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.
You want to invest in multifamily properties, but with all the apartment buildings in your city, you could spend all your time looking at them, analyzing them, and comparing them without ever getting anywhere. You need a simple, effective way to analyze buildings to save you time and help you make judicious decisions. The following three guidelines are all you need to rule out unprofitable deals and narrow in on the best.
1. Cap Rate. Cap Rate is an abbreviation for capitalization rate. It’s the return on investment on a percentage basis if you paid all cash. The formula for Cap Rate is NOI (Net Operating Income, which is simply your revenue minus your expenses) divided by the purchase price. Here’s an example: You have a property with a NOI of $50,000 per year. You paid $500,000 for the property, so the property has a Cap Rate of 10%. It’s wise to look for properties that have a Cap Rate of at least 10%.
2. Price Per Door. The price per door is simple to calculate. Just divide the price of the property by the number of units. As a general rule, if the price per door is less than $25,000, it will probably have an acceptable Cap Rate and cash flow. The price per door also tells you the class of property you’re dealing with and whether or not it’s a deal for you. However, it isn’t wise to look only at the price per door without analyzing the other two guidelines. You may miss out on some key information that could help you make a good decision.
3. Unit Mix. The unit mix is the percentage of units that are one bedroom, two bedroom, and three bedroom. A property that has more two bedrooms than one bedrooms will have higher rent or higher revenue per door. Between a property that is 80% one bedrooms and another that is 80% two bedrooms, the property with more two-bedroom units will have higher revenues and most likely a higher Cap Rate. Some people say they like to have more two-bedroom units than three-bedroom units because the three-bedrooms attract children. One bedroom units bring single people or couples. Two bedrooms are typically for roommates and small families.
Once you have collected the above information, you’ll be able to cut to the heart of the deal and weed out properties that don’t meet your needs.
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.
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.
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.”
In one of our seminars, we talked about the principle of faith .
This was a great Aha moment because it helped us to understand one
of the major differences between people who make their goals happen
and people who just keep waiting .
“It’s about faith . Most people don’t start the journey because they
want to see over the horizon to their final destination.”
“If you take a step and get started, you can always course-correct
at any point along the journey, but you’ve got to take the first step .”
I hope you take that first step on the journey. It’s a fabulous journey.
Lance Edwards’ Multifamily Apprentice Student Quote:
Here’s an Aha Moment that can really affect how you act .
Have you ever felt hesitant to act because you didn’t know how every detail would turn out?
This student realized that taking action can set off a string of events that may never have occurred otherwise.
“A lot of times people are worried about how they’re going to get the money, but how do you know that you’re going to need the money?”
And further:
“People don’t take action because they’re trying to figure out everything before they do it. …Money loves speed. If you just take action , all these things you can’t see will reveal themselves to you just because you sent out some letters or called a broker.”
Here’s another “Aha Moment” from one of my classes. This student has realized how simple it is to determine whether or not a multifamily property is worth buying.
“Being able to immediately identify the averages you gave us is powerful, being able to figure out on the back of an envelope whether or not you should move forward with a deal only has to take a few minutes.”
You can have this knowledge, too, and it will jump start your apartment real estate business.
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