Pricing land for development can be a daunting task for the untrained investor. As a niche subset of both residential and commercial real estate, using comparables for land can be as dangerous to a developer as it is mysterious, sometimes causing the failure of what was certain to be a fantastic development. However, for the savvy investor, there is one universally accepted land valuation method used by development professionals, corporations, and appraisers alike; the Land Residual Method. By using this method you will be able to determine the current and future value of any piece of land, whether its use be residential or commercial. You will also be able to price land, such that any development you propose will have built in profit. With some practice, you will be able to employ the land residual method in just a few moments, summing up the value of almost any property just on sight. The land residual method has a fancy sounding name, but to use it all you need is an understanding of some simple math. The land residual method is a calculation that takes the highest and best use of a particular piece of property and subtracts out the total cost of development to arrive at the residual value: the land value. Once you have the numbers it’s that easy. “How do you get the numbers?” You ask. It takes some research, but even a novice investor can figure it out relatively quickly. For the sake of this article I’ll be speaking to residential single family development or single family lot land. Rest assured, commercial development uses the same principles, though the calculations are a little more in depth. Use and Utility You’ve heard the term “Location, Location, Location” thrown around in many real estate circles.  It is never more true than when developing land.  While I don’t recommend using any type of comparables for valuing land, it’s generally accepted that land near the ocean, or any other high priced corridor, has a higher intrinsic value that land based further away from a hub or commercial center.  It boils down to use and utility.  For instance, a 100 unit office building in downtown Seattle will probably be worth more than the same building in rural Arkansas.  Generally speaking, the land those properties sit on will be valued accordingly.  It’s one thing to accept that, but another to understand why. Property value is determined by its highest and best use. A piece of property that can be developed into a regional shopping mall will be more valuable than a property that can only be developed into a single family home. This is because the end use of the former has a much higher finished value than the latter. The value of the materials are more and the expected income from renting or owning the first is significantly more valuable than the second. It all comes down to profit and a return on investment. Generally speaking there is more profit to be made in larger commercial buildings than a single family home. However, the commercial property takes significantly more risk and money to develop. Hence, the larger land value. The first part of the land residual method is to estimate the final or future value of the proposed property.  This can be done by several approaches.  In the case of a single family home development it can be quickly estimated by using recent sales comps from a local real estate broker or agent.  Make sure you’re dealing with true comps; similar in style, size, amenities, and age.  You shouldn’t be using a 10 year old sale as a comp for an about to be built home. For our example, let’s assume you’re building a 3 bedroom, 2 bath home, 1,500 sf in size, with a lot size of 1/2 acre.  Let’s also assume your comparable report shows the median home sales price in the last 6 months for this type of home to be $500,000. Once you’ve arrived at an estimate for the final or completed value of your property you move on to figure out what it will cost to build your proposed property. Development Costs Development costs can vary wildly from state to state and city to city, dependent on things like the amount of work in the area and the cost to deliver materials to your site.  When estimating development costs I counsel investors to research their market by calling local developers.  Find out what they paid.  Talk to contractors and find out what the going rate for material and labor is.  Talk to local builders’ associations.  They often keep data on home building costs in the area. There are two ways to estimate costs.  You can use a $/sf method, or actually go line item by line item.  The second method can only be done if you have a list of all the line items required to build your home.  The $/sf method is easier to obtain, but not as accurate as the line item method. Your goal is to determine the total soft and hard development costs.  Soft and hard costs break down as follows: A hard cost is anything that contributes to the direct construction of the structure itself.  These are usually limited to the costs to go vertical. Soft costs are anything that do not fit into that category.  Some soft costs are brokers fees, financing fees, horizontal development like running of utilities, demolition of existing structures, clearing and grading of the land, curbs, roads, and driveways, among others. If your local contractor tells you the average hard and soft cost to build your home would be $100/sf, then you know your total development cost would be $150,000 ($100/sf  X 1,500 sf  = $150,000). Do the Math Now it’s time to resolve your numbers.  The value of the completed home is estimated at $500,000, which is hopefully the amount it will fetch when you’re ready to sell.  Your development costs are  $150,000.  The residual land value is the difference between finished value and development costs.  In our example, the residual land value of the proposed property is $350,000 ($500,000 – $150,000 = $350,000). What this means, is that for you to build a home that would cost $150,000 and have a value of $500,000 in the open market, you could pay up to $350,000 for that piece of land.  This is the break even point.  If you pay more for the land there is a great potential for you to lose money.  If you pay less for the land you’re potentially building in profit.  And that’s exactly how a professional developer would do it.  They don’t stop at the residual land value.  They go one step further by working in their profit. Work in your profit As a developer/investor you’re here to make a profit.  You want to work that into the equation before you price your land and make your offer.  Most developers of residential property like to make between 20-30%.  Anything below that will be hard to finance through a conventional lender, and would also be a risk on your part. Markets move up and down, sometimes as much as 10% in a few months.  If your profit margin was only 15% and the market drops 10% you’re left with a 5% profit.  For that kind of money you don’t need the risk of development you can just go out, buy a T-Bill, and sip iced tea on your front porch until retirement. If you’re cost to develop was estimated at $150,000 and you’d like to make a 30% profit on costs, your profit margin would be $45,000 ($150,000 X 30% = $45,000).  This number is then subtracted from the residual land value of $350,000 for a maximum offer price of $305,000  ($350,000 – $45,000 = $305,000).  That means, to make a 30% profit on your development costs, you wouldn’t pay more than $305,000 for the land. Well that’s fine and good, but most developers want to make profit on their entire project, not just the costs.  Thus we do this calculation one more time; this time on the land purchase portion as well.  Assuming you’d want to make 30% on the land portion to, how much would you have to back out?  You’d back out approximately $90,000 ($305,000 X 30% = $91,500). Max Offer Price Take your residual land value minus your profit on cost and your estimated profit on the land cost and you can determine your maximum land offer price.  For our example, the final land value and max offer price would be $215,000 ($305,000 – 90,000 = $215,000). For the property cited in the example I would offer the seller no more than $215,000  to purchase their piece of land.  This ensures I can get the development done and make a nice profit for myself.  Just to check my numbers, I run the math one more time. Check the math To check your final expected profit, simply run the numbers forward from the start.   Here’s how it would look: $215,000 Land Purchase + $150,000 Development and Construction Costs $365,000 Total Project Cost $500,000 Projected Revenue from Sale –  $365,000 Total Project Cost $135,000 Profit $135,000 profit / $365,000 total project cost = 37% total profit Margin Keep in mind we have not accounted for taxes of any kind.  That will of course reduce your profit margin, but still, this is not bad for a development that probably took less than a year from start to finish. For even higher returns, your land offer would be made at an even lower number than your max offer price, in case you end up negotiating the price higher with your seller. You can see that the residual land value method of obtaining land value is an easy and efficient way to make sure you’re paying the true market value of the land, while working in profit for your potential development. 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This is the third blog post of three meant to share answers about commercial investing from the BiggerPockets community. Be sure to also check out the first, “Should You Invest in Commercial Properties? 10 Investors Weigh In,” and the second, “Why Is the First Commercial Deal the Hardest? Advice From Investors.”  While working on new lender partnerships for BiggerPockets members, I realized there was a gap in my knowledge of how commercial investors decide which property to buy and who to work with. Since only 15 percent of investors on BiggerPockets invest in commercial, I thought that perhaps there are questions many investors want to ask—specifically about getting that first deal. So, we posted a survey about commercial investing in the BiggerPockets Announcement Forum. Below you’ll find the answers from top commercial investors in our community. The questions are: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? Today we tackle question No. 3. What Should Every First-Time Commercial Investor Know to be Prepared to Speak With a Lender? Here’s what investors have to say! Starting With My Favorite… “They should know what a lien waiver is. I cannot believe they loaned my dumb ass the amount of money they did.” — Anonymous “Know a successful commercial investor.” “Every first-time commercial investor should know someone who is successful in your field and doing business in the area you’re doing business. If you have the opportunity to partner up with those who already have a track record, then that’s gold. You can learn and earn all at the same time.” — Jeffrey Rollon, San Diego, CA, Developer “Share your past successes.” “Best to have some experience doing what you propose to do. A success story or two or three that you can show a lender goes a long way.” — Jim Schneck “Know your numbers. For real.” “Be ready with a personal financial statement.” — Aravind M. “Know the project inside and out. Understand the challenges, and be prepared to have an answer to it, and mitigate the risk to investors. Every project has challenges. Be realistic.“ — Karen Margrave, Redding, CA, Realtor with 35 years of experience “Know the numbers inside and out. You should be able to speak about income, leases, and who your tenants are. You should also know every expense and who pays for them. Hopefully, your property has triple net leases.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “You have to know how all the numbers associated with the property are related. On the income side, know what current market rents are, what increases are currently in the area, and what your competition is. Be on top of why someone would want to rent from you vs. the other available spaces near you. This will help maintain your income stream and lessen chances of vacancy. On the expense side, you must know all your expenses. What are your utilities, taxes, impact tenant change-over will have, upcoming repairs on the HVAC system, etc. As you scale up with multiple commercial tenants, so too will the expenses. Keeping expenses in line and making small increases in rental income can provide for quick increases in property value. On the flip side, escalating expenses and stagnant rents can just as quickly eat away at your value.