Buying a home in America’s largest cities is expensive. In fact, purchasing an average starter home in cities like New York, LA and Boston can, and often does, cost upwards of a million dollars. A residential building, though, is a good investment on many levels as apartment units can generate income for the owner quite easily. Remember, though, that an apartment block also presents some challenges.
One of the effects of high home prices is that they keep people renting apartments. This is why more real estate investors buy into apartment ownership every day. Investing in apartments requires careful planning. Benzinga’s guide to apartment investing helps you find out more about how to do it.
How to Invest in Apartment Buildings
The allure of investing in apartment buildings is obvious. A high-rise apartment building is aspirational and reminds us of The Jeffersons. You buy a building that generates cash flow through tenant rents, which also pay the mortgage, while you sit back and watch your building appreciate in value. That’s how it works in a perfect world. The real world of apartment ownership is more complicated. Not every apartment building is a good investment, and some apartment buildings lose money.
Everyone has heard the adage “let the buyer beware.” This sentiment is especially true when it comes to apartment buildings. They cost a lot of money and are not easy investments to extricate yourself from if you need to liquidate an asset.
All of this means that you’ve got to do lots of due diligence before you buy a building. If not, the apartment building you bought to generate passive income could end up putting you in the red every month.
It’s smart to take a number of factors into account when conducting your due diligence on a multi-family housing investment. The first one is financing. Unlike single-family homes, no federally subsidized mortgages are offered for multi-family housing. That means you won’t be able to finance a building for 3% down with a 30-year fixed mortgage.
You should budget for a 20% down payment and a 15-year mortgage. The first piece of your due diligence is being realistic about what you can afford. Be as conservative as possible with this calculation because other out of pocket expenses will be required before your building starts making money.
Once you have a budget, you need to consider important underlying fundamentals. Remember that an apartment complex is like other businesses; you want to know how much money the business takes in. Study your chosen property’s balance sheet carefully to answer the following questions.
- What is the building’s current occupancy? Most buildings won't generate cash flow if the average daily occupancy is under 96%, and most banks won’t finance buildings with high vacancy rates. You might also need to move out apartment residents if you need to renovate.
- What is the average cost per square foot in relation to the rent? You want the dollar amount per square foot to be as high as possible.
- What is the delinquency rate? A building with lots of unpaid rents means you’ll be paying more of the building’s expenses than you should. What’s worse, you’ll pay out of pocket to evict non-paying tenants.
Aside from the balance sheet, you need to take a good look at the building. Are the exterior fixtures up to date? Is the roof in good condition? What is the state of the plumbing and electrical systems? Many times, owners sell buildings because they require more capital improvements than the owner is willing to make. You need to find out what those needed improvements are before you buy.
Consider external factors such as the local and state tenant laws that apply to your building. In order to combat spiraling rents, many cities and states have adopted rent control ordinances that cap the annual rent increase you can give to pre-existing tenants. If rent control laws exist in the city where your building is, your potential rental upside could be restricted to vacant units.
Find a Partner or Management Firm
Owning and operating apartment buildings by yourself is a lot of hard work. You need to keep on top of bookkeeping, repairs, tenant relations and capital expenses all at the same time. That’s why it’s a good idea to consider having an equity partner who can share the workload.
The good news is that almost every city has lots of small- to medium-sized management companies who are also owners and operators of their own buildings. If the fundamentals of your deal are right, one of these firms may be willing to invest with you. You may also consider buying a smaller building (5 to 15 units) in a business partnership with a friend or associate.
Companies like this can also help you if you want to offer furnished living instead of unfurnished apartments.
In either case, if you don’t plan on handling the day-to-day operations of your building, you will need to hire professional management and factor the cost into your building budget. Most management companies charge between 5% and 8% of the monthly rent. Remember, someone who does this every day is an expert in the field and they work hard to get you your money back.
Other Ways to Buy Apartment Buildings
In the past, the only way to buy apartment buildings was as a sole proprietor or as a member of a small partnership. Now, thanks to the internet and the loosening of government regulations, you can tap into several ways to invest in apartment buildings without having to manage them directly. Alternatives to hands-on ownership and management of apartment buildings include:
- Real estate funds: You can buy numerous well-respected mutual funds and exchange traded funds (ETFs) based on apartment buildings and other income-generating real estate assets. They usually require less capital than buying an apartment building free and clear, but you may also need to be an accredited investor to buy into them.
