Advice on making the jump?

Question

I would like to get into  commercial apartments (say 20 unit) - but the only way to raise the cash would be to sell my residential multifamily properties. I have 4. I could likely then raise 200k.

Should I sell? Is it worth it to make the transition? I think I am feeling some growing pains. Any advice, experience, encouragement appreciated.

Jon Holdman · Answer

Well, at least one poster here, MikeOH, has something like 100 SFR rentals, and manages them himself.  Look around for his posts, and read about his experiences.   Its not all goodness and light, but it sure doesn't seem like a management nightmare.  So, I don't think there really is any point where you HAVE to jump.

That model doesn't work for me because prices 1) SFR prices around here are way, way out of whack with rents, and 2) I don't want to do it long distance.  So, I'm looking at small apartment buildings.  Those have a much better price/rent ration.  I've read a couple of books (Steve Berges, David Lindahl) on the topic.  I've spoken to my mortgage broker about what kind of terms I can get for various scenarios.

Are the places you have now really making money?  That is, if you assume expense are 50% or rent, or use the actual expenses - which ever is higher, and deduct the expenses and debt payment form the rent, do you have cash left over?  If so, then I see a couple of choices.  One is to accumulate that cash flow until you have enough.  Another is to borrow against the existing units to generate a downpayment for the apartment.

If you're not really making money on the existing units, based on the above formula, then selling would be the right thing. Regardless, when you sell, the costs are high.  You say you could raise 200K.  Is that after considering all the sales related costs?   Take roughly 8% of the selling price off the top for sales costs, subtract the loan balance.  What's left?  Borrowing to get your equity may be easier than selling.

Ideally, you would do a 1031 exchange if you wanted to get rid of these properties and roll the money into a bigger one.  Selling four units, buying another, and getting it all done within the time frames will be tricky.  You might work with a commercial broker who could help you sell you four current buildings as a portfolio.

I'll still contend it comes down to numbers.  "Management nightmark" can be quantified into hours the management takes.  If you don't want to do the management yourself, then your property manager should do it for you, and greatly reduce your effort.  You won't be earning the property manager's cut.  30 tenants are 30 tenants, regardless of where they housed.

I do see some economies of scale.  An apartment building has one roof per every, what 10? 20? 30? units.  A triplex has one per 3.  The apartment roof is going to cost more to maintain, though, and a lot more people are going to be upset if you have  major problem.

Figure out what you're making now.  Figure out what you can make if by buy 10 more triplexes.  Figure out what you can make if you by a 20 or 30 unit building.  Do whatever reaches your goal.

Jon

Scott Scribner · Answer

You are right on your advice on the numbers. I have duplex, two (2) triplexes, and a quad.

The problem is I don't know what 20unit commercial deal I might stumble into in the future and if I am not prepared for it (haven't sold mulits, no cash), I will have no possibility of buying it.

I guess I was hoping for more general advice. For instance, growing now might mean having 10 triplexes. You might tell me, its a management nightmare. The only way to grow is to go larger. And economies of scale always win out financially. Is it true? I seem to be answering my own question(s), but are these the right answers? I could by more triplexes. At some point of growth one has to jump. Perhaps the question is WHEN. So when?

Scott

Jon Holdman · Answer

Do the numbers.  Can you sell the small properties, but the apartments, and make more money?  Be sure to include all the transaction costs.

Commercial and small residential properties are driven by different factors.  SFRs are priced based on comparable sales, and are strongly tied to demand and the ability of people to buy them.  Apartments are a purely income play, and are priced based on their ability to generate income. Duplexes, triplexes, and quads are in between, and are driven somewhat by both, seems to me.

In my area, for rentals, apartments have a much better return than SFRs.  The downside, as you've noticed, is the money required to get in.

Jon