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “The current lease terms and length, any existing tax debt or other debts, actual income generated by the property.” — Efrain Hernandez, Queens, NY, Rental Property Investor with 2 years of experience “The lender wants to know the income and expenses for the building (Pro tip: you should want those numbers, too!) The lender will then calculate the debt service coverage ratio and will want to see at least 1.25. Loan terms are typically no longer than 20 years and there is often a balloon well before that.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “KNOW YOUR NUMBERS. Go in there with the numbers the lender is going to care about: rent rolls, cap rate, cash flow/mortgage ratio, and your personal or business balance sheet plus income statement. You should know your net worth and show them that it really doesn’t matter because the deal can stand on its own. If you show them you’re in the business of doing business, they’re very receptive.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience Takeaways & Resources Takeaway 1: Learn from someone who has done a commercial deal. Recommended Resource: Find networking events near you to attend to meet local investors, and learn from the best in the BiggerPockets Commercial Real Estate Investing Forum. Takeaway 2: Complete a deal or two before scaling into commercial investing. Recommended Resource: Share your residential investments with the BiggerPockets community by adding it to your profile under “Investments.” It’s a great place to highlight your work, so when you need to brag to a lender, you can point them to your BiggerPockets profile. You’ve already done the work! Takeaway 3: Know your numbers. Recommended Resource: This is an oldie but a goodie: Commercial Real Estate Vocabulary 101 – Commercial Deal Analysis. I hope reading the above answers helps you understand what you need to prepare before scaling into commercial properties. Be sure to read the answers to the other questions here and here. If you feel the need to ask more questions about commercial investing—I know I have many more—start talking with our community in the Commercial Real Estate Investing Forums. The reason BiggerPockets exists today is that people in real estate like to talk about real estate. When I say like, I mean LOVE. So go ahead and start learning how to scale. If you are interested in commercial investing, what is your next step to get started? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

This is the second blog post of three meant to share answers about commercial investing from the BiggerPockets community. Click here to read the first, “Should You Invest in Commercial Properties? 10 Investors Weigh In.”  In an attempt to spotlight the opportunities associated with commercial investing, I asked commercial investors on BiggerPockets three commonly asked questions about this type of investing. The questions are: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? In this post, we tackle question No. 2. What Was the Hardest Part About the First Commercial Deal You Completed? Here’s what investors have to say! “Getting others to see the vision.” “Getting others to see the vision for the project and putting their hard-earned money behind it.” — Karen Margrave, Redding, CA, Realtor with 35 years of experience “Overcoming the belief that everyone should get started with a single-family house. My first investment purchase was a $1 million office building, and I knew I had to get it done in order to prove my business model.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “Getting commercial property financing.” “Getting financing on a vacant, foreclosed, mixed-use building in what was then a bad neighborhood.” — Jim Schneck “Spent a long time looking for and finding the right lender.” — Aravind M. “Overcoming a learning curve.” “The hardest part for me was learning how to be a landlord as I went. I had no experience with commercial real estate and was simultaneously trying to develop my dental practice. It took a lot of dedication and time to learn, network, and really put myself out there to find tenants, negotiate leases, and be ready to manage projects when something broke, build-outs needed to be done, or building improvements were needed.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “Finding a good deal on a property close to downtown was difficult. A vacant 4-office building came on the market and I decided to make it work.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “Learning all of the lingo. When you first start in commercial real estate, it can be like learning a new language. I started at a large REIT and had to write down every word and acronym I did not understand during a meeting to Google later.” — Anonymous “Learning the zoning and ordinances and rules. I bought the land while zoned ag, even though it had a large structure on it. I got the necessary permits to demolish and burn the existing buildings on site. There were also 3 buildings that I dismantled and sold. When I was burning the debris, the neighbor got pissed. The state was worried I was burning asbestos but I had a professional remove it. I am sure glad he documented everything well. Building the new building was uneventful, except for pouring a nice truck dock and a bunch of concrete inside that had to get torn out. The truck dock is beautiful but has never been used. I guess to sum it up, being new was the hardest part about the first deal.” — Anonymous “Planning upgrades.” “Just getting into all the units and building out that day 1 punch list. Prior to jumping into a 7-family house, I only house hacked. Trying to get my arms around deferred maintenance on 7 units was tough. I trimmed it down to only focus on the things where I had immediate returns from (heating system, insulation) and health/safety (fire alarm system), then set it up so the tenants can request maintenance from the property manager on the things they wanted fixed. This seems to be working out well and prevented me from spending money fixing something that the tenants find no value in.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience Takeaways & Resources Takeaway 1: Managing a commercial property can be difficult. Recommended Resource: 4 Key Considerations to Successfully Manage Commercial Property Takeaway 2: Finding financing can take longer than you think. Recommended Resource: Talk and start to understand what you need to get a commercial loan. You can start by connecting with top commercial lenders on BiggerPockets. Takeaway 3: There are so many things you need to learn when you decide to scale into commercial investing. Recommended Resource: Network, ask questions, and read posts about commercial investing in the BiggerPockets Forums and on the BiggerPockets Blog. They are free! If you are currently investing in commercial, what was the hardest part in closing on your first deal? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

This is the first blog post of three meant to share answers about commercial investing from the BiggerPockets community. Let me start by saying I am not a commercial investor. However, I have had the pleasure of speaking with both commercial investors AND commercial lenders over the past couple of months. My main takeaway: commercial investing isn’t that different than residential, but not all investors are ready to scale into commercial. Since we don’t have a commercial investing webinar (yet!) I asked commercial investors the following three questions: What made you decide to invest in commercial properties? What was the hardest part about the first commercial deal you completed? What should every first-time commercial investor know to be prepared to speak with a lender? Today we tackle question No. 1. What Made You Decide to Invest in Commercial Properties? Here’s what investors have to say! “I was tired of paying rent.” “My start into commercial properties was purely by accident. I was a recent dental school graduate and had my office in the building that I eventually purchased. The owner at the time got the property in a divorce settlement and did not like being a landlord. Consequently, the building was not well maintained nor operated efficiently. As I was trying to grow my dental practice, I was faced with either moving my office to a new location (which isn’t easy or cheap) or taking over the building that I was in and fixing it up. Either way, I wasn’t flush with cash, as the economic downturn was in full effect. After almost signing a 10-year lease with another property that would have required an expensive build-out with little TIs, I made the decision to approach the owner of my current building about selling. Looking at the total rent that I would be paying for my new space, I figured why don’t I put that toward owning?! Fortunately, I was able to negotiate with the owner a seller-financed deal that worked for both of us. We ended up closing on the deal at the same time our first child was born—just in case things weren’t already interesting enough! Since then, I’ve been able to increase the monthly rental income by nearly 50% through value-add sweat equity and creating more rentable space within the building. And it was during this process that I truly began to appreciate the power of commercial property investments. Those regular 3-4% annual rent increases, creation of an additional rentable SF, and creating a desirable building that people compete to be in all equate to significant increases in cap rate valuation of the property and cash flow.” — Will Kenner, Seattle, WA, Rental Property Investor with 10 years of experience “I own a small accounting practice and was tired of paying rent. I knew the math behind owning real estate and decided it was time to take the plunge. Looking forward to closing the next deal this summer.” — Bob Langworthy, Brunswick, ME, Accountant & Real Estate Investor with 10 years of experience “I have several businesses and I needed a commercial space because the city enforces zoning laws in the area that I was located.” — Anonymous “My small business had the equipment and expertise to construct commercial buildings more cost-effectively than most. Keeping the construction costs low keeps the returns high.” — Anonymous “I was looking for another property.” “I was looking for another property in a certain small town I invest in, and Fannie Mae had a foreclosure listed for a 4-unit apartment building. As I learned more about the property, I found that it also included a building of storage units, as well. Since the price was right, I bought it. We are in the middle of rehabbing the apartment and still working on possession of the storage units.” — Lynnette E., Tennessee, Rental Property Investor with 2 years of experience “I saw an opportunity.” “Saw a niche in the market that wasn’t being met and designed projects to fill them. We’ve designed and built spec office buildings, small office parks, office/retail condos, residential subdivisions, medical/dental clinics, and more.” — Karen Margrave, Redding, CA, Realtor with 35 years of experience “I just wanted more units under 1 roof. Anything over 4 units had to go commercial. I found a 5-unit that I liked and went down the commercial lending path and found it super easy and fun. Now I only want to deal with commercial lending. The credit union that I’ve been partnering with lets me do way more creative financing stuff and rolls with whatever I want to do. Of course, the deals I’ve brought to them make sense on the key metrics they use in underwriting.” — Jonathan Bombaci, Lowell, MA, Real Estate Agent with 1 year of experience “Commercial property is valued based on the income it generates, and investors have the ability to control how much income is generated. Thus, investors can control the value of the asset.” — Danny Randazzo, Charleston, SC, Apartment Syndicator & Commercial Investor with 6 years of experience “I found a mentor in commercial investing.” “Six years before I got into commercial, I met a successful developer already doing commercial deals, and he was younger than me. Over the next 6 years, I’ve followed his success and we stayed in touch. When he invited me to help with his downtown projects, I jumped on the opportunity to learn from and work with him.  That—and I see the growth in downtown San Diego—and it was a no-brainer.” — Jeffrey Rollon, San Diego, CA, Developer “Mentorship through employment at large commercial real estate investment firms.” — Anonymous Takeaways & Resources Takeaway 1: If you are interested in scaling into commercial investing, finding a mentor or someone you can shadow is helpful in learning the ropes. Recommended Resource: BiggerPockets Commercial Real Estate Investing Forum is a great place to start meeting seasoned investors. Takeaway 2: Own a business? If you have the cash flow, it might be worth buying a property instead of renting. Recommended Resource: Talk with a realtor in your neighborhood to see what’s available. It’s free to talk & view properties. Takeaway 3: There is always an opportunity to scale from residential to commercial, you just have to be open to scaling. Recommended Resource: This helpful video explains how one investor began scaling: “How I Went From My First Rental Property & Scaled to Commercial Real Estate.” When you are ready to get a commercial loan, we can help, too. If you are interested in commercial investing, what is your next step to get started? Share in a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

