Apartment Investing – The Complete Guide to Success
March 3, 2019
Investing in an apartment is a time-tested method of building capital and generating stable rental income. When done right, condo investing can yield lucrative returns, making it a smart investment for many commercial investors. If you’re just getting started or want to continue investing in condos, you need to understand the basics and current trends. In this article, we will answer the question: Is buying an apartment complex a good investment, especially in 2019. We’ll also discuss the basics of condo investing and provide some case studies of how great investors are making money investing in condos and other multifamily properties. Finally, we’ll look at some success stories.
2019 trends favor investing in apartments
Apartment investment will benefit from good economic conditions and a benign balance of supply and demand.
Economic conditions are conducive to investing in apartments
It looks like 2019 will continue The 2018 Goldilocks economic conditions for condo investing. These include:
- Interest rates: The pace of economic growth slowed in the fourth quarter of 2018, and experts expect a further slowdown this year. This means that the Federal Reserve has the option to delay or forgo future interest rate hikes in 2019. Higher interest rates aren’t necessarily a bad thing, because they can keep some potential homebuyers out of the mortgage market. This creates demand for rentals, which helps support returns on apartment investments. However, if interest rates rise too much, loans for the purchase and construction of apartments also become more expensive. Current interest rates are still reasonable and should not deter you from investing in condos (apartment buildings).
- Unemployment: We are currently in a full employment economy after a decade of improvement. Yet many families today do not make enough money to afford a down payment or monthly mortgage payments. It turns out that these people belong to work housing tenant segment. To clarify, this is a group of workers who cannot afford to own a home and instead live in apartments and apartment buildings. They live within easy reach of the employment center. The bottom line is that while US wage growth remains stagnant, the need to workforce will provide support for investment in apartments.
As you can see, the economic fundamentals look solid for continued rent growth in 2019.
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Supply and demand factors in 2019
Recent Forbes article points to some softness in rents in select U.S. markets after years of rising apartment prices and new construction. It is by no means monolithic and each market requires individual research. The result is often a flatness net operating income (NOI). As you may recall, we have already discussed the role of interest rates. As we said, we don’t think rates will have a significant impact this year as GDP growth recedes. Interestingly, softer rents from new construction and higher property taxes will affect some markets but spare others.
Video – Apartment building market trends
Basics of investing in apartments
The bottom line is that, as always, focus on the fundamentals when investing in condos. The long-term profit potential of apartment investments remains compelling. What are the basics? Here are three:
- Investment in an apartment with added value: Value-added investment means increasing the value of the property through renovation and better management. Renovations will help increase rental income and reduce vacancy rates. Better management will reduce costs and increase margins through efficiency gains. Areas of opportunity are a new wrinkle in tax law that encourages value-added improvements to buildings and businesses. Adding value is a fundamental strategy for increasing NOI.
- Conservative underwriting: This is real estate jargon that allows you to make realistic assumptions about the income and expenses of an apartment investment. Being realistic means considering the cost of the changes you will make. This includes the financing options you can access. In addition, it includes profit rate (or cap rate) which corresponds to comparable properties. The best practice is to set a minimum limit rate and not invest below it. Remember, the higher the cap rate, the better the deal for the buyer. The lower the limit, the better the deal for the seller.
- Accommodation, Location, Location: Yes, it’s corny, but it’s also true. People need to live. All things being equal, most prefer to live in a place that satisfies them. This could mean a highfalutin condominium. Or maybe it’s an apartment in the city center, close to places of work and entertainment. Don’t forget that we discussed renting work accommodation, which should be affordable but comfortable. In conclusion, you need to know your market and then focus on niches that make sense for that market.
What is the potential return on investment in apartments?
