Your approach when buying a multifamily property should be to only buy properties that will cash flow. You want to be able to pay for them and leave some cash at the end of the day. As a buyer, you want the cap rate to be greater than the prevailing interest rate plus 2%. Cash flow is what is paid after the NOI minus the debt service.
For example: You purchase a 10-unit property for $220,000. The NOI is $27,000 per year. The debt service is $22,000 per year (this is principle and interest payment). So you will take $27,000 and subtract $22,000 and you will have $5,000 per year as your cash flow. That’s not a great cash flow but in this deal there is no cash out of your pocket.
In order to determine your cash flow, you need to keep in mind the cap rate. Your minimum cap rate needs to be greater than 9%. If you follow that rule, then your property will cash flow. If it costs 7% to buy the property and the property returns 9% or more, then there is enough to pay the interest and principle of the loan. The property has enough to pay itself.
You should use 10% as your minimum cap rate. If the interest rate were to go down then that 10% rule would change. The market cap rate would change if the interest rate changed drastically. So your formula for determining cash flow is: Loan interest rate + 2%.
The reason you need to have a 2% buffer is that you want to have a principle and interest payment. Some of the payment is going to interest and some of it is going to principle. The principle is paying down your equity, but from a cash flow standpoint you want to make sure there is money leftover. The more buffer you have the more money you are going to make.
There are people who buy at lower cap rates but they buy on the basis of appreciation. They have other things that they consider such as the area that the multifamily property is in so they will pay less. That is what may drive our market rate down. The competition for deals may go up so the market cap rate may shift down.
If your market cap rate goes down, that is good for you. A decreased market cap rate drives your equity up. It causes your existing properties to be worth more. If the interest rates go down, the value of your property goes up because your market cap rate went down. You can still buy properties above that spread.
Your goal with multifamily properties is to turn a nice profit with as little of your own money as you can. The important thing when examining a multifamily deal is to try and design the deal so that there is cash flow after everything is said and done and the numbers are all crunched. .
An “all bills paid” property means that there is one bill for the entire property and you are paying the electric bill instead of the tenants. As a result, you charge more for rent. You will discover that many properties, especially Class C, will be “all bills paid” properties. You need to weigh the pros and cons of offering all bills paid with your properties.
Typically, you will be faced with deciding whether it is beneficial to switch from all bills paid to individual meters for each unit. Most people are not looking at going from individual meters to all bills paid.
All bills paid properties are usually easier to rent because the potential tenant does not have to come up with a credit check and it is more convenient to have the electric bill included in the rent. The tenants are writing one check to you instead of two separate checks. Another advantage is that if you had a tenant not paying on time, you could have the electricity shut off.
You could convert an all bills paid property to individual meters but it is capital intensive. The tenant will have to get his account set up with the utility company.
The argument against all bills paid properties is that utility prices have been going up and if something is “free” to a tenant, they will not be very judicial with the use of their utilities. The disadvantage is that you can lose money based on usage. You could overcome this by adding a clause to your tenant’s contract that says if the utility bill exceeds a certain amount that you reserve the right to bill back the tenant.
An option would be to leave it as a single meter for the property and put a monitor on the individual units to measure the usage. You can outsource that to a company who will monitor the usage every month.
There is a service that you can pay with a capital cost of $500 per unit. They will put in a measuring device to determine how much electricity is used. For a small fee, the company will measure the usage remotely and bill it back for the electricity used. This is much more cost-effective than putting in electrical boxes for each unit. The cost for actually converting a single unit is more than $500 because you are putting in a new meter box.
If you do offer the all bill paid to your tenants, ultimately, you are still responsible for the electric bill. You are the electricity “provider” so if you are flexible with that, you can charge more rent for the convenience of that service. All bills paid properties have their advantages and disadvantages and it is important to weigh all of your options when considering making a switch.
Are you trying to figure out a way to raise the rent on your multifamily property? You can raise rents through a process called repositioning. Whenever you buy a property and make improvements or repairs or convert a property from a Class D to a Class C or a Class C to a Class B, you are repositioning. There are three ways you can reposition your multifamily property.