How do you know if an apartment building is a good deal? In this article, I give you the 3 main indicators and rules of thumbs to find out. You’re interested in apartment building investing, and you see a bunch of multifamily properties for sale on Loopnet. Maybe you’re even (yikes) thinking of making an offer. But how do you know if the asking price is reasonable? And if it’s not, what price makes sense? The 3 Main Ratios for Valuing Commercial Real Estate There are 3 main ratios for estimating the value of an apartment building. Here they are: Capitalization Rate (a.k.a. the “Cap Rate”) Cash on Cash Return Debt Service Coverage Ratio Let’s talk about each in turn. I’ll cover what they are, how to use them, and what value to look for in a good deal. Key Indicator #1: The Cap Rate In order to know the fair market value of a building, we need to know its “cap rate” and its “NOI.” The NOI is the net operating income, and this is the income after all expenses but before debt service (i.e. the mortgage payment). The cap rate is a multiplier that is applied to the NOI to determine the value of a building. It’s like saying that the building can be valued at “10 times its net operating income.” The cap rate is the rate of return if you were to buy the building 100 percent in cash. You probably wouldn’t do that, but this is the standard way to measure the returns and value of a building. Cap rate is such an abstract concept that an example is in order. Imagine you have an ATM machine that makes $100,000 per year for you after all expenses (your cost to lease the space, to pay someone to maintain it for you, repairs, etc). So the NOI of this ATM machine is $100,000 per year. You then talk to a group of people who are interested in acquiring your ATM machine. You ask them, “What would you be willing to pay for this ATM machine?” One buyer might say, “One million dollars,” and you ask him how he came up with this number. He says that if he buys your ATM machine for $1M and it produces $100,000 in income, then that is a 10% cash on cash return on his money. And this sounds like an excellent investment to this investor. Another investor ups the offer to $1.1M. The ATM finally sells for $1.2M. This would produce an 8% return to the buyer if he paid in all cash. In mathematical terms, the cap rate is a ratio consisting of the NOI divided by the price (or value) of the property. In the case of our ATM machine, the cap rate is 8% ($100,000 divided by $1,200,000). If you’re in the market of buying ATM machines, you could quickly compare one with another by using the cap rate. If the prevailing cap rate for ATM machines is 8%, then you can quickly calculate it’s fair market value if you know its income. Related: Don’t Think You Can Do Your First Apartment Deal? Then Read THIS. Applying this to commercial real estate, let’s say our broker brings us a deal and tells us that “buildings in this area typically trade at an 8 cap.” This means that you can use a cap rate of 8% to calculate the fair market value of a property in this area, like this: Suppose the marketing package you get from your broker shows a net operating income of $50,000. Applying an 8% cap rate, our building should be worth $625,000: The cap rate is useful for determining the fair market value of a building because buildings in the same area tend to share a similar cap rate. In general, the nicer the area, the higher the prices and the lower the cap rates, typically 7% and under. Conversely, properties in not-so-nice areas have lower prices and therefore have higher cap rates. How do you determine the cap rate? Glad you asked! The cap rate requires knowledge of the NOI and sales price of comparable properties in the area. The best people who know about both of these are commercial real estate brokers and appraisers. Start by asking the listing agent what the prevailing cap rate is for buildings of this kind and in this area. Use that cap rate. If it gets more serious (i.e. you’re going to make an offer), then get a second opinion from several other brokers. Better yet, call an appraiser; it’s their business to value buildings every day, and they’ll be able to give you an unbiased opinion. What cap rate should I look for? The rule thumb is to purchase properties at a cap rate of 8% or higher in our current market environment. Note that this is only a rule of thumb, as cap rates can vary from area to area. Also be aware that for the cap rate to give you an accurate value, you have to base it on ACTUAL financials. Many times you see a marketing package advertising the deal at a 9% cap rate (great!), but then you discover that the expenses are low. Well, shoot, what value is the cap rate if the expenses aren’t accurate? That’s why I advise that you use the “50% Rule” for expenses: Assume the actual expenses are at least 50% of the reported rental income. Use that figure and you’ll get closer to the truth. Let’s talk about the second key indicator, the cash on cash return. Key Indicator #2: Cash on Cash Return Cash flow is king, and the cash on cash return measures how much cash you’re getting back each month based on how much cash you invested. The cash on cash return is the cash flow after ALL expenses (including debt service) divided by the total cash invested. So if our annual cash flow after expenses is $20,000 and we put $200,000 into the deal, then our cash-on-cash return is 10%. Is that a good return? Related: How I Bought a Multi-Million Dollar Apartment Complex at the Age of 26 It depends on your investment criteria, but you should look for properties with at least a 12% return after you’ve “stabilized” the property. “Stabilized” means that it has an occupancy of at least 90%. This means you could buy a deal with only a 5% cash on cash return in the first year, but your target is at least 12% after you’ve filled up all the units. Key Indicator #3: Debt Service Coverage Ratio This is a ratio most often used by banks to determine the risk level of the building if they were to grant a loan to you. The debt service coverage ratio (DSCR) measures the ratio of net operating income to the amount of annual debt service you need to pay. Typically, banks look for a debt coverage ratio of at least 1.25. Here is the formula: Assume that the net operating income is $50,000 and that the annual debt service (principal and interest) is $40,000. Then the debt service coverage ratio is: Since we’re above the bank’s minimum debt coverage ratio of 1.25, then 1.3 looks OK. You should look for deals where the DSCR is at least 1.5, which is more conservative and is more likely to keep you out of trouble. Conclusion Now you know the 3 main indicators for figuring out if an apartment deal is a good one or not. Stick to these 3 metrics, and it will help you narrow down the field of deals and give you a margin for error. BUT having said that, these 3 metrics (and the rules of thumb) are a bit of an over-simplification of the process of evaluating apartment building deals. That’s because if you buy a value-add deal, for example, where the vacancy rate is low or expenses are high, your 3 indicators may be low, but it may still be a good deal overall. In other words, if we’re going to evaluate a “value-add” deals, we may have to break our rules of thumb for the 3 key indicators. Any questions about these evaluations? Where are you in the process of finding an apartment deal? Let me know your questions, comments, and experiences below! Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Have you joined the club yet? If you’ve been excited about real estate investing but unable to find well-priced assets, then I invite you to join the club. You’re not alone. This is typically the case if you’ve been looking for multifamily assets of any size. Or single family homes to flip. Or homes to build a single family portfolio. It’s been tough out there, and it’s not just limited to you Californians—or New Yorkers, Jerseyites, Texans, Floridians, or Las Vegans. It’s no longer limited to large and popular cities or newer, stabilized assets. It’s tough all over and there are many reasons for this. I’ve discussed a number of reasons that multifamily is overheated on this blog. Many of the same issues apply to single family homes and other popular asset classes. After years of banging our heads against the wall, my company decided to do something about it. We decided to look outside multifamily to alternative asset classes. Assets that aren’t as cool or exciting. Assets that are, well, quite boring. We began to explore self-storage and mobile home parks. And what we found was anything but boring. When we studied alternative assets, we learned that the profile of the current owners—the sellers—was a critical factor in achieving substantial profitability. I’m going to spend the rest of this post discussing self-storage and touching on mobile home parks—assets within my realm of experience. But what I’m saying may apply to other asset classes, too, like land, garages, parking lots, and more. Related: Work Less & Earn More With Commercial Investments—Here’s How Fragmented Ownership – A Key to Alternative Asset Success They say you make money when you buy. But I’ve always believed that to be partially true, you actually make money when you buy, when you upgrade, when you operate well, and when you sell. But here, more than in most other realms, you really do have the potential to make massive profits through buying well. It is estimated that about 74 to 76 percent of self-storage facilities are owned by less-than-sophisticated operators. And about 66 percent of all facilities are owned by single-facility operators—also known as mom-and-pop owners. There are almost 55,000 self-storage facilities in the United States. That is more than the combined total of McDonald’s, Subways, and Starbucks. About 40,000 are run by independent operators. Perhaps 36,000 or so are single-facility operators. Many of these independents are mom and pops, and they run their facilities that way. They don’t need to run them better. They’re making a profit and they’re happy. Contrast this ownership breakdown with the situation in multifamily right now. The apartment world has been increasingly dominated by larger, well-capitalized players. It is hard to acquire an under-performing property from this group. This is why our firm expanded outside of the multifamily syndication world. Now we really love self-storage. According to the National Multifamily Housing Council, 93 percent of multifamily assets with 50 or more units are owned by operators with more than one asset—potentially sophisticated operators. The largest player in the self-storage arena, Public Storage, owns only about 7 percent of the market. A different study shows the market share of the top 10 self-storage firms at only 26 percent. Check out the average returns from a variety of REIT sectors from 1994 through 2018. In particular, check out the returns in 2008. Note that self-storage was the only asset class here to have a positive return in 2008. In fact, every other sector experienced double-digit losses ranging from -12 percent (health care) to -67 percent (industrial). Buy from a mom and pop! So, what are some of the characteristics of a typical mom and pop-run self-storage facility? Though these don’t apply to all, and I’ll almost certainly offend someone with this generalization, I’ll give you a quick overview of what I’ve observed. Common Characteristics of Mom-and-Pop Operators If you build it, they will come. This worked in the early days of the business and some operators have kept up the tradition. No website (or a poor one). Similar to No. 1, the business was largely characterized by drive-by marketing for years, and this still works for many. (But can they really maximize revenue? They often don’t need to.) No showroom. The opportunity for ancillary income is not a priority. Tenants can buy their boxes, tape, scissors, and locks at their competitors. Rare price increases. Many small operators become friendly with their tenants and rarely raise rents. The result can be below-market pricing. Across the board pricing. Where a savvy operator might raise their price on the last few units of a