You’re about to discover what most people will never know about how to invest in apartments…successfully. The vast majority of advice on apartment investing is wrong! You’ll learn the right way to invest in apartments here:
6 Steps to Regret
Most google searches for how to invest in apartments will lead you to blogs and videos with these 6 basics steps:
- Find a good property
- Get it under contract
- Do your inspections
- Get bank financing
- Hire a local and good property manager
- Close the deal
These six steps seem reasonable, but they are wrong. They are missing a key component. By following these steps you will overpay for the property, have limited cash flow, and if you try to resell the property you will lose money. All this equals regret.
4 Types of Apartment Investors
Apartment investors fall into at least one of these four categories. And knowing which category you are in is important because each one requires a different skill set. If you just follow a generic script, you won’t be successful because each type of investor requires a different strategy.
- Builder: The builder purchases an apartment building, renovates, and then stabilizes the property. After the property is stabilized, the Builder seasons the net operating income. This will be nine to twelve months of great cash flow, showing a lender that the higher NOI now equates to increased property value. The next move is to refinance, doing a cash out refi, pulling out the down payment and then repeating the process. The Builder is keeping the property and using the equity to buy another property, building up their portfolio. Discover more about the Builder investor in this video: Passive Income for Busy Professionals
- Holder: The Holder buys an apartment, upgrades and renovates to stabilize the asset, and then instead of seasoning the NOI, holds the property for long term cash flow. Learn more about the Holder investor here: Why Invest in Apartments Over Single Family Rentals
- Exchanger: The Exchanger purchases, renovates and stabilizes the apartment, increasing the cash flow and property value, and then sells the property to do a 1031 Exchange. A 1031 Exchange allows you to defer all the capital gains from the sale of a property if you buy an equal or larger property. You can roll the cash over to a larger and larger property. Learn, step by step, with a case study, how to do a 1031 Tax Deferred Exchange: 1031 Exchange Case Study
- Syndicator: The Syndicator purchases their apartment with investors. They renovate and stabilize the property and season the NOI to force the appreciation. However they exit the property by selling it, paying back the investors a healthy return, and then repeat the process. Get the basics on Syndication here: Basics of Real Estate Syndication and a real world example of a syndicated deal in my video Beginner Buys $5M 66-Unit Apartment Deal.
How to Invest in Apartments Successfully
The missing key component to the basic steps is knowing how to evaluate a deal and calculate the numbers. This is the key to investing in apartments successfully. Using an example deal of a 24 unit apartment in the Midwest, I will demonstrate how the typical seller or agent would present a deal. Then using the same example, I will show you how we at Commercial Property Advisors evaluate the same deal.
24 Unit Apartment Deal – Seller/Agent Calculations
Income: $230,400/year (each unit renting for $800/month x 24 units x 12 months)
Expenses: $69,120 – Sellers and agents generally set expenses as 30% of the total income
NOI: $161,280 – To calculate the NOI subtract expenses from the income
Market Cap Rate: 6% – Divide the market cap rate into your NOI to get the property value. $161,280 divided by 6%.
Property Value: $2,688,000
This is how a seller/agent will determine the list price for the apartment and they will list it for $2.688 million.
24 Unit Apartment Deal – CPA Calculations
This is how we teach our students to evaluated a deal to ensure that they don’t overpay and purchase commercial properties that cash flow. Here are our calculations for the same property.
Income: $218,880 – Our projected income is lower than what the seller is proposing because they haven’t accounted for vacancies. All 24 units will not be occupied 100% of the time. To calculate for potential vacancies take off 5% from $230,000, which drops the income to $218,880.
Expenses: $96,000 – Our expenses are higher. The seller or the agent will say expenses are 30%. However, we know from owning properties all over the country for the last twenty years that property expenses are much higher. Expenses for this apartment will be about $4,000 per unit, multiplied by 24 is $96,000 for the year.
NOI: $122,880 – The increase in expenses drops the NOI to $122,880. You can see the difference the numbers make in the NOI and subsequently in cash flow.
Market Cap Rate: 6% – $122,880 divided by 6%,
Property Value: $2,000,048 – There is a $600,000 difference between the sellers evaluation of the deal and our evaluation. If an investor believed the sellers numbers, they would overpay by a half a million dollars. Do you see why you can’t follow the generic script? You must follow wisdom and experience. This property is worth $2,048,000, not $2,688,00.
Proforma (Projected Performance)
Another consideration when evaluating a deal is the proforma, or what the property could do in terms of rents based upon your research. Sometimes the brochure or a seller will tell you how well the property performs. Don’t believe them. Do your own research and find out what it can do. We teach our Protégé Students how to get this data. This is important because we base our offer and pursue a deal not only on the current numbers but also on how well the property can perform in the future. Here’s an example Proforma using the same 24 unit apartment, based on our calculations, not the sellers.