1. Cosmetic: You are likely to hear some vernacular in the industry like “putting lipstick on a pig”. This refers to things like painting or landscaping and anything else that is non-structural in nature.
2. Complete Rehab and facelift: This option is more involved. You can put in all new appliances and new carpet on the vacant units and completely rehab it so some of the stuff looks new. The rehab does not necessarily change the class that the property is in. For instance, if you have a Class C property that was built in the 60′s, it will still be a Class C after you rehab it.
3. Put new management in place: If you buy a distressed property that has a 70% occupancy rate and has an existing manger, the first thing you want to do is fire the manager because he probably has bad habits. If you are serious about what you are doing, you want to put new guidelines in place. Clean house and replace the property manager because that is the first step to raising rents and increasing the occupancy.
There might be a contract in place with the property manager but most have a 30- or 60- day out clause for both parties so you would have to give notice. Management contracts are usually pretty flexible.
The first thing you want to do when repositioning is to remove the bad tenants because they are dragging down your property. Other tenants in the complex know who the bad tenants are. You want to get rid of the bad tenants so you can create a family-friendly environment. You want your tenants to feel safe and secure.
Even if the bad tenant is paying his rent on time, you still want to remove him because he is bringing down the rest of the property.
Repositioning offers you a way to raise the rent on your multifamily property. You can either go “all out” and completely rehab the property or go with the less intensive changes of cosmetic improvements or management restructuring. Be sure to carefully evaluate which option is best suited for your needs.
Here is one student’s Aha Moment from Lance’s recent Live Event:
“It was when I realized yesterday that it, that it is at least theoretically possible and others have done it to one deal with my J – O – B.”
Increasing the revenue of your multifamily property does not always mean that you have to add an amenity or a service. Finding additional revenue can be as simple as increasing the rent or increasing the collections.
If you are looking at raising revenues on your multifamily property, there is a very simple formula that you can utilize to help you catalog your different methods of raising revenue.
Your formula for revenues is:
Rent rate x occupancy percentage x collection percentage + other income
This formula gives you your actual revenue. In order to determine your rent rate, you need to take the rent you charge and multiply it by the number of units in the building.
This is also known as your scheduled rent or your theoretical rent.
If you had 100% occupancy and all of your tenants were paying as scheduled, then that is your gross scheduled rent. You need to take this into consideration when you are looking at raising actual revenues.
In raising the revenues, you can raise the rent just as they are sometime by government subsidized rent programs. There are many government subsidized rent programs such as Section 8 housing. Other programs include housing for battered women, people with HIV and the homeless. Some programs pay more than others but it is a way to raise your rents.
You can also raise your rents through repositioning. When you buy a property and make improvements and repairs, you are repositioning. If you convert a Class D property into a Class C property, you are repositioning. This is a way to get more rent as well as increase the occupancy.
If you opt not to raise rent, then you can increase the collections on your existing tenants. Many people overlook this option and go straight to eviction of non-paying tenants. Try to work out a payment plan with the tenant. It is much better to have a payment plan than to evict them and have to go through the process of finding another tenant.
Eviction is a drawn out process. You can always start an eviction process and then stop it whenever you want to. Starting the eviction process can let a tenant know that you are serious about collecting payment. If you are able to come to terms on a payment plan, you can then terminate the eviction process.
So when you are evaluating your revenues and considering various ways to increase revenues with your multifamily property, be sure that you do not overlook the basics of raising rent or increasing collections. These are two simple yet cost-effective ways you can generate more revenue with your multifamily property.
When you are dealing with multifamily properties, it is very important to understand the different classes of properties. The class that a property is assigned can tell you a lot about the property and if it is worth your time and money to invest in. There are four different property classes: A, B, C, and D.
Property Classes are really set by the conditions of the property and where it is located. They are not set by the appraisers. The classes are not something that is formally defined but more of something that is set in the vernacular.
Class A properties, naturally, are the cream of the crop. These apartments are newer and have a higher rent than apartment buildings that are in the other classes. You can actually have a new Class A property in a Class B area. They are classified as Class A because they are new but they have lower rents than other Class A properties because of their location.
Class B properties are multifamily properties that are 10 – 15 years old, well-kept and are in the “middle class” part of town.