popular size, this is often too much trouble for a small operator who would have to use white-out or mark up his well-worn price sheet. Rent what we got. Storage facilities are mostly sheet metal and rivets. They can usually be reconfigured to meet the current local demand. If the demand for 10′ x 10’s is high, and 10′ x 20’s are empty, walls and doors can be added to optimize occupancy and income. Most small operators wouldn’t do this. Poor maintenance. Some of the 70’s and 80’s facilities look like… well, 70’s and 80’s facilities. There is little reason to update or maintain them well, and their revenues reflect this. Poor security. The No. 1 crime at self-storage facilities is theft (obviously), and many smaller operators don’t go to the trouble of installing security cameras and gated fencing. No marketing budget. Many of these operators boast that their marketing budget is close to zero (except for that donation to get their name in the charity raffle brochure). Their revenues suffer, but they may not know it or care. Untapped land. Many operators have unused land or parking lots for RVs and boats that could be used for profitable expansion through a beautiful new climate-controlled building. You may be the one to make this profitable expansion. Pest control and water infiltration. Many facilities get a bad reputation. In 1999, when my antique furniture was roach-infested and water-stained, I wasn’t a happy self-storage customer. Rental truck income. Rental truck operations (U-Haul or Penske, for example) can often be a great source of ancillary income with little capital expense or effort. In addition to a healthy boost to the bottom line and asset value, this can also lift occupancy by 3 to 5 percent. Most small operators don’t go to the trouble. Last summer, my company considered acquiring a small self-storage facility in a fast-growing area near Raleigh, N.C. The aging owner’s dad had constructed it in the late 70s. It was painted a gnarly brown and tan. It was only using the back half of its land; the front half was begging for a climate-controlled building. There was no website. (“Why bother? I’m full!”) No truck rental. All the units were one (odd) size. No gutters. She was renting under-market. She had handwritten books. And she only accepted cash and checks—classic mom-and-pop facility. Mobile home parks have similar characteristics. Though I haven’t been able to verify this, I read a statistic estimating that there are about 50,000 mobile home parks in the U.S. It’s estimated that about 99 percent are run by mom-and-pop, unsophisticated operators. Many of the characteristics of a mom-and-pop mobile home park operator are similar to those listed above. I can imagine it is similar for garages, land, parking lots, etc., though I admittedly haven’t studied these asset classes. Related: Why Self-Storage Investing Is Red Hot Why You Should Buy From a Mom-and-Pop Operator You may fancy yourself Chip and JoAnna Gaines, Jr. (If you’re actually them, please contact me. I have an investment opportunity for you.) You may invest big bucks to remodel and fix up and renovate and beautify and stage your $300,000 home to the level of any million-dollar home in Texas. But if your home is in a $300,000 neighborhood, you’ll never get the value you hoped for. You may even lose hundreds of thousands on it. (We’ve all seen examples of this.) That’s because the residential real estate world is appraised by comparable properties, or “comps.” This is not so in commercial real estate. In commercial real estate, the value is derived by a formula. Value = Net Operating Income ÷ Cap Rate The cap rate is an average investor’s expected rate of return on an asset like yours in your market at any given time. It used to be in the 7 to 10 percent range. Lately, cap rates have ranged between about 4 and 7 percent in many asset classes. By increasing the numerator (the net operating income) in the value equation, we are able to proportionately increase the value of the asset. By compressing the denominator (the cap rate) in the value equation, we are likewise able to proportionately increase the value of the asset. Both of these possibilities are likely when buying a well-placed asset from a mom-and-pop operator—especially when the asset can be repositioned to sell to a REIT. Potential Upgrades in Self-Storage The power of buying from a mom and pop lies in the numerous upgrade opportunities available to you as the new operator, as well as the asset and equity value this creates. Examples include: Utilize road frontage (signage, visibility, etc.) Clean-up/refurbish (corner guards, fences, locks, gates) Security and lighting Modernize systems (collection, accounting) Add truck rental Free moving truck (for incoming tenants) Free shelving Tenant insurance Administration and late fees Ancillary retail sales (locks, boxes, tape, scissors) Expand facilities (add climate-controlled facilities) Boat & RV storage Billboard, cell tower, ATM, etc. Timely evictions Improve marketing (signs, web, social media, PPC, geotargeting, remarketing, move-in specials, etc.) Price by demand Size by demand Price by tenant motivation Now let’s string together a handful of these improvements to see how it could impact value. These are only examples and results may vary widely. Assume your facility is 500 units, and you purchased it for $6 million. Assume rents on a typical unit are $100/month. Raise rents by 20% to market level. 500 units x 90% occupancy x $20 x 12 months = $108,000. Add truck rental. $2,500 per month x 12 months = $30,000. Add boat & RV storage. 20 spots x $200 x 12 months = $48,000. Cell tower contract. $800 x 12 months = $9,600. Sell tenant insurance (w/revenue share). 60% penetration = 300 units $5 x 12 months = $18,000. But the commercial real estate value formula reminds us that the bigger significance is the additional value you’ve just created. Commercial real estate investors enjoy the value in the cash flow. But they even more enjoy the value of the cash flow. Value Increase = Net Operating Income ÷ Cap Rate Value Increase = $213,600 ÷ .06 = $3,560,000 That’s pretty amazing. Theoretical appreciation of over 59 percent ($3.56 million ÷ $6 million). This assumes the cost of operations didn’t increase from these improvements and assumes a constant cap rate of 6 percent. But it’s better than it looks. If you used debt in the equation, the value increase flows straight to the equity investors. Assuming a modest 60% percent loan-to-value ratio on the initial $6 million purchase means debt of $3.6 million and equity of $2.4 million. This means that the $3.56 million value increase translates to a theoretical equity increase of 148 percent.  To be clear, that’s $3.56 million divided by $2.4 million. And this doesn’t even include the potential appreciation from cap rate compression. Selling an upgraded mom and pop to a REIT can result in a cap rate reduction from say 7 percent to say 5.5 percent. This would compound the asset appreciation by over 20 percent and the equity appreciation by over 50 percent. And lest you think I’m dreaming, I can tell you that there are a number of operators I personally know who are achieving returns like this. One of the operators we invest with has been providing investors with over 40 percent IRR over the past 21 projects. And they are not alone. Do you see why I love commercial real estate? And why I love fragmented alternative asset classes? Check them out for yourself. I think you’ll agree that this is a rare opportunity. But it won’t last forever. Have you experienced pain in looking for assets among mature asset classes (like apartments or single family homes)? Have you experienced the power of investing in fragmented alternative asset classes? Leave a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Have you ever had a dumb idea that you thought was amazing—until you realized it wasn’t? Those who said yes likely didn’t follow through with the idea. Well, I did. Let me tell you about the most interesting real estate purchase I ever made. It Started With a Story in the Newspaper I can get erratic at times with purchases. This comes from my background in wholesaling. As a wholesaler, you can take chances and then let your end buyer take the risk. Well, this purchase I was the end buyer—and man, was I taking a risk. Before we get started, let me provide the backstory. My wife and I were looking through the local newspaper. On the first page, there was an interesting article detailing how a local school district needed to sell or raze a turn-of-the-century school building. I paid it no mind, but my wife is a property scout when it comes to real estate bargains. Her first comment was, “This is a very attractive-looking building. We should buy it.” Related: The ‘Excitement’ Of Real Estate Investing — Really? No comment on what I was thinking. It’s the wife though, so I said, “Oh,” and didn’t give it much more thought. “Why would she have found the article interesting?” you may be wondering. Our family not only is involved in real estate but we also operate a successful non-profit about 45 minutes south of Chicago. It’s in a midsize, working-class community called Kankakee. She saw the former school building as an opportunity to help with the agency’s expansion into providing daycare services. I have to say my wife, my mom, my brother, and my sister-in-law can always find ways to help people. I, on the other hand, enjoy helping others, of course. But my head is always focused on real estate. Then My Wife Twisted My Arm I figured since the school district had to sell or raze the building, it must be in serious need of repair. See, this is how it always happens. She throws out an idea, and I can’t help but to analyze it. My mind is just wired that way. This was her first step in getting me to show interest. Verrry clever, Mrs. Maloney. She spoke with the school district, inquiring about the building and gauging how they were receiving offers. The whole time she was working on this I had no clue. (Dumb husband…) The school district was going to do a blind auction. But one of the school officials slipped and stated there were no offers on the table (so my wife says). By then, she had pulled me in the building. Just from a walkthrough, it looked solid. Related: The Best Real Estate Deal I’ve Done This Year Then My Whole Family Peer Pressured Me I couldn’t do what I would normally do in this instance—run numbers, create my exit strategy, create a rehab budget. You know, all the typical things a fiscally sound individual would do on a project. This was completely different and out of the box. A day care?! What were we going to do with a day care? The other four (wife, mom, brother, and sister-in-law) said, “Fill it with kids. Let’s continue to help the community but in a different way.” My wife and sister-in-law had experience running a daycare, and they saw the opportunity where I couldn’t see it. Mike (my brother) was on board once he evaluated the potential and did his research. I was still focused on the exit strategy and potential rehab and holding cost. But eventually, they won. I decided to do it. I focused on financing and the building rehab. They followed the pro forma they created for child care equipment, marketing, staff, and other essentials. I Got on Board and Dove In As scared as I was, I went to the blind auction. My wife was right; it was only me there. So then, I really began to panic. “I’m the only one trying to buy this thing?! There has to be something the inspector and I missed.” Suddenly, my investor senses kicked in. I had the thought that since I was the only one there, we could probably get the property cheaper. I submitted the bid, left the auction, and drove straight to my new project—because I knew we were going to get it! And we did. Now We Own a School I’m glad we made this purchase. My sister-in-law runs a very, very profitable daycare. Once we purchased this property, it expanded even more. When I’m in town, I always stop in on school days. I like to see the children playing on the playground and to witness how this place created jobs within the community. The kids are happy, my family is happy, and the property and the business are very profitable. Fortunately, everything worked out. What would you have done in my position? Do you have any crazy real estate stories like this?  