There are endless books, blogs, podcasts, and other media that detail the benefits of investing in apartment buildings. But it would be naïve to think that investing in apartment buildings is a way to “get rich quick,” as some have promised.
In fact, the most successful investors only become so by learning the ins and outs of the industry, including the key issues to look for prior to investing in a specific property.
Here are four critical apartment management issues to watch for when considering an investment opportunity.
Key Considerations Before Investing in Apartment Buildings
1. Unexpected maintenance.
Many apartment investors underestimate the costs of unexpected maintenance at their properties, and as a result, do not keep sufficient reserves on hand for emergency repairs. This can be particularly devastating to first-time investors who may already be stretched thin from covering the costs of closing on the property (e.g., a 20 to 25 percent down payment, closing costs, and more, which can total tens or even hundreds of thousands of dollars).
Apartment investors should have at least three months’ worth of total property costs (principal, interest, taxes, insurance, and routine maintenance) set aside as reserves from which to draw on in the event of unexpected maintenance—like a leaky roof or HVAC system that unexpectedly dies.
It’s also important for apartment investors to build a rolodex of trustworthy contractors that they can rely on with short notice. When a pipe bursts and is flooding your basement in the middle of the night, you don’t want to be, proverbially, flipping through the yellow pages trying to find a contractor.
In fact, having strong relationships with contractors is important for any property investor, as it ensures they get a fair deal for the work and can trust that the work will be done properly the first time around.
2. Renovation work.
Anyone who’s ever watched HGTV knows that renovations rarely go according to plan. Apartment investors should plan for unexpected costs to arise when doing any renovation work. It’s not uncommon to start pulling out walls to find things like asbestos or mold, which will drive costs up.
There are two keys to managing renovation work. First, be sure to conduct proper due diligence before investing in any apartment deal. Have a knowledgeable contractor walk the property with you to identify potential risks. They should also be able to give you a rough estimate as to a realistic renovation budget.
A second way to mitigate unexpected renovation costs is to budget accordingly: at a minimum, set aside 10 percent of your total renovation budget as a contingency fund to cover any surprises.
3. Easy value-add opportunities.
Many investors evaluate properties based upon their value-add potential: Can additional units be added? Could oversized units be converted to smaller units to add to the unit count? Can you charge for parking or build in storage lockers and charge a premium to tenants for this amenity?
But many investors overlook some of the easier value-add opportunities. For instance, there could be a leak in the water system. Go through water bills with a fine-toothed comb and see if there are unusual usage patterns. A small leak could be driving down your bottom line.
Consider a property with a 5 percent cap rate. If you can reduce operating costs and save $5,000 a year as a result, that’s effectively adding $100,000 in value to the property—just by fixing some minor maintenance issues! That’s much more effective than reconfiguring building units.
Another strategy is to implement what’s known as “RUBS,” or ratio utility billing system. This involves separating out utilities and billing the costs back to the individual users. If individually metering each unit isn’t practical, another option is to charge each unit individually as a proportion of the usage. For instance, in a 100-unit apartment building, the owner might charge each unit 1/100 per bedroom.
There are companies that implement RUBS systems for landlords for a fee. Every cost that can be passed back to the tenant ultimately increases the value of your property.
4. Understanding state and local laws.
One common mistake we see is investors who overlook changes in property taxes. Many first-time investors and real estate developers run their numbers on a deal using the current property taxes. Many forget that taxes change after the property is sold.
Most municipalities will re-asses the property upon sale, and in many cases, the property taxes go up as a result. It is surprising how few people fully understand how taxes are levied on a property.
Taxes can be one of the biggest line item costs in a pro forma—underestimating the costs can be disastrous from an investment perspective. Whereas you can pay down a mortgage, property taxes are a cost that never goes away.
While apartment investing can be highly lucrative, it’s an asset class that’s far from foolproof. For those just getting started, consider partnering with someone who’s more experienced and can guide you through apartment management issues such as these.
Do you have questions about investing in apartments? Or do you have additional advice for anyone who’s thinking of doing so?
Let’s discuss in the comment section below.