Most people who own stocks are in fact speculators and not investors, according to my definition. These stockholders are speculators because their holdings don’t produce an income that exceeds their expenditures. Expenditures for stock holders include the erosive effects of inflation on the true value of securities and the cost of holding the stocks or commissions and management fees. These stockholders are speculating that the price of the stocks in their portfolios will rise over time and they will cash out their winnings. Meanwhile, the stock price could down or the company could go out of business and they could lose all of their invested capital. It has always been interesting to me that most people who buy stocks actually consider themselves investors when they are really speculating.

Analysis. What Analysis?

Many of the people who have an interest in apartment building investments are somewhat fearful of actually buying one because they don’t know how to evaluate them properly. On the other hand there are other investors, who also lack the necessary knowledge to truly evaluate the investment potential of an apartment building but they have no fear at all. This second group jumps right in and begins to make offers on properties just based on the recommendations of a realtor or even a friend who is equally inexperienced. Warren Buffet once said that “risk comes from not knowing what you’re doing.” In my opinion this sums up the true risks inherent with an apartment building investment. For this reason, all new apartment building investors should carefully study how to evaluate whether an apartment building will really be a profitable investment.

How to Learn Apartment Building Investing

The way to get the proper education is simply to read as many books as possible about the subject and learn how to analyze the rent rolls, the income and expense reports and the commercial appraisals when available. The new investor can also contact experts in the industry such as commercial mortgage brokers, commercial realtors and commercial appraisers. This is truly the “edge” that apartment building investors have over stock investors and even residential real estate investors. With apartment building investments you have access to the blue print for the business. It is just your job to properly understand what it is saying. The answers are in the details.

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Tags: apartment building investments, apartment investing, buying apartments

Let’s take a look at some of the actual returns for a small apartment building investment over a period of five years. Whenever you are making projections into the future concerning investment returns it is always necessary to make some assumptions. In this case we will keep our assumptions very conservative and well in line with historical averages.

Also, I will be using as an example an eight unit apartment building with a purchase price of $300,000.00. I want to use a smaller property with smaller numbers because I believe that just about anyone, who properly prepares him or her self with the proper education and preparation beforehand can realistically purchase, manage and profit from an apartment building this size. There are many methods for securing the money for a down payment that I discuss in my course but I don’t have the time right now to list and explain them all.

The purchase price for our eight unit apartment building is $300,000.00. We are using a bank loan for 75% of the purchase price and we are making a down payment in the amount of $75,000.00. The Net Operating Income of the building is $27,750.00. Our annual mortgage payment on the property is $19,952.76 based on our 25 year bank loan with a fixed interest rate of 7.5%. After paying our mortgage payment the building’s cash flow is $7,798.00. This cash flow gives us a cash-on-cash return of 10.4%. (the cash flow of $7,798.00 divided by the down payment of $75,000.00.)

Let’s take a look at what happens to your returns after five years. We will assume that the building’s income has grown by 3% a year. We will also assume that the expenses have increased 3%. The fixed rate mortgage payment remains the same for the life of the loan.

The Net Operating Income has increased from $27,750.00 to $32,169.86.

The new Cash Flow for year five is:

The new Net Operating Income of $32,169.86

-

The mortgage payment of $19,952.76

_______________________________________

= $12.244.00 Cash Flow at Year Five

The cash-on-cash return has increased from 10.4% in the first year to 16.3% in the fifth year.

In the mean time the actual value of the building has increased by 3% each year to $347,782.00. And increase of $47,782.00 after five years

In addition, the mortgage balance has amortized. The principle amount of the 25 year fixed rate loan has decreased by $20,106.76. The remaining loan balance is now $204,893.24.00.

Putting aside the income returns seen from the Cash Flow every month for 60 months and just looking at the appreciation and loan amortization you have a total return of $47,782.00 + $20,106.76 or $67,888.76. That is a whopping 90.5% cash-on-cash return for a period of five years.

These kinds of returns for many investors who are stuck in the stock market might seem too good to be true. But, remember that we only used one real assumption and that was a growth rate of 3% which is well within historical average norms.

Tags: apartment building investing, apartment building investments, apartment building investor, apartment investing, apartment investment returns

It is no secret that inflation has reared its ugly head in the US and around the world. And it is easy to see its effects whenever you go to the gas station to fill up your car or to the grocery store to buy a loaf of bread. You can read the statistics: gas prices are above $4.00 while corn and wheat prices are touching record high in the futures markets. However, for the individual investor it can be difficult to gauge the devastating impact of inflation on his or her investment portfolio.

Most investors have the bulk of their money invested in paper assets such as stocks, bonds and mutual funds. Paper assets as opposed to hard assets like gold or real estate usually fair the worst during inflationary periods. The reason for this is because while goods and services are rising in price there is a simultaneous drop in the value of the US Dollar and the price of securities or common stocks.

Public companies tend to trim operations during inflationary and recessionary economies because they find it difficult to pass on higher production costs to consumers who are spending less. This usually means that stock prices decline along with corporate growth. This is especially dire for the individual investor’s stock portfolio because as the price of stocks decline so does the value of his or her portfolio. This situation is only exacerbated by the fact that while stock prices are dropping there is also a decline in the value of the US Dollar. The overall value of an investment portfolio is eroded by two factors, the falling currency value and the falling stock values.