I’d love to read them in the comments below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Who doesn’t love a slightly controversial headline? I can already sense the upset commercial mortgage brokers, investors and real estate agents ready to unleash a mouthful of comments below. Now before you take the gloves off, please keep in mind that I’m a big believer in commercial real estate investing and see it as a MUST end game for any investor starting of with single family or multifamily properties. So don’t take your gloves off just yet and read on. You might have heard that any type of property, whether it’s commercial or non-commercial, is a good investment opportunity. And more so, commercial properties offer much more financial rewards in comparison to non-commercial properties. But did anyone also tell you that investing in commercial properties is quite a bit riskier and messier than investing in non-commercial real-estate? There are so many issues like legal requirements, additional laws and in-depth knowledge that make commercial properties more difficult to manage. In this article, I’ll touch on the key issues that make commercial properties so difficult to handle and why you’d better think twice before doing it. Commercial real estate is a class of property assets that are used for business purposes. It consists of three sectors: office, retail and industrial. Commercial property is often preferred for reasons like high returns on investment, longer leases and smaller deposits. All these factors ring true, but these things look good mostly on paper. There are risks associated with commercial properties that you need to be aware of before investing — risks that just aren’t there with residential property investing. 6 Reasons Investing in Commercial Property Might Be a Bad Idea Commercial properties are complicated to understand. Buying a residential property requires you to have a good understanding of the sales and the rental market. You need to learn how much a house will cost, what it will cost to repair the house, the value of the house after repair and the kind of rent that you’ll be able to get from it. Well, all these things come with experience, and none of them are overly complicated. In fact, you can get a lot of information simply by asking people. Need to know more about the neighborhood? Ask the neighbors. Simply looking at what other places nearby are able to collect in rent will immediately give you a good idea of what you can expect. Related: What Every Investor Should Know About Forcing Appreciation in Commercial Properties Not so with commercial property. This requires an understanding of similar concepts, but it is much more complicated than that. Figuring out the numbers requires knowledge that’s not readily available and certainly requires some experience. The other crucial factors that hugely affect the value of a commercial property are the future desirability of your property, the lease period, how solid the tenant is and the type of business that best suits your property. The value and the rent of your property also depend on the types of businesses running in the area in which your property is located. In addition, laws are less strict in some areas. That means that the transaction will be governed by contractual agreements rather than state law. All this together makes it quite complicated to jump into commercial real estate investing. Usually, it comes down to picking a niche and focusing on that. Commercial properties are sensitive to economic conditions. Sure, as the economy grows and shrinks, residential properties change with it and can have a lower ROI than expected. But where that might be true, commercial properties are far more sensitive to a changing economic climate. Everyone needs a place to live, and most jobs are relatively stable. Even when the economy is taking a downturn, people will always need to have a roof over their heads. But the same can’t be said about commercial properties. When the economy is strong, the demand and the price of commercial real estate go up. People renting commercial property may choose to operate from home instead and close shop when the market is bad. But, even when the economy is doing great on a national scale, local economic changes play their part as well. Maybe the location you’re offering is no longer as desirable as it once was. When that happens, your property might go years without having a tenant. Valuing commercial properties is difficult. Residential properties are usually rented out by using rent comparison. This means the owner compares his property to similar properties that have recently been rented out in the same area. In the case of residential properties, finding similar residential properties is much easier. It usually means going around the neighborhood. In some cases, you can get by on common sense. In the case of commercial properties, it is very difficult to compare two properties. A number of factors affect the value of these properties. Also, it is hard to find similar looking properties that have been rented out recently and are also relevant for the same audience. One way to value commercial real estate is to take a look at value per square meter. This is something that can be used when you own a property in a shopping center, for example. Location is important, but at least neighboring properties can be of some guidance here. If that doesn’t work, as an alternative. commercial properties are valued using an income approach. An income approach takes into account the profit a property can make per year and multiplies it with the market cap rate to reduce the value of the property. The market cap rate varies based on different types of properties, the type of tenant, the length of the lease, the credit rating of the tenant, the condition of the property, market conditions and different locations of a property. But even then, the value of a property is a very fluid concept and requires a lot of insight. This is not something you’ll be doing on your own straight off the bat. Finding tenants takes longer with commercial properties. Though commercial properties can enjoy long-term leases of three or even 10 years, once vacant, it usually takes much longer to find suitable tenants for these properties. Since these properties are rented out for business purposes, finding a suitable match between the location of the property, the type of the property and the business requirements of relevant companies usually takes a longer time. That has a pretty big effect on the cash flow. The owner is also expected to cover all the costs during this period. This can be a huge burden on the owner, as taxes can be a lot higher compared to residential real estate. In addition to all this, the terms for a commercial lease are quite complicated in comparison to a residential lease. A commercial tenant has many options for lease, like a gross lease, modified gross, double net and triple net. The market cap rates also vary depending upon the types of leases. Laws also vary per state, so what might be possible in one state can be downright illegal or way too expensive to try and pull off in another. Once again, handling tenants, lease value and vacancy agreements demands quite a lot of expertise. Old commercial properties are a threat to new and upgraded properties in the same area. Investors of old commercial properties are always threatened by newer and upgraded commercial properties in the same area. Tenants always look for modern and upgraded office areas or business spaces. It’s the same with residential properties, of course, but upgrading an office can get a lot more expensive than upgrading a house. As new properties pop up, the risk of vacancy to existing properties increases which might mean more costs. Related: How to Use Commercial Real Estate to Add $1M to Your Net Worth in 5 Years Financing a commercial property is difficult. This is not to be underestimated. It is not all that difficult to get financing for purchasing residential rental properties, as there are a large number of lenders available who will offer loan for a period of 15 to 30 years. Usually, the residential real estate isn’t that expensive anyway and is something that can even be paid off using rent money. In the case of commercial properties, the loan amount will be amortized for less than 30 years and will mostly follow a balloon payment mode. This means that the entire balance of the loan will be due after a certain amount of time — let’s say after five or 10 years. The investor is supposed to pay off the loan when the balloon payment is due. This is not always convenient for the investor. Many investors look forward to getting refinanced when the balloon payment comes due, but if the market changes, refinancing the loan is difficult. Add to that the fact that commercial property is usually more expensive to purchase, and things get even more difficult. It’s true that larger properties can yield a more steady income, but to get that kind of money from a bank, you’ll need experience to go with it. Commercial property investments require a lot of ground work. You need to pay your due diligence evaluating the market and the property. If you want to go ahead with investing in commercial properties, you better keep a hawk’s eye on local market and property conditions. You have to do a lot of number crunching, as a number of factors affect the value of a commercial property. Lastly, while you do all that, you should have a solid exit strategy in your plan. It’s all these things that make residential real estate so much more attractive for investors, especially those who are just starting out. What do YOU think — is investing in commercial property worth the hassle? Feel free to jab me a few comments below, but watch out for my right hook! Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Have you heard stats such as “80% of millionaires attribute their wealth to real estate”? Or heard stories of living the good life off passive cash flow from rental property? Combine this with the recent years of unpredictable, disappointing stock markets, and you get masses of people realizing they have no control over many of their investments and therefore their life savings. Tired of blindly following the crowd of 401K stuffers, many have started looking at why so many wealthy people own real estate. In this article, I will break down the numbers in the simple yet rarely talked about truths behind the wealth building abilities real estate carries. Who doesn’t love to focus on the wealth and freedom real estate can give you? We all love it so much, we forget to explain how it does this. This void in education leads people jumping in not realizing that even some investment strategies within real estate do not carry the benefits of others. Going to meet ups, listening to podcasts, or reading articles, you frequently hear about people building wealth and the successes they have accomplished through owning investment real estate. What we forget to ask is why and how owning investment real estate is able to make this happen so much better than other investment strategies, including flipping, stocks, private lending, and any other form of investing. In this article, I will answer that very question. Why I Focus on Multifamily When it comes to real estate investments, I focus in multifamily apartment complexes because of the control it provides in determining the investments results. Some of the most powerful factors in real estate are control, debt (leverage), and taxes. For the average investor, leverage is commonly used in real estate, but not in stocks or private lending. In addition, the IRS and owners of investment rental property might as well be best friends because the IRS has made so many rules to benefit us. Related: New Study: Ability to Delay Gratification Predicts Wealth, Health & Success There is a lot of useful information packed into this article. You will have to read this article slowly and maybe even a few times. If you don’t know a term, stop and look it up. Stop to understand the math. Even though there is a lot of math, it’s only addition, subtraction, multiplication, and division. I actually wrote this article on my iPhone using the iPhone calculator, so don’t let the math overwhelm you. Once you truly understand all of the words and math behind it, you will see how simple it really is to build wealth in real estate and why our wealthy continue to attribute their financial freedom to real estate. The best way to illustrate the truth is through math and examples. Rather than look at the same old surface results, we are going to drill way down into why all these millionaires attribute their wealth to real estate — and specifically multifamily and other commercial real estate investments. Today, You’re Buying an Apartment! You put a $200k down payment on a $1M building at a 8% capitalization rate (very achievable). This leaves you with $80k net operating income ($1M x .08). When you borrowed the $800k from the bank, they lent it to you at 4% interest with a 30-year amortization. This means your year one mortgage payments equal $45,832 ($31,744 interest, $14,088 principal), leaving you