Real Estate Investing: Houses vs. Apartments

There is a saying in real estate that you make your profit when you buy and get your cash when you sell. When deciding whether to invest in houses or apartment buildings, be aware of the differences when it comes to creating value. Investors are looking for a good return on their money. Make sure you keep this goal in mind and don’t get caught up with other aspects of real estate.

One broker said that apartments are real estate and houses are feel estate. The difference is that the value for apartments is based on numbers. The value of single family houses is based on a number of subjective attributes like wallpaper, carpet, paint, location, and many other factors you can’t control.

Apartment values, on the other hand, are based on the numbers and the net operating income. The more net operating income you generate, the more money you can put in your pocket when you refinance or cash out. Multifamily real estate investors have a larger degree of control over the revenue and expenses of their real estate than investors in houses. Apartment investors can estimate the value up front and even predict the value of the property if certain changes are made. For instance, if the owner of an apartment building raises the rent by $10, he can know exactly how much money will be coming in each month.

Single-family investors have to play more of a guessing game. An investor could spend several thousand dollars replacing carpet in the hopes of increasing the value of the home only to discover that the next potential renter hates carpet. The value of upgrades is subjective, and it’s difficult if not impossible to predict what will really add value and attract tenants or buyers.

Clearly, investing in apartment buildings offers a much greater degree of control and security than investing in single-family housing. If you like to be able to predict success based on numbers and follow through to that success, multifamily real estate is right for you.

Aha Moment Video: Position of Strength

A position of strength is very important in any real estate transaction.

Jim Craig, a student from one of my classes, had an “Aha moment” regarding this very thing.

I’ll let him speak for himself:

“They say we need proof of funding or to know how strong the investors are before we bring this agreement in front of a seller.”

“My response back to him is we have enough money to cover a 20% down payment, and frankly, my clients are not about to release their financials unless they have something concrete, a signed deal. When they pass that information back to the seller, the seller says, ‘That’s fine. No problem.'”

Aha Moment Video: Beginning With the End in Mind

Why are you doing this?
If you have the answer to that question, you’ll find yourself in a great place. If you begin this business with the end in mind, you’ll always have motivation to be your best.

Here’s what one student had to say about beginning with the end in mind.

Beginning with the end in mind, you know that once you create financial freedom, you can come from a different place from that point on because now the bills are taken care of and you can really be in charge of your deals.”

What is “the end” in your mind? Is it financial freedom? Is it security for you and your family? Listen to this student’s “Aha Moment” and see if it resonates with you.

Asset Management vs. Property Management

The ability to improve real estate properties, particularly multifamily properties, boils down to being a good asset manager. Asset management is different from property management. Property management is the day-to-day operation of a multifamily property, involving such matters as keeping the property up, collecting the rent, and maintaining it. Asset management, on the other hand, is adding value to a property.

Whereas property management can feel like drudgery at times because the tasks are usually the same, asset management is the fun part where you get to use your creativity. The purpose of asset management is to increase equity by raising the NOI (net operating income) to cap out the property.

Asset management involves the following four areas:

1. Property management. You may start out as the property manager for your apartment building, but your long-term goal should be to work as asset manager while making sure the property manager you’ve hired is doing his job. The better your property is managed, the greater your NOI will be. Proper property management affects the value of your property because it will affect your collection rate. A good property manager will decrease the vacancy rate and keep the current tenants happy.

2. Repositioning. Repositioning is changing the appearance, reputation, and image of the property. It involves capital if you are rehabilitating properties and changing the tenant mix. It might mean converting an “all bills paid” property to an individually metered property. Many times repositioning has to do with the reputation of the property, and therefore, you may need to change the property’s name. Some property owners put out a sign that says, “under new management,” but a brand new sign including a brand new name is even better.

3. Adding income sources. Apartment owners can add income sources to their properties by installing vending machines or adding Laundromats. Be creative when thinking of ways to add income sources. Perhaps your tenants have a need for storage; add small storage units for rent. Other possible sources for income include an onsite daycare center, cable television, an exercise room, clubhouse rental fees, pay phones, house cleaning services, and Internet access.