Many savvy investors, during inflationary periods, chose to invest their capital in hard assets like commercial real estate to counteract and hedge against the forces of inflation. A commercial real estate investment such as the purchase of an apartment building offers distinct advantages over paper assets.

The apartment building investor is directly benefiting from inflation because as prices for goods and services rise, so do rents. The most popular method for the valuation of an apartment building investment involves calculating the building’s Net Operating Income. Rising rents and net operating incomes can increase the overall value of an apartment building investment. In addition to increasing the market value of the apartment building rising rents can also help to defer the increasing operating costs.

The US dollar can be viewed as any other commodity such as wheat or soybeans because its value is primarily driven by supply and demand. Banks and lending institutions have cut back their lending on most residential and some high risk commercial construction projects around the country. Therefore money supply for new apartment building construction projects is very difficult to obtain. Also, there are fewer commercial construction companies willing to risk the development of a new apartment building complex while the costs of raw materials are rising. What this means for the apartment building owner is that there will be fewer vacancies on the rental market and a tightening supply situation in many metropolitan markets. The tightening supply of new apartment units combined with an inflationary economy should continue to cause rent prices to rise.

The demand for rental housing in most metropolitan markets around the country is forecast to increase in the next five years. The new demand for rental housing is being driven by two major factors. The first factor effecting apartment unit demand is the rise of residential real estate foreclosure rates around the country. Many thousands of homeowners have been forced to vacate their homes due to an inability to pay their mortgages and subsequent bank foreclosure. In addition, many first time home buyers are finding it impossible to qualify for a mortgage to purchase a new home because banks have tightened their underwriting guidelines for new home loans. Home buyers with no or poor credit are finding it especially difficult to find loans because there is no demand in the secondary market for packages of sub prime mortgages. All of the above mentioned people are going to need a place to live and most likely they will be looking for an apartment. These new additions to the rental market should help to buoy demand for rental units all over the United States.

Simple economics dictate that as the supply of rental units remains steady and demand is increasing then the price or rents for those should increase as well. In my opinion many real estate analysts are underestimating the potential demand for rental units and therefore I believe that sale prices for apartment building should rise well above most people’s expectations.

Tags: apartment building investing, apartment building investments, apartment buildings, buy an apartment building, buying apartments, inflation, landlord, rent, rent inflation

As a commercial finance consultant I speak with new apartment building investors on a daily basis whom respond to one of my fliers or visit my website. Typically, here is how the conversation unfolds:

Investor: Hello Ted, my name is “first time apartment building investor” and I am calling because I was visiting your website and was interested in the loan program you are offering for multi-family properties.

Me: Great, tell me about the apartment building you are purchasing.

Investor: Well, I found this great 38 unit apartment building in Austin, Texas. My realtor told me that the gross income from the property is around $500,000.00 and the taxes are about $15,000.00. The asking price is $5,000,000.00. I am willing to put down 20% of my own money and I need a loan right away because the realtor said there are other serious buyers looking at the property. What do I need to get a loan on this building?

Me: Have you figured out what the DSCR for the property?

Investor: The what?

Me: The Debt Service Coverage Ratio is the number that banks look at to determine if the apartment building will pay for the property’s annual expenses and mortgage payments. DSCR is figured by dividing the (NOI) by the annual debt service of the property.

This is where I gently advise my potential client to perform more due diligence on the property by obtaining the income and expenses on the property for the past few years so that we can determine exactly what the net operating income is.

Here are how the property financials break down:

Gross Rents $500,000

Annual Gross Revenue $500,000

Minus 5% Vacancy Rate $25,000

Actual Gross Income $475,000

Real Estate Taxes $7,500

Insurance $2,500

Maintenance $2,500

Exterminator Service $2,500

Up Keep $2,500

Utilities $2,500

Off Site Management Fee 5% $25,000

Replacement Reserves

$200 Per Unit X 38 Units $7,500

Total Expenses For Operation $52,500

(NOI) Net Operating Income $422,500.00

The net income on this property includes all of the property expenses except for the monthly mortgage payments or “debt service”. The “debt service” is simply the principal and interest payment on the mortgage paid over a one year period of time.

Loan Amount: $4,000,000

Interest Rate: 7%

30 Year Term

Debt Service = $319,345.20

To figure out the DSCR, divide the NOI ($422,500.00) by the Debt Service ($319,345.20).

NOI $422,500.00/ Debt Service $319,345.20 = DSCR of 1.32

With a 20% buyer down payment this building has a DSCR of 1.32. This basically means that the building’s income will cover all of its expenses including the loan payments and show a profit. Banks are eager to lend money on a property like this. A DSCR number of 1.0 would indicate that the building is breaking even and a DSCR lower than 1.0 means that the building is losing money. Commercial lenders require that an apartment building have a DSCR of 1.2 or higher.

Armed with this information, the diligent investor is one step ahead of the herd. Preparing an accurate loan package is an essential ingredient to your success as an apartment building investor and calculating the DSCR early on in the process will save you a lot of time and headaches.

Debt consolidation loans available from The Debt Line

Tags: apartment building investments, apartment loans, Commercial Real Estate, debt service, DSCR, multi-family debt service, real estate