with $34,168 in cash flow ($80,000 – $45,832) or a pre-tax cash on cash return of 17%. But wait, there’s more! So if you cash flowed $34,168, do you pay tax on $34,168? NO! Another beauty of real estate and leverage is the depreciation tax benefit. This is one the benefit the IRS has given to their buddies who are real estate investors. Even though you only put 20% of the $1M into the property, you get ALL of the depreciation benefits. Apartment buildings are depreciated over 27.5 years, which means you get to depreciate the building’s value. The building’s value does not equal the property value because the building sits on land, and that land also has value. The IRS does not allow you to depreciate the land. A typical percentage of a property value that is allocate to land value is 20%, or in this example, it would be $200k. This leaves you with $800k of building value to be depreciated, so $800k/27.5 = $29,090. What does this mean? It means you barely pay any tax on that $34,168 cash flow you made on the building. You actually only have a taxable gain of $19,166 ($34,168 cash flow + $14,088 principal portion of your mortgage payment – $29,090 depreciation). We add back the principal amount of your mortgage payment because it is not a tax deductible expense and subtract out the deprecation we listed above. Since you were able to put $200k down on a property, I’ll assume you’re doing pretty well financially. Because of this, I’ll even venture to guess you’re in a 35% tax bracket. Since your tax bracket is 35%, the taxable gain of $19,166 would result in cutting a check for $6,708 to the IRS, leaving you with $27,460 ($34,168 – $6,708). This means your after tax return is 13.7%. This is where most people shut off the brain and say, “My financial advisor says I can earn 8% in a mutual fund, and those have no tenants, no managing the property manager, no headaches. That peace of mind in itself is worth not owning real estate, right?” NO, not true at all! There are more major pieces to this puzzle that the wealthy use that so many that give up at this step never see. Related: One Simple Habit the Vast Majority of Wealthy People Practice Every Single Day How to Use Taxes to Your Benefit Let me jump back to the taxes, specifically depreciation. Another tool our buddies at the IRS gave real estate investors was a cost segregation study. They found out we like depreciation, and so they gave us more! In accountant talk: A cost segregation study identifies and reclassifies personal property assets to shorten the depreciation time for taxation purposes, which reduces current income tax obligations. In normal person language, this means the IRS lets you accelerate deprecation on things like cabinets, appliances, carpet, light fixtures, and other parts of the building. This forces more tax savings to the investor sooner. Rather than try to break down all the different parts of the cost segregation and their deprecation rates, I’ll just give a round number of what a cost segregation study would do for you and this example. You really don’t have to know the nitty gritty on how to do them because you will hire a professional to do it for you. For our example, doing a cost segregation study would increase the total depreciation allowance by $10K. Nice! This means we can adjust the above math to now look like this ($34,168 cash flow + $14,088 principal portion of your mortgage payment – $39,090 depreciation). So now our taxable gain was only $9,166, which also reduces the amount we have to pay the tax man to $3,208 ($9,166 x 0.35). Even though you put $34,168 into your pocket, the first year you only paid $3,208 in tax. This means you, Mr. 35% Tax Bracket, only had to pay a 9% tax rate on your income! I told you the IRS and real estate investors are buddies, so their always trying to find a way to help us out! Because of this, your after-tax cash-on-cash return is 15.4% ($30,960/$200k). You’re thinking, “Hmm, 15.4%. Maybe this kids on to something.” We’re just getting started. Read on. The Power of Debt A huge difference between other investment classes and owning investment real estate is the power of debt. With most debt comes amortization. Wealth is built in the amortization of the debt you put on the property. Back to our example, the $800k in debt you put on the building will have an army of tenants paying down your mortgage month after month. This is amortization. Now let’s wrap the amortization into our example. Using the loan terms I mentioned, the first year of the loan will result in a $14k reduction in the amount you owe. If the property value stays the same, that can also be seen as a $14k increase in equity. If we add that $14k to the after-tax cash flow, we are left with an all-inclusive after-tax return of 22.4%. In this example, we assume the value of the property will not go up in value one cent — which is smart because assuming is another word for speculating, and speculating is risky investing. However, in multifamily (5+ units) or other commercial investment real estate, the value of the property is based on the income the property produces. The wealthy love to control things — this is exactly why the wealthy focus on commercial property such as multifamily apartment complexes. Being that you control the income and expenses in a property, you also control the value. What this means is if you have a way to increase income either by raising rents, billing residents back for utilities, or adding any other source of ancillary income to the operations of the property, you will also add value. Also, the flip side of the equation is if you decrease expenses by renegotiating operating expense costs, billing residents back for utilities, reducing turnovers and vacancy, putting in energy efficient light bulbs and plumbing fixtures, or ANY other way to cut operating expenses, you increase the value of your property. Increasing Multifamily Value So let’s look at our example one last time. Say this $1M building was a 20-unit apartment complex. The reason you bought this complex was because you’re smart and you saw opportunity in it — the opportunity to add value by both increasing income and decreasing expenses. Nothing major, just a few things you could do right after purchasing to help the bottom line. Before purchasing, you noticed that the previous owner had owned the building so long, they had not been keeping up with market rents. You noticed similar units in your area rent for $900-925, but yours were only renting for $850. Being that all the residents were on month to month leases, you went ahead and implemented a minor $25 a month increase in rents to all units in month one. You wanted to keep rent below market so you wouldn’t lose your residents but thought that was still fair to everyone. This added $5,700 (20 units x $25 x 12 months – 5% vacancy allowance) of income to your bottom line annually. Another opportunity you wisely saw was in vendor costs. Over the past 20 years, the vendors had slowly crept prices up above market rates for their services. The previous owner was comfortable with the properties operations and had a good relationship with his vendors so they never bothered to check the going market price. Day one of owning the property, you were able to negotiate the following monthly expenses down: Monthly dumpster fee from $110 to $95 — an annual savings of $180 Per cut grass cut expense from $150 to $100 — an annual savings of $1000 Property management fee of 8% down to 7% — an annual savings of $1,600 This all doesn’t seem like much, and was really simple to do. Let’s see how it affects the returns in our example. After increasing income $5,700 a year and simultaneously decreasing expenses $2,780 you were able to increase the money you put in your pocket $8,480. The extra cash is nice, but the real power behind this is the fact that commercial real estate is valued based off the income it produces. Since you increased the income the properties produces, you also increased its value. Let’s look at how this affected our example. Your property still is in the same market and asset class that awards it with the same capitalization rate of 8% that you bought it for. Now that you have found ways to add $8,480 to the net operating income, this gives you a total net operating income of $88,480. By dividing the net operating income by the cap rate, we can find the new value of the property. $88,480/.08 = $1,106,000. That’s right! Making those minor changes increased the value of your property $106k. Your mortgage didn’t change, so you still owe the same — you simply raised the equity you have in the building $106k without putting a single dollar more into the investment. New & Improved Totals To find what the all inclusive return is now that you have added value, add $8,480 you your taxable income, which will result in an additional $2,968 due to the tax man. This takes your new and improved total after tax cash flow to $36,472 — or an after tax cash on cash return of 18.2% Add in your total $120k equity accrued in year one ($14k from amortization and $106k from forced appreciation), and you have an all inclusive return of 78% (($36,472 + $120K)/$200k). Now that you found a way to make all this money, you may be thinking the taxes will hit hard once you sell the property. My first response is, “Why sell it?” This is a fantastic property. Hold on to this cash cow, milk it, pull all the equity out in a cash out refinance, which is not a taxable event, put it in a trust, and hand it off to your heirs. Or if you love the velocity of money and are looking for the biggest bang for your buck, sell it. But do so in a 1031 exchange, which defers all tax into the next property purchase. Do this until you die, and the taxes die along with you. And that is how the wealth is built in real estate. [Editor’s Note: We are republishing this article to benefit our newer members.] Do you agree with this assessment? Why or why not? Let me know your thoughts with a comment! Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Nothing hurts a real estate investor quite like writing a rent check, especially for their own offices. But there are subtle aspects of a deal that can help you buy your own space without disrupting your monthly budget. Here I was with a successful real estate company and a teaching and training business, yet I was leasing our office building for $2,643 a month. As investors, once we know the proper techniques to buy on terms without using our own capital or signing personally and pledging assets, it makes any training we get all that much more worth it—especially if we can purchase our own home or office. Looking to Buy Office Space It may run contrary to the for-profit mode many get stuck in, but buying your own space is an investment in yourself and your business. Of course, it’s more complicated than simply wanting to own your own office. The timing should be right, and factors like location and room for growth should be considered. And then there’s the deal itself…. When we decided to look for a larger office space for ourselves to accommodate our expansion, the properties that matched our needs and wants were running from $3,800 to $5,000 per month—enough to make anyone cringe. So we started looking to potentially purchase on terms (which also happens to be what we teach other investors to do). With energy focused in that area, results came quickly. A Realtor referred us to a property for sale by owner near a busy intersection. It happened to be one I drive by all the time, yet I totally missed this property. The seller was not new to real estate and had obviously done his homework to find this prime location 22 years ago. Once we were introduced and talked more, he took care of the Realtor fee and chose to deal with me directly. Negotiating a Terms Deal In talks with the seller, I learned he owned massive amounts of real estate in the area (mostly land). He originally bought this property for his son to use, but his son had moved out of state. With both of us in the business and a sense of trust built by dealing directly, we did this deal without a purchase and sale agreement. I’m a handshake deal kind of guy and would love to do more of them, but it’s just not safe or realistic to do with everyone. There was no deposit, and the seller gave his word he’d take the “for sale” sign down the next day. It also turned out our attorneys were in the same building, so we’d let them close the deal when the time came. Related: When You Should and Shouldn’t Consider Rent-to-Own Investing Breaking Our Own Rules As I’ve often said, there are times when an experienced real estate buyer will pivot in a particular deal. Our own deal included several aspects, any one of which could be a useful and advantageous way to structure a deal