No one will invest in apartments to get a loss or even a measly profit. Why bother when you’re better off accumulating Treasuries? Instead, investing in apartments should be profitable. Very happy, maybe. The question then becomes, “How do you predict and measure your profit potential?” Here are some key factors:
This particular metric starts by taking into account all the money you have put into your condo investment. Then you take the net money left over at the end of the year and divide it by your total investment. This is of course after collecting rent and paying expenses (including debt service). The amount of cash profit you require should be relative to the level of risk you are willing to take.
We consider three categories of risk:
Investing in apartments with a low level of risk
You are buying a rent-stabilized apartment building with low vacancy in a high-demand neighborhood. Rents are likely to stay about the same, rising slowly but rarely falling. The cost of purchasing this type of real estate is higher than the cost of minimal risk. You can expect a return on cash in the range of 4% to 8% from low-risk real estate. It is an ideal passive investment because there is no need to increase the value of the property.
Investing in apartments of medium risk
You can get a higher return on cash by investing in an apartment with working-class tenants, slightly higher vacancy rates, and average rents. Typically, a building may be located in an area that is beginning to gentrify. What’s more, if you still want a no-nonsense approach, expect cash-on-cash returns in the 8% to 12% range. However, if you can provide more hands-on involvement, you can increase your return on cash to the 12% to 16% range. That means taking on duties like shoveling driveways, minor repairs and renting out vacant units. In other words, you invest more money and effort to get a higher return.
Investing in high-risk apartments
If you are looking for the highest possible return and are not afraid of risk, investing in high-risk apartments may be the perfect option for you. This means buying a building in a low-rent area with a higher vacancy rate. Naturally, there will also be higher eviction rates, more rent difficulties and a worse demographic profile. Not surprisingly, your tenants may be eligible for government rent subsidies. Sure, it’s a headache, but it also means you’re more likely to get a good price. Clearly, this type of property is ripe for appreciation.
However, you will probably have to manage the building yourself to get the efficiency you need. So if you want to commit, you can expect a higher return on cash. These returns can start from 20% to 50%. This is true in such highly complex areas. Yes, under the right circumstances, you can get a full payback in as little as two years. And the whole enterprise can burn down – that’s what makes it risky. These types of investments are extremely management intensive.
A few success stories in investing in apartments
Here are well-documented examples:
Grand Cordone, host of The Cardone Zone radio show, bought my first apartment in the early 1990s. The 38-unit building cost $1.9 million and he put down $350,000. He chose a building in an area where the city does not allow new buildings to be built. Since then, he has put his initial investment into owning more than 5,000 units. This was based on a favorable balance of supply and demand and extensive leverage.
Michael Blank bought a small 12-apartment house he receives $40,000 annually. Blank needed $227,000 to close, which he received from five investors who shared 50%. In other words, he did not work for his own money. With money from investors, he bought the property for $530,000 and spent $54,000 on renovations. He charged an acquisition fee of $15,900 and receives 30% of the profits, of which 15% goes to the investors. Five years later, he sold the building for $850,000, a profit of about $40,000 a year. This was due to cash flow, asset management fees, disposition fees, capital appreciation and a decrease in principal.
Jared Sturm invested in a multi-million dollar residential complex at the age of 26 years. Four years ago, Jared and his brother bought their first dilapidated old house. Since then, he has participated in seventeen (17) fix and flip projects. He also bought a bunch of rental rehabilitation centers, which he later refinanced. They relied on their own capital to grow their company. They started with bank financing before moving to private money. Then he doggedly searched for their first modern building, guarding against overpayment.
To their credit, they were able to find a 1989 building intact with 95% occupancy. The purchase price was 89% of the estimated value. They increased the cost by installing individual water meters for each unit. They have also converted some premises into pay warehouses. In addition, they replaced the coin-operated laundry with rental washers and dryers for each unit. The loan was an 80% LTV 5 year ARM at 4.25% interest. The term was 20 years with a 25-year amortization period (called a 25-year amortization period). The investment turned out to be extremely successful.
The benefit of investing in an apartment can be significant. For more information on condo investment financing, call us at Assets America® today 206-622-3000.