- Real estate investment trusts (REITS): These funds combine their own money with investor capital to own and operate commercial real estate. The advantage of REITs is that it allows investors to get the benefits of property ownership without having to manage it hands-on.
Are Apartment Buildings Profitable?
Apartment buildings are like any other investment. They can be profitable but come with no guarantee of profit. The big thing to consider with apartment buildings is that although they generate revenue, they still have expenses. Every building has a different range of expenses, but as a general rule, the larger or more luxurious the building is, the higher the expenses will be.
That means you’ve got to do a lot of number crunching before you make a purchase. Once you figure out how much money your chosen property generates, you’ll have to subtract the following expenses:
- Mortgage payment
- Property taxes
- Management fees
- Ancillary professional services (accountants and lawyers)
- Capital improvements
- Vacancy loss
If you take those expenses into account and subtract them from the money your chosen apartment has generated on an annual basis, you’ll have a rough estimate of your projected profit. If it sounds like a lot of work to you, it should. That’s why so many apartment investors prefer REITs and crowdfunded investments to sole ownership.
Disadvantages of Owning Apartment Buildings
Making monthly income from a profitable apartment building is a dream for every real estate investor. However, you’ll want to consider the serious potential disadvantages of owning apartment buildings.
First, there is the time and expense factor. Good apartment buildings are not cheap. They’re hard to find, and even if you get one, you will need to be a hands-on manager to keep the property making money. You must be prepared to look over the books on a regular basis and be proactive about both routine maintenance and capital improvements.
Second, some factors are beyond your control. The old adage in real estate “location, location, location” holds true when it comes to apartment buildings. The neighborhood where your apartment building is will go a long way towards determining what kinds of rents you can expect to collect. Unfortunately, you can’t do much by yourself to change a neighborhood.
Buildings in better neighborhoods will have higher rents but also higher costs. Everything from the acquisition cost to the property taxes and management fees are higher when you buy buildings in quality neighborhoods. You have to find a Goldilocks property that’s affordable, in a good area and still gets good rent. However, everyone else is looking for the same thing.
Third, your apartment building will only perform as well as the people you have running it. If that’s you, you need to commit yourself to being an effective manager, which is potentially a 24/7 job. Remember, toilets don’t only back up between 9 a.m. and 5 p.m. on weekdays. If you’re not going to manage the building, you need to hire high-quality management. Poor management will lead to a lot of lost revenue and could put your building in the red.
Compare REITs, ETFs and Real Estate Crowdfunding Platforms
Owning a multi-family property can certainly be a profitable investment. However, it’s by no means a sure shot, and it takes a lot of work to make a multi-family housing run right. Most investors find it requires too much hands-on work and prefer to invest in REITs, ETFs or real estate crowdfunding apps. If that sounds like the route for you, take a look at this list of Benzinga’s best REITs, ETFs and real estate crowdfunding platforms.
- securely through Nada / Cityfunds's websiteBest For:Accredited and Non Accredited InvestorsRating:
Frequently Asked Questions
Are apartment buildings good investments?
Apartment buildings can be good investments, but they are not guaranteed to make money. If you want to know whether an apartment building is a good investment or not, you need to look at a number of factors.
You have to consider how much the building is making in relation to its cost. On an annual basis, a good apartment usually generates between 7% and 10% of its total cost. However, you must still subtract the cost of expenses like taxes, debt service, insurance, property taxes and maintenance from your building’s annual revenue before you have an idea how much cash flow it generates. In general, buildings with high cash flows are good investments.
However, savvy investors can identify buildings with low cash flow and turn them into solid investments through proactive management, aggressive rent increases and capital improvements.
How much does it cost to buy an apartment building?
The cost of buying an apartment building depends on several variables. A list of those variables includes:
- Total square footage
- Quality of construction
- Desirability of the building’s neighborhood
- Total revenue generated by the building
The better a building is in relation to all those factors, the more expensive it will be. Buying apartment buildings usually costs significantly more than buying single family homes.
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