of your own. The seller was initially advertising owner financing with the property listed on the market for $650K. He wanted a 20 percent down payment and a mortgage of 20 to 25 years at 5.5 percent. By the time we were dealing with him, the price was slashed to $565K. We came back with a slightly lower offer of $550K and different terms. These terms were based on me not wanting to exceed our then $2,643 monthly lease payment, and we reverse engineered our offer in that way. At the closing, we put down $35K, which was coming in from ongoing terms deal as the first and third paydays as opposed to personal savings or business reserves. Remember, when structuring terms deals the way we do—lease purchase and owner financing—we have three paydays. Oftentimes they’re over a set period, which gives us a nice projected payment schedule to count on for income and business building. I consider it a reallocation into a greater investment. One of the more nuanced aspects to the deal was to ask for three months of no payments after the deposit. This was to avoid an overlap of paying rent on the leased space and on the new office space, and it freed up roughly $8,000 to use on moving and building improvement costs. Just being free from paying double that first month and having available funds to get the new refurbished property to meet our needs was a great aspect to this deal, but we added even more. Related: 4 Reasons Negotiating Regularly Will Make You Richer, Wiser & More Confident After the three months of no payments, I negotiated four months of fixed, principal-only payments at $2,500 monthly—a rate lower than our previous lease payments. That put another $10,000 down on the principal. While it may seem like this is purely delaying payment, we structured a large sum payment for month eight and allocated funds for our incoming terms deals to pay another $15,000 that month. A structured, reliable cash flow from our other deals made this deal possible. We set the balance on the loan to start amortizing (including interest, which we usually don’t do in our investment deals) in month eight, not day one. So with that last payment of $15,000, the seller got the desired $60,000 deposit total and then it became more of a conventional amortization of the $490,000 balance. Our new monthly payments toward the $490,000 remaining principal paid at 5.2 percent, which I negotiated down from 5.5 to keep those payments under $3K. Yes, $2,921 is north of the $2,643 lease payments we’d been making in our old offices, but we now owned the space and did not disrupt our monthly budget to get there. We also had three-and-a-half times the space and additional rentable suites from which we could profit. There were two existing tenants in the building. Both were there over 20 years (remember, the owner had the property for 22) and never had an increase in rent. I met with them both and negotiated a $1,550 per month 24-month lease on one and a $550 12-month lease on the other. So the month immediately following closing, we had a nice $2,100 income coming in to offset our outgoing cash. That $2,100 covers most of our payment (not counting taxes and insurance). The Structure of the Deal $35K deposit No payments for 3 months Fixed, principal payments for months 4 through 7 ($10K applied to principal) $15,000 on month 8, stashed each month from terms deals and rent coming in from tenants Traditional monthly payments on remaining $490K Interest negotiated from 5.5% to 5.2%, so monthly payments were under $3K 20-year term ______________________________________________________________________________________ When the real estate market gets hot, it’s investors with negotiation know-how who get the deal. In The Book on Negotiating Real Estate, J Scott, Mark Ferguson, and Carol Scott combine real-world experience and the science of negotiation to cover the negotiation process and boost your odds of reaching a profitable deal. Pick up your copy from the BiggerPockets bookstore today! ______________________________________________________________________________________ Do you rent office space? Would you consider buying? Why or why not? Leave a comment below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

A little over four years ago, my brother and I walked into a ugly house built in the 1800s that had an obsolete floor plan and over a century of deferred maintenance. That junky old house was the first piece of true investment real estate we ever bought. That property kicked off the journey that four and a half years later led us to our most recent purchase of a multimillion-dollar apartment complex. In this article, I walk through exactly what it took and the steps along the way. The Road to This Point Was Far From Easy By leveraging our skills in particular trades, we were able to rehab, rent, and refinance a bunch of these 1-5 unit buildings over a 3 year period. Pair that with 17 fix and flip properties, and we were fortunate to have the ability to pursue our larger goal of buying apartment complexes while also maintaining our existing portfolio. To get to this point was hard! There are far easier ways to go about growing a successful real estate investment business. At the time, unfortunately for us, we simply were not aware of those other ways, so we just did it whatever way we could figure out. What we lacked in sophistication, we made up for in work ethic. We were not and never will be the smartest at this stuff. Actually, in the beginning, we didn’t know much at all. The reason I bring this up is I don’t want to make it seem like this is easy, but at the same time, I want people to realize anyone can do it—if you’re willing to sacrifice and work hard to get there. As we continued to put out heart and soul into the business, it grew to the point where we needed help. At this time, we brought on a over-qualified property manager/bookkeeper with the agreement we would bring him on as a partner later to run the asset management after a proven year of success. I’ll tell you more about him later in the article. Why We Did Not Use Private Investors’ Money Before I dive in, I feel it is important to explain how we paid for this apartment complex and why we did so the way we did. Real estate investment education is flooded with no money down and how to use other people’s money to boost returns and enter the game. Because of this, some may wonder why we went such a standard route by using conventional financing to purchase this apartment building. Although we used bank leverage, we still had to come up with almost a half a million dollars to complete the purchase. Being that this was the majority of my brother’s and my own saved money from the previous 4 years of hard work, many asked why we didn’t just bring on outside investors. Actually, by this point in our career, we had quite a few people notice our growth and offer to participate by being investors. Related: How to Start Investing In Real Estate at a Young Age (or a “Young at Heart” Age) The reason we did it with our own money is because we have always believed before borrowing private money, one should prove the concept and your ability with your own money first. Not to say using private money is wrong; we actually run our whole business model around it now, but for us, it was important to first prove it with our own cash. At the time, we had proven to ourselves in the smaller unit buildings, but never in the large commercial niche. We did not doubt our abilities but were adamant about sticking to this for our own personal standards. Because of this, we rejected offers from outside investors and went in on the deal using only our cash to fund the needed cash outlay. Determining What Type of Property We Were Looking For So it was time to buy an apartment! We were pumped because from the beginning of our career, we realized to achieve our long-term goals, ultimately we needed to get into larger apartment complexes. That’s all great—but what did we want to buy? Answering that question was harder and more important than I anticipated. Fortunately, we had the right partners to answer this question! With my brother’s degree in Economics with a focus in real estate, our third partner’s Masters in Accounting and his CPA, and my degree in Marketing, paired with our strong experience in real estate and construction, we came the conclusion that the following points were the general guidelines of what we were looking for in a multifamily asset. Financial Metrics Price range: $500k-3 million Asset class: C-B Cap rate: 6% or greater Median household income: >$35,000; preferably $50,000 range Target Market Cincinnati metropolitan area Property Type Distressed properties welcomed Value add strongly welcomed Built 1980s or later PVC drain lines Separate gas/electric Pitched roof preferred Brick exterior preferred Obviously, there were much more detailed analyses when it came to sub markets, but we found this short general list to be so important when it came time to begin building relationships with brokers. The multifamily industry is not easy to break into, especially in a hot market like we are in. A clear one-page document like this at least allowed us to clearly show brokers what we were looking for and separated us from just another phone call tire kicker. Finding the Deal We knew the multifamily industry was hot and competition was high. What we found is in the price range (up to $3 million), it seemed buyers were willing to pay outrageous prices. We heard from many brokers that buyers under $3 million were high income earners, buying mainly for tax benefits. This allowed them to be comfortable paying far more than we were willing to. Brokers knew this, sellers knew this, and we now knew it. It was disheartening for sure, but when times get tough, I go back to my roots. No mater what the obstacle, we will always have work ethic, so work harder is what we did. I built a list of all the brokers who had any multifamily listed in our target areas. I made lists from the public record websites of all the owners who had bought or sold property zoned multifamily in the past 15 years in our target areas. And I called them all. I called a minimum 5 brokers and 3 owners a day, EVERY day. After about 3 months, I had circled back on my list a couple times and called a big time broker in the area to remind him of the purchasing criteria doc we had sent him and to let me know if he had anything. That’s when he said, “Yeah, actually I have one that meets what you want perfectly that’s been under contract quite a while, but I just got word it’s about to officially fall out of contract here in the next few days.” I asked him to email me with any information he had on the property. And I would call him back by the end of the day to schedule a walk through if we were interested. The property hit most, if not all, of what we were looking for. Purchasing the Property After reviewing financials and walking the property, we were ready to move on it. We knew that like any real estate deal big or small, when everything lines up right, you have to be quick on the trigger or it will be gone to someone else who doesn’t pause. We were one of three offers; the other two had done deals with the broker in the past and were known in the multi family market. Despite this ,we convinced the seller to accept our offer. We did this by being willing to pay more than the other bidders. I know you’re thinking, “OK, great, this guy’s purchasing strategy is to overpay?” Yes and no. I’ll explain. What we realized when looking at several other properties and competing against the high income earners that buy mostly for the tax benefits was that they are not creative because they don’t have to be. They simply run the analysis in a spreadsheet, take the NOI, divide it by the cap rate, and say, “This is what it’s worth. I’ll pay 90%-100% of that.” Because of this type of buying, we realized we needed to see something that others were missing. This building had just what we needed. Related: How I Went From $100,000 in Debt With No Job to Debt-Free in 5 Years The property was in great shape—built very well in 1989 by a well-known builder and maintained well. Occupancy was hovering above 95%. BUT we realized three opportunities the others may have missed, which made us comfortable to bid just enough higher to have the seller accept our offer. In the end, we bought it at 93% of asking price and 89% of the appraised value. The 3 Opportunities We Noticed 1. Sub Meters During our walk through, with our background in contracting, we realized the water lines were run individually to each unit for both hot and cold lines with their own hot water heaters in the units. But the property was still master-metered, with the landlord paying a $29,000 water bill each year. During due diligence, we found that it would cost us only $200-$250 per unit to put wirelessly read sub-meters in each unit for water. This would allow us to have all water billed back to the residents, which is common practice in the area. With rents being slightly below market as they were when water was included, we were confident that adding water bill back to residents would not drive residents out. And lastly, we found from other large investors in the area that total water consumption decreases 30% when tenants are responsible for the cost of water. This means you decreases your expenses X, but you only increase the residents cost of living 70% of X. 2. Storage Units There were eight total 10’ x 13’ common area laundry rooms through out the complex, only four of which were being used. The others were empty, locked, and the current owner never had the key. During due diligence, we surveyed every resident and asked, “What would make your living experience better?” We had a large amount of residents request extra storage space, which was not available. We then followed up by asking them, “If a 30 sq. ft. storage unit was available in the building for $29 a month, would you rent it?” We had lots of residents agree. This meant the unused old laundry rooms could be remodeled into storage units for rent. Four rooms were doing nothing as they currently sat, so all we had to do was spend $500-800 dollars to have some basic storage units built in each of them. The other four would come later. 