4. Reducing expenses. Reducing expenses means looking at every expense as something that can be eliminated or reduced. That said, landlords have a responsibility to their tenants to provide safe and decent housing, but with creativity, you can find ways to cut costs. Perhaps the previous property owner hasn’t shopped around for better deals on insurance, repairs and maintenance, pest control, security, and lawn care. By lowering one or more of these costs, you can increase your NOI, thus adding value to the property.

How to Profit with Fourplexes

Fourplexes are popular properties for investors who are graduating from investing in single family homes but don’t yet feel ready for larger apartment buildings. One of the great things about fourplexes is that you can buy a fourplex and get some tenants for it and then hold it for fifteen years and let the tenants pay down the mortgage for you. All the while, your equity is building and you are reaping depreciation benefits.

Be aware, though, that buying and operating a fourplex is different than buying and operating an apartment building. Take note of the following differences if you’re interested in buying a fourplex.

1. Market Research. When looking for an apartment building, you will use the NOI (net operating income) as a base measurement to compare properties. Based on the NOI, you can figure out what the Cap Rate would be, and then you will know whether or not the property is worth your time and money. With a fourplex, however, the Cap Rate is really low. It’s difficult to get fourplexes that cash flow. They’re better for holding long term in order to build equity. So when you’re researching fourplexes, you’ll have to use comparables, like you would if you were looking for a single family house. Fourplexes are considered residential properties, even if they’re run like multifamily properties.

2. Loans. When considering a fourplex, a bank will look at the strength of the borrower and then the potential for payback on the loan. Lending for fourplexes is similar to lending for single family homes, but there is an occupancy component to qualifying the loan. A fourplex in an area where vacancy rates are low will qualify for a loan easier than a fourplex in an area with high vacancy rates.

3. Resale. There are a lot of buyers for fourplexes, even out of state. If a neighborhood is beginning to look up, then fourplexes in the neighborhood will move up in value, and buyers will be plenty. Again, fourplexes are often stepping stones between single family homes and apartment buildings, so there are generally more buyers for fourplexes than for larger properties.

Depending on your investment strategy, fourplexes may be the right investment for you. Keep in mind that market research is based on comparables, that occupancy is a factor in getting a loan, and that the neighborhood will affect your resale, and your investment should be a success.

Apartment Brokers Are Your Deal Source

Brokers can be valuable members of your team when you invest in real estate. When using a real estate broker to look for commercial properties, there are a few points you should keep in mind.

1. Know which broker you’re dealing with. You can sign up on a broker’s website and get emails full of potentially good deals, but the brokers will use other brokers’ deals, and it’s difficult to know who the originating broker is. The problem with this is that the originating broker will know all the details about the property and situation and other brokers will not. You need to be able to reach the person with all the details of the property so you can make an informed decision.

2. Understand that not all properties will have a listing agreement with a broker. Sometimes brokers will list multifamily deals but won’t have a listing agreement with the seller. Some sellers don’t want to commit to one broker because they don’t want to be limited to a greedy broker who won’t consider co-brokering a deal. Sometimes sellers will agree to pay the broker a percentage if they find a buyer, but the sellers don’t actually sign a listing agreement.

3. Be up front with the seller about the role brokers will play in your real estate transaction. You may find out about an apartment building on your own and be in negotiations with the seller when a broker steps in and wants a commission. You might know more about the property than the broker does at this point, so make sure you have an agreement with the seller about what place a broker has (if any) in your deal.

4. When asking for a broker’s help in finding properties, be specific about what you’re looking for. The best brokers are very busy and don’t have time to waste hunting down properties for people who probably won’t be serious about them. If you say to a broker, “I’m looking for a Class C property, 50 units, a value play, less than $25,000 per door,” then the broker knows you are someone who knows what you’re looking for. You sound stronger, and you hold more sway.

5. The broker fee on commercial properties is generally the same as the fee for residential properties. Figure on paying around 7% to sell your apartment buildings and other commercial properties.

