Done Right, Investing in Apartments Can Be VERY Lucrative
Most real estate investors begin with single-family houses. That's because single-family homes are safe. They're comfortable. They're familiar.
But there's no rule that says you can't begin in another niche. In fact, many investors who discover multi-family properties have so much success with them, they stay with them forever!
Let's look at four common myths of investing in apartments:
- You'll spend all your time dealing with problem tenants. One reason people are afraid of multi-family investing is because of tenants. That's understandable. After all, most of us have lived in an apartment building at one time or another, and we've seen nuisance tenants firsthand. The thought of having to deal with irresponsible renters is terrifying.
But the fact is, investors who make fortunes in apartments treat it like a business. Each property is handled separately: It has its own ownership entity, checkbooks, and property manager (management company). Each month, separate financial reports are created and reviewed.
And done right, that's where you will be spending your time--reviewing reports and looking for more deals--not managing tenants. Your property manager will do that.
- You'll have to permanently change your name to "Mr. Fix It." This is just another myth perpetuated by those who don't know how to do it right. Just like managing tenants will be left to your property manager, maintenance will be left to your maintenance staff. A smart investor in apartment buildings NEVER does rehab or maintenance tasks himself/herself.
- You should always start with single-family homes first. For most, starting with smaller properties just seems safer since you're dealing with smaller numbers. But think about this: If you have a single-family property and lose your tenant, you've lost 100% of your income. With an apartment building, you'll always have other tenants paying while your property manager is working to fill the vacancy.
In addition, apartment buildings are no more complicated or risky than single-family houses--they just seem that way. Don't let fear of the unknown keep you from the profit potential of multi-family investing.
- You Have to Have Money to Invest. Banks will usually only finance about 80% of the money you need to purchase a property. But there are a great many ways to get other people to put up the remaining 20%--especially if you offer them a share of the cash flow and profits.
The bottom line? Just like other types of properties, you can purchase apartments without using any of your own money.
Burned Out Landlord-owners
Now that we have exposed the top four myths of real estate investing, I hope you see that trying to do everything yourself is NOT the way to get rich with apartments. If you are too much of a "do-it-yourselfer"--and think you'll save money by managing the property yourself--you will become a disgruntled landlord in no time. You'll work yourself to the bone collecting rents, paying bills, dealing with tenants, and worrying about your properties.
You'll likely be burned out in two years time, and just want to sell your property. If that happens, you've missed the point. Because the trick is to buy from these landlords, not become one of them!
How to Find Great Deals
Burned out landlords are everywhere, and their properties are easy to find: Simply look for properties that are run down and in need of rehab. When you see them, you'll know that owner is a don't-wanter, and he's advertising this fact to the world with his poorly-maintained property.
How do you find him/her? Here are several ways:
- Ask the neighbors.
- Ask the tenants. (They probably call him regularly to complain about repairs.)
- Go online to the county tax assessor's office and find out where the tax bill is going.
Once you find the owner's information, give him a call or send him a letter letting him know you'd like to purchase the property. Then you can purchase it, hire the right people, and run it the right way. In other words, manage your management company, not your tenants. Do that, and before long it will be time to start looking for more don't-wanters!
Selecting the Appropriate Property Class before Looking for Deals Will Make Your Search Much Easier
Investing in apartments involves an initial selection process. Before you decide on a property to purchase, you must first decide what kind to look for--and what kind not to look for.
In every community there are several types of multi-family housing. That's why multi-family properties are typically put into one of four property classes. You should get familiar with these--and decide which type you'd like to invest in--before beginning your search for the right deal.
Each "class" of properties has a letter grade. These grades are used to help investors and real estate brokers speak a common language so they can understand a property's characteristics and condition quickly. They are as follows:
- Class A: Luxury rental housing.
- Class B: Housing for working people who simply choose to rent instead of buy.
- Class C: Housing for working people who can't afford a house.
- Class D: Properties for low-income families that are usually government-subsidized housing.
Let's take a look at each in detail so you can decide which property class would be right for you from an investing standpoint. Keep in mind that criteria for each class can vary somewhat by market.
Class A
Class A properties are luxury units. They are usually less than 10 years old and are often new, upscale apartment buildings. Average rents are high, and they are generally located in desirable geographic areas.
White-collar employees live in them and are usually renters by choice. For instance: They don't want the hassle of home ownership. Maybe they've been transferred to the community recently, or are only staying for a period of time. Perhaps they are soon to be married. Or perhaps they travel a lot and have yet to "settle down."
From an investing standpoint, Class A properties have the highest valuations--often referred to as per door--and the lowest market cap rates. Their main attraction is appreciation.
Class B
Class B properties can be 10 to 25 years old. They are generally well maintained and have a middle class tenant base of both white- and blue-collar workers. Some are renters by choice, and others by necessity.
From an investing standpoint, cap rates--an important commercial valuation ratio--will be higher than Class A, but lower than Class C properties. However, Class B properties are valued primarily for appreciation rather than cash flow.
Class C Class C properties were built within the last 30 to 40 years. They generally have blue-collar and low- to moderate-income tenants, and the rents are below market. This is where you'll find many tenants that are renters "for life." On the other hand, some of their tenants are just starting out. And as they get better jobs, they work their way up the rental scale.
Class C buildings are very attractive as an investment because they offer better cash flow than Class A or Class B properties. Plus, they can be the first to appreciate in an emerging market.
Class D
Class D properties are where you'll find many Section 8 or government-subsidized housing tenants. They are generally positioned in lower socioeconomic areas. These neighborhoods are sometimes referred to as "war zones" and can be located in areas of the city that are prone to violence.
Class D properties often cash flow, but typically do not appreciate because of their condition and location.
You can make money with Class D properties. But they are management-intensive. As an investor, you'll find yourself spending more money and time on management, security and tenant turnover.
Where to Focus for Profitability
Now that we've covered each property class in detail, what type should you focus on? Ultimately it's up to you, but in general, you will make most of your money in B and C properties. C properties will generate the most cash flow. B properties will throw off less cash, but will appreciate faster. Thus, the cash flow investor generally considers Class C properties as the bread and butter of apartments.
What about D properties? The truth is, you can make just as much money buying a B or C property as you can a D--and with much fewer headaches. So it's probably best to stay away from D properties.
Determine the property class you want to invest in and start looking around. Whatever class you decide on, you'll find small, medium, and large ones to choose from! In a future issue, we'll talk about ways to profit once you find the right deal!
