Purchasing an apartment complex as an investment is a fantastic way to watch an asset single handedly generate thousands, even hundreds of thousands of dollars in a very short amount of time!
A popular investment strategy, especially for new investors, is to purchase a more run down, mismanaged apartment complex at high cap rates. The cap rate, or capitalization rate, is found by dividing the Net Operating Income by the Purchase Price.
Cap Rate = NOI / Purchase Price
Owners of properties that are low performing often sell their apartments at a higher cap rate because there is more of a risk associated with them. These properties are in need of many changes in order to become a profitable commercial property that is working at its maximum potential.
Before you purchase a large commercial apartment complex, you need to obtain certain information. This information is crucial to your assessment and evaluation of the property.
There are two states you need to understand regarding the property, the state it is in currently, and the state it will be in after you fix all the major problems.
When you first find or are introduced to a property, be sure to ask for the income and expense statements for the last 12 months (called the “trailing 12”). A lot can be told from analyzing the numbers that are reported on a monthly, quarterly or yearly basis. You can even use them to see how the property has performed over time. You will be able to see gross rents, expenses, net operating income, and all the items in which income and expense fall under such as refrigerator rentals and pool maintenance, respectively. Use this tool as a way to project future income after raising rents, filling the vacancies, transferring all costs to the tenants, and making the community an overall enjoyable place to live.
You must know how many units are in the complex, and what condition they are in. You can see what condition they are in by checking a certain percentage of the total units and assume that most are in that condition. However, it is always better to check all the units so you know exactly what condition the apartments are in. This could be a basis for lowering the asking price if the units are in far worse condition than you originally thought.
The vacancy factor is an important one. When a property has many vacancies, like 20% and above, it is not performing well. If you can fill these vacancies, then your ability to turn the property around is much greater! You must view all working leases, and ask the current tenants to sign a paper to verify that the leases that you were given by the owner or working manager are accurate. You would be surprised how many owners may try to decrease their vacancy factor by false leases, just to make their property more enticing. However, if you are fixing the property up, then the larger the vacancy, the more opportunity you have to increase value and find a profit!
In order to evaluate this property, you must divide the asking price by the number of units and see what the price is per unit.
Price Per Unit = Asking Price / # of units
You can use this to compare other similar complexes in the area. You also want to know what they are charging as rent, and what type of leases the tenants have. If the rents are below market rents, then you have the ability to increase value there. You can see what comparable rents are by using rentometer.com. If your tenants have a full service, or net-net lease, then you have an opportunity to change it to a triple net lease, where the tenants pay taxes, insurance and utilities. You can literally pass all the costs of running the apartment to the tenants. After all, they are the ones using the facilities.
I am sure you can see the themes here. You want to identify areas where you can either increase or create value that was not there before. Be sure to get all the facts and numbers verified first before you purchase your great investment. Be prepared to do some work to turn the place around. However, it will definitely pay off shortly when you use some simple tool, like increasing the rent and painting the exterior, making it a community where people want to live!
Bill Manassero is the founder/top dog at “The Old Dawg’s REI Network,” a blog, newsletter and podcast for seniors and retirees, that teaches the art of real estate investing. His personal real estate investing goal, which will be chronicled at olddawgsreinetwork.com, is to own/control 1,000 units/doors in the next 6 years. Prior to that, Bill and his family lived in Haiti for 11 years as missionaries serving orphaned, abandoned and at risk children.