Class C properties are in low to moderate income or blue collar neighborhoods. They range in age from 30-40 years so they have usually been through at least one rehab. The average rent for a one bedroom is $400 – $425.
Class D properties are in very bad neighborhoods. These are in high crime neighborhoods; neighborhoods where you do not want to get out of your car. You generally do not want to work with Class D properties.
If you are going to do Class D properties, you need to be in that niche. You are not going to turn around a Class D property without turning around the neighborhood that it is in. Class D properties are suffering from a neighborhood problem and not a property problem.
Class D properties are bought only because they are cash flow machines. You will not get any appreciation on them. They require intense management and heavy security.
Class C and lower Class B multifamily properties are your bread and butter and they do not offer many amenities to tenants. The further you go down from Class A to Class D, the better your cash flow. The premium deal is finding a Class C property in a Class B area that you can reposition.
If you could find a property that is considered a Class D because of its condition but it is in a Class C neighborhood, you would have a great deal. In this case, you can come in and clean up the property by either making a physical change or a security change to it. You can buy it low, make the changes that are needed and then sell it for a great profit.
Your understanding of the property classes enables you to effectively assess the potential value a multifamily property has as an investment for you. You can then more easily decide if it is deal that you would like to pursue or not.
Toni Ward, a graduate of my program, was interviewed about her first successful multifamily deal. Toni debunks the myth that you have to “graduate” from single family housing to multifamily housing.
Listen as Toni shares her experience and what she learned through the process.
Face your fears head-on.
Lances says: “Do your feared things first. Because that’s what’s the huge energy block that’s holding us back. Again, the first olive out of the jar is the hard one.”
Jim, a student of Lance Edwards’, adds his own observations:
“All the people working the program call them brokers from day one. The person’s going to think “He’s really hopping right into it.” Well, that’s exactly what you want and just practice. Then don’t think, like, if somebody finds out you’re new it’s any big deal. You don’t know it’s not their first day on the job. We all have assumptions.”
Rich Hadden, a graduate of my Raising Private Money Program, was recently interviewed about his experience with my programs and how I made all of the pieces fit for him to be able to put together his first multifamily deal.
The key ingredient to putting together a multifamily deal lies within your ability to raise private money.
You need to know how to “cap out” a property or create value in a property. If you are going to wholesale properties, you need to understand this concept because it improves your ability to package your deals for sale to another buyer. Understanding Market Cap Rates is vital to increasing value in multifamily properties.
The better you can communicate what could be done to a property and how to make money with a property, the higher the assignment fee you can get when you sell that property.
It will have much more impact if you can say, “I have a 50 unit apartment building that is currently at a 9 cap that could easily be at 11.2 cap if you do these things” instead of saying, “I have a 50 unit property, do you want to buy it?”
The more educated, empowered and knowledgeable you sound, the more value you bring to the deal whether you are going to hold it or flip it. In order to do this, you need to understand the Market Cap Rate. This is the cap rate that most properties are trading on a retail basis. The Market Cap Rate can vary from city to city.
As more demand increases in the market, the Market Cap Rate goes down because people are getting more excited about the appreciation. The demand is driving the price.
How does knowing the market cap rate help you? It helps you in terms of determining the value of your property or selling your property. You know that Cap is the NOI divided by the price so you can turn that around and say that the price equals the NOI divided by the Market Cap.
So if your NOI is $27,000 and your Market Cap is 8.5%, then the value of your property would be $317,000. If you paid 220,000 for the property, your equity would be $97,000 ($317,000 – $220,000).
The way you create value in apartments is by raising NOI. Knowing what the market cap rate is allows you to immediately assess the value. If you want to know how much your property will be worth if you do some improvements, just divide it by your Market Cap Rate.
When you are analyzing a property, you want to buy at a high cap rate but you want to sell or refinance at a market cap rate. An appraiser will look at the market cap rate to assess the value of your property. If you just bought a property, you will want to wait twelve months before you refinance.
The more knowledge you acquire regarding your market and the property, the more you are able to accurately assess the property and in turn, create more value. The Market Cap Rate is just one tool you can use to create value.
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