The seller hasn’t raised the rents in five years. Remember the rents are currently $800 a month. After doing renovations and based on our research in this area, we can raise the rents on all 24 units $150. $950 x 24 units minus 5% vacancy is $259,920.
Projected Income: $259,920
Expenses: $96,000
Projected NOI: $163,920.
Cap Rate: 6%
Projected Property Value: $2,732,000
If you spend a couple years working to increase the rents, you can increase the property value to 2.732 million. But if you bought it for $2.688 million, all that work was for what? You overpaid. You can see now that knowing how to evaluate a deal correctly is key and this process comes from experience.
Past/Present/Future
Another way to look at the three apartment examples is as the past, present, and future. The seller’s calculations are the past, or what they have reported in the last 12 months in terms of income and expenses. Our evaluation of the property is the present. How the property will perform based on 20 years of Commercial Property Advisors experience. If you want to invest in apartments successfully, this is what to base your offer on.
The Proforma is the future and again, you base your proforma on our evaluation of the property, not the sellers. Every commercial property needs to have a future and this is our bread and butter. Our business model is to buy a property, fix it up, stabilize it, season the NOI, make it worth a lot more money, and then do a cash out refi or purchase something larger. This strategy is only possible if you know what the future looks like.
3 Tips to Invest in Apartments Successfully
- Verify the Past, Present and the Future: Do not rely on the agent or seller to verify the numbers. You need to verify the numbers. It’s a skill you need to have. And if you can’t calculate the past, present, and future, don’t do the deal. It is as simple as that. Remember, you will overpay for the property, have limited cash flow, and if you try to resell the property you will lose money. All this equals regret.
- Have a Goal: If you want to invest in the apartments successfully, your first goal is to buy a property that’s priced under market. That takes skill and it’s what we teach our students to do. Your second goal is to buy a property with rent upside potential. If you raise the rents, you can force your appreciation and that opens up a lot of options for you. Your third goal is to be in a good neighborhood. You know the saying, “you can fix a property, but you can’t fix a location”. So those are the three goals: priced under market, the ability to raise the rents and a good location.
- Know Who You Are: You need to know what type of an apartment investor you are. Are you going to be the Builder, or the Holder? Or are you going to be the Exchanger or the Syndicate? Know who you are and master the skills and strategies you need to be successful.
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Alex says
Peter, thanks for continuing your efforts to educate us, listeners. It is very helpful and appreciated. Big time.
Based on your videos (and I watched almost all of them), I know that you are a big believer in apartment investment.
I read your book and followed your advice to the “each letter”, which gave me confidence to invest in a mix-use property with 3 apartment on the second level and Commercial space on the first floor. I have added w/d in unit (as many of your videos suggested) and that helped me to increase rents/income/CF dramatically and that, of course, increased the property value.
Now I want to expand my portfolio and maybe switch to industrial properties so I can have NNN contracts, but my question: is there are ways to increase property value in industrial properties? Do you have experience with that and maybe make a video with some suggestions? Based on my research, the triple net contracts that are already in place are locked and there is nothing you can do about it.
Or is the NNN properties’ cash flow at all? Seems most of them are barely covering mortgage payments.
Thanks in advance.
Andrew says
I really could not say which one that I am because that could change based on which one is more profitable to me. I would have to say as of right now. It would probably be a builder or holder.
PHILLIP JOHNSON says
IM MORE OF A BUILDER
Adam says
Syndicator
Adam Goodman says
I’m a syndicator I believe.
Nathaniel Marcellous Jr says
Holder, then be a blessing to the community.
ALAN BONEBRAKE says
Holder
GWJ says
EXCELLENT overview. There’s nothing like having and working with actual facts and real-world numbers plus your company’s decades of experience to discern the truth, use it to become successful, then sustain and expand one’s financial independence. And helping others achieve THEIR independence
Tim says
holder and exchanger
Dexter D Markes says
I’m a single residential home builder
Glenda Smith says
Thank you so much Peter. I am looking for a multi-unit property that my Husband and I can move into where will not have to pay for the unit that we live in. We would like the other rents to be able to cover the entire mortgage. We are going to move in while our home is remolded. We live the Oakland California area and watching video on past, present, future plan makes perfect sense. However, most of the properties in the good areas are selling for 1.5 to 2.5 million and when I use the first step which is to analyze the income sometimes the rents don’t even cover the mortgage. Should I put in an offer with the correct amount that will make sense financially for me or move on? I also see that these properties stay on the market longer.
Peter Harris says
Sounds like you are looking at over-priced “ON-Market” properties. First and foremost, you’ll need to concentrate your search on “Off-Market” properties. Furthermore, you may need to be a bit flexible on which area you buy in, especially in Oakland where there are rent controls in certain districts.
Tracey Fergerson says
I like that Peter Harris is responding directly to those who comment. This provides me with a lot of confidence in that he is really an educator. Thank you.
Stanley Johnson says
Haven’t decided what might be best for me