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.
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.
I love it when my students have “Aha Moments,” when they understand a new skill for the first time or put together the pieces of the system.
I’ll paraphrase the student in this video. She says, “After flipping houses and looking at comps. . .the neatest thing for me was that all we need to know is the NOI to figure out the value of a place.”
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