3. Washer and Dryer Hookup Each unit was equipped with washer and dryer hookups in the units, but coin laundry was the only option available for residents. After the year or so it will take to transition all residents onto sub-metered water, we will be left with another opportunity in year two to remove the coin laundry from the common areas, fill those rooms with storage, and begin renting individual washers and dryers to each unit. This process will take roughly 24 months to complete. All the while, we will never raise rents one penny. With our rents only being 17% of of the median household income, we are comfortable even with these additional optional expenses, our residents will not be over-extending their means. Through this, the value of our property is projected to increase close to $425,000. This is why I now say spreadsheet analysis is a commodity. It is basic math that everyone can do. There are free spreadsheets online to plug in the correct income and expenses in the correct slots, and out pops a value. The real value comes from creativity between those lines—seeing value that has been left unnoticed for years and exposing it. Financing Through our sacrifices, we were fortunate to have enough money to put a down payment on this property and secure the rest from a local portfolio lender, as I have mentioned at the beginning of the article. But how do you get a bank to lend you all that money? We have used the same 2-3 lenders for the entire time we have been in business, but have stuck to one primary lender. This lender is a small, two-branch portfolio lender that we work very well with. We knew we wouldn’t be the strongest borrower on paper to be asking for the size of loan needed to buy the type of building we wanted. Because of this, in 2015 we decided to move our business accounts into our primary lender not only so that they could see the transactions in detail, but also so that we would be one of their large account holders. With income like cash-out refis from our other properties, we did not have taxable events, and therefore, they never show up on a tax return. However, if the bank sees money going into their accounts and sitting there, they become more and more comfortable. Once we had the property under contract, we went to our lender to present the deal. They gave us conditional approval for a 75 LTV loan at 4.75% interest, 5/5 ARM, 20-year term. We were pumped! The bank was going to lend us the money! After the excitement calmed, we wised up and began to shop to deal around to our other lenders. After a few rejections and much back and forth with two banks, we end with our initial primary lender. The loan structure was: 80% LTV 4.25% interest 5/5 ARM 25-year amortization 20-year term Minimum closing costs No pre-payment penalty after 12 months We pushed very hard to get one of the lenders to 80% LTV. They were very resistant based on the fact that this was our first larger apartment and that our personal financials didn’t look awesome based on the fact that we are self-employed and much of our income comes from non-taxable events like cash-out refis. After hearing “no” several times on the request to go from 75% to 80% LTV, I offered to deposit the 5% difference (roughly $100k) into a CD at their bank for 6 months. This would allow the bank to benefit by being able to go lend out the CD money and earning more interest on it. Actually, due to the fractional reserve, the bank was allowed to lend out roughly 10 times my deposit. This was an offer they couldn’t resist. This would also give us our money back in 6 months to use elsewhere. Ultimately, we agreed to a 12-month CD. In the end, we were thrilled with the terms we got. There may be better out there, but for our specific situation, these were great terms. Related: Behind on the Path to Financial Freedom? Here’s the Good News You NEED to Hear Taking Ownership After closing on the property, we held a cookout for our staff to introduce them to each other and to meet the residents and answer any questions about the welcome letter we had sent out explaining our procedures. Shocking even to us, we had every single resident pay that first month with no issues! The business plan continues to chug along just as we predicted, and within in 24 months of purchase, we should be refinancing and pulling all of our cash back out of the investment. Each Experience Opens New Doors I hope this article inspires others to stick to their plans, make sacrifices, and chase big goals. At the age of 26, I was able reach my goals faster than I hoped and be a part of an awesome journey along the way. Now that we understand the process and our team has executed on this transaction, we are actively pursuing larger opportunities. By reaching the point where we are comfortable bringing in equity investors, we are now actively looking for apartment complexes in both the Cincinnati and Atlanta markets up to a $10 million dollar purchase price. To pursue this goal, I even moved across the country to live in the Atlanta area to learn the market, build relationships, and expand our company. This is just another sacrifice I am willing to make to build a secure foundation on which we can create an empire on for many years to come. [Editor’s Note: We are republishing this article to help out readers newer to our blog.] Investors: What are YOU doing to reach your goals? Any questions about this particular deal? Let me know with a comment! Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! We hate spam just as much as you

Let’s talk about scaling in real estate, whether that means moving from no properties to single family or single family to commercial. In general, we’re just going to talk about taking your business to the next level. To explain how scaling is possible and how to have the courage to take the plunge, I’m going to talk a little about how I did it personally. Starting Out in Single Family Real Estate It all started for me in student rentals. When I was 19 and in college, I started getting the itch to invest in real estate. I saw people around me investing in university towns. Where I was living, a roommate’s dad owned the place. I thought it would make sense to just have people pay you. You own it, and you collect the check. It sounded so simple at the time. My parents didn’t necessarily want me to do this. They wanted me to focus on school. But I was fortunate enough to have other people around me who owned real estate and invested in real estate. It just showed that it was possible. I know not everyone has people like that in their lives. So it may take them longer to realize it’s possible. Long story short, I got into it with a $245,000 property that was 19 or 20 years old. There were five girls living there, close to the college and attending that college. The going rate per person for rent at the time was $500. So five girls at $500 a piece for 12 months, that’s $30,000 a year! The reason I remember this is because I found out they weren’t paying market rents. I thought there was a value-add component to that, even though I didn’t know that’s what you call it. So I got this property, and unbeknownst to me, I was already doing some of the things real estate investors should be doing. Take the 50 percent rule, for instance. I was looking at $30,000 and figured around $18K of net operating income, so what kind of yield does that get me? Related: 3 Rules of Thumb to Size Up Deals Quickly (& Land Properties Before Anyone Else!) It’s pretty good, at least in my market. I know some investors in other areas wouldn’t be impressed with that return. But my market is similar to New York or L.A. Yields even back then were pretty low. That property was on a street called Williams Street. A year and a half later, I refinanced it, and that’s what got me into the next one. The next property was on a street called Marshall Street. That one had six male student athletes living together. Needless to say, I learned a lot. Anyway, I kept this pattern going. I eventually got up to four properties in the college area. Part of my goal at the time was getting to a million dollars in valuation. I thought that would be cool. And that’s one of the benefits of real estate in general—how scalable it is. You should have these short-term and long-term goals. Another one of my goals? To be featured in a Canadian real estate magazine that I always read. It was part of my education to get into real estate. I did it, and it actually helped! It gave me a little bit of credibility with some of the banks I was working with. I held those four properties for years. I only sold them about three years ago. Related: The Ultimate Beginner’s Guide to Real Estate Investing Scaling to Multifamily/Commercial Real Estate What happened is I began working downtown after college. That’s when I started getting into condos. I was thinking that if I bought cash-flowing condos, if there was appreciation and I could capitalize on it, I’d have the option to sell those and parlay that money into something bigger. But those four initial properties that I bought allowed me to break into commercial. How and why? When I sold them, they all had appreciated quite a bit. The amortization (pay down of the loan) was decent—a good chunk of change. I started partnering with someone who works on the multifamily side of real estate. As an agent, my partner Jonathan buys $10, $20, $50 million apartment buildings for clients. This is stuff that hopefully we’ll be able to afford sometime but can’t right now. I saw he was in that market, and it was somewhere I wanted to get. He had a great balance sheet but never bought a rental property. I had a lot of debt, but I had a little bit more know-how when it came to actually being a real estate entrepreneur. So we teamed up and bought an apartment building. It’s 11 units. We still own this today. The rest is history! Our goals now, as we move the goal post further and further, is get to 100 units. Like I said, this is the beauty of real estate. It’s so scalable. Once you get one single family, all of a sudden you’ve socialized yourself with getting two. Then you get five. Then you meet someone who is doing retail plazas or commercial or industrial. And you think, well if they can do that, why can’t I? You really can build something. I wanted to share this to help some people out there who are trying to get into their first property. Then maybe once you get into the first one, you can move onto multiple or even the commercial side. I think commercial is one of the most lucrative places to be in real estate. It’s not for everybody. But especially on the apartment side, you can really scale under one roof. Do you have any questions? Do you like my mustache? How many Luigis out of 10 does it get? Let me know in the comment section below!   Free eBook from BiggerPockets! Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks, and techniques delivered straight to your inbox twice weekly! Actionable Advice for Getting Started, Discover the 10 Most Lucrative Real Estate Niches, Learn how to get started with or without money, Explore Real-Life Strategies for Building Wealth, And a LOT more Sign up below to download the eBook for FREE today! Click Here to Download the eBook Now! 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