As you search for multifamily real estate properties, be aware that realtors can help you find good deals. But don’t rely solely on their advice and resources. Use all of your options to help you build your wealth and acquire properties.

Pros & Cons of “All Bills Paid” Apartments

One of the decisions you as an investor will make when you own an apartment building is whether or not to advertise the apartments as “All Bills Paid. ” In an “All Bills Paid” apartment building, there’s only one bill for each tenant that includes rent and all utilities. That means that you as the owner are responsible for taking care of the utilities. What are the pros and cons of this scenario?

Pros

Easier to Rent. “All Bills Paid” apartments are easier to rent because tenants enjoy the convenience of not having to worry about utility bills. They’re also easier to rent because the tenants don’t have to come up with a credit check or a deposit for utility companies.

Simplified Accounting. The owner only pays one check each month to the utilities company for the entire building.

Potential to Increase NOI. If you calculate conservatively on utilities usage, you could potentially increase your NOI (net operating income) with “All Bills Paid.” If you’re charging $250 on top of rent for utilities, but utilities actually cost you $200, you have increased your NOI.

Cons

Could be Costly to the Owner. When tenants aren’t monitoring their own utility bills, they’re less judicious about conserving energy. If electricity is “free,” they won’t worry about leaving the air conditioning on while they’re away for the day. Meanwhile, the building’s electricity usage is climbing, and you will end up footing the bill.

Friction Among Tenants. If you have to raise rents because utilities prices have increased, some tenants may complain that they have been conserving energy while other tenants have been wasting it. Usually, the tenants will work this out among themselves, but the property manager will likely hear about it.

Considerations

If you are concerned that an increase in utility charges or excessive usage by tenants will hurt your bottom line, you could add a clause to the contract that says if the utility bill exceeds a certain amount, the property manager reserves the right to bill back the tenant. This increases tenants’ awareness of energy consumption.

If your building is set up with a single electricity meter, you can put a monitor on the individual units to measure usage. You can outsource this service to a company that monitors usage every month. This can be helpful in determining which tenants are overusing energy.

“All Bills Paid” apartment buildings are Class C buildings . If you own an older building and wish to simplify your accounting, attract new tenants, and potentially increase your net operating income, consider converting to “All Bills Paid.”

Apartment Sellers: The Basics

With any real estate, single family or multifamily, sellers may be quite attached to their properties. Sellers’ pride in their properties can make negotiations exceptionally difficult at times. When evaluating a multifamily property, buyers need firm details about rents, occupancy, cap rate, and so on. But how do you get past a difficult or emotional seller?

1. Walk away from an unreasonable deal. Sellers can afford to throw out unrealistic numbers if they have plenty of time to sell. They put a price out there under the bigger fool theory and wait for the bigger fool to show up. As a buyer, however, you need to know how to evaluate a deal and walk away from one that won’t help you meet your goals. This can be difficult when you find a beautiful property and you’re anxious to invest. Have the determination that you’re looking for a good deal and you won’t settle for anything less. Your patience will pay off.

2. Make an ally out of a difficult seller. When you come across a seller who has set a too-high price for a property, you can build a relationship with him even if you can’t buy his property. For example, you could say, “It sounds like you have a beautiful property and I’m looking for a value play. Your property is not probably one I could look for here, but are you looking for other deals in the area? If I come across a deal, maybe you’ll want to buy it or invest in it.” You’ve just made a contact with someone you can do business with in a different way.

3. Be specific about your requirements. Some sellers have not thought through the finances of their property and may not be able to talk with you about its market cap rate and net operating income. But you can do the research and find out the details. Then, if the price is just too high, you can leave an offer you can afford, an offer that will give you a little cash flow and be a workable deal. You can tell the seller that you realize it’s a low offer, but it’s all you can do. He can consider it a backup offer in case he ever needs it. If no “bigger fools” show up, you may well get a phone call.

Remember that you’re going to come across all kinds of sellers. Try not to write anyone off completely. If you keep your mind open and your goals in sight, you can come up with a good deal and possibly a greater network of fellow real estate investors in your area.