Purchasing an apartment building may seem like a huge step in real estate investing. Investors who have mostly dealt with single-family homes may be cautious about engaging in larger multi-unit buildings. However, buying an apartment building can be a smart and profitable investment.
Significant Benefits of Buying an Apartment Complex
A purchase of an apartment building represents a significant milestone in the evolution of any property investor. However, this choice may present numerous benefits that a duplex purchase would not. The following are examples of these invaluable advantages:
Advantage #1: Reduced Potential Loss on Investments
Apartment buildings are high-priced but low-risk investments in real estate. The possibility for greater financial gain exists in acquiring an apartment built well. It’s safe to assume that your earnings will increase when you buy a complex with five to twelve apartments. A multi-unit building is a safer investment than a single-family home.
Even if one of your renters moves out, you can still collect rent from the other occupants. Diversifying your renter pool across demographics like age, gender, and profession will help safeguard your annual income. One way to ensure that your rent roll is always even is to stagger your tenants’ lease start and end dates.
Advantage #2: Reduced Repair Expenses for Each Rental Property
Your investment’s overall running expenditures per unit will decrease as the number of occupied units increases. In many older multi-unit buildings, individual units do not have utility meters. It can calculate the accurate utility charge for each renter by using a Ratio Utility Billing System (RUBS).
Each unit’s contribution is determined by its total floor space. Plus, you can save a ton of money by buying appliances and building supplies in bulk for your units. Saving on labor costs is another benefit of upgrading multiple residences at once.
Advantage #3: A Tax-Advantaged Investment
Even though they are classified as commercial property, apartment buildings are primarily used as living quarters for their occupants. In general, apartment buildings have a higher depreciation rate than commercial properties because tenants live there. As a property owner, you will have to pay more often for renovations and less in taxes.
Advantage #4: Inflation-Linked Rental Fees
Generally speaking, apartment rents rise along with the general rise in consumer prices. On top of that, most apartment leases are for a single year, giving property managers ample time to analyze market trends in rental rates. On the other hand, commercial leases typically have a fixed term of three to five years, allowing for a one percent rise in rent each year.
Advantage #5: Profit Potential Determines Loan Approval
Several financial institutions will lend money to investors regardless of their credit history if they can prove that the apartment complex, they are financing will provide a positive return. The main thing the lender cares about is whether the investment property will generate enough income to cover the investor’s payback obligations. Net Operating Income (NOI) is calculated by deducting operating costs from gross rents. Loan payments and payouts to investors or co-owners should all be covered by the NOI amount.
Advantage #6: Opportunities for Extra Income
Those who own or invest in apartment buildings can benefit in several ways from the extra money generated by the many perks available to tenants. Some examples of these features are on-site laundry facilities, a business center, a fitness center, and a swimming pool. Tenants typically pay these fees repeatedly.
Various Types of Apartment Complexes
Starting as an apartment complex investor, you must know the differences between the four main types of apartment buildings. The following types of structures fall within this category:
- Class A Buildings. These properties typically have a range of desirable amenities and are less than ten years old.
- Class B Buildings. The average age of these communities is under 20 years. Class B hotels are in good shape but lack the luxuries of Class A hotels.
- Class C Buildings. Apartment complexes that are 30 years old or somewhat less are likely to need renovation due to their age and the lack of amenities.
- Class D Buildings. These apartment buildings are generally located in disadvantaged neighborhoods several decades old. They lack any conveniences and may be in serious need of maintenance.
The Monetary Consequences of Buying an Apartment Complex
Keep the following financial considerations in mind when you begin looking at apartment buildings as an investment:
- Rent rolls. Managing your property is simplified when you establish and routinely update a document forecasting cash flow difficulties. The tenants’ rental records will be considered in this document. All the current rental rates and the number of bedrooms and bathrooms in each apartment are displayed. All names of the tenants, as well as the dates and amounts of all security deposits, are included.
- Several Occupied Units. When calculating this figure, you may see what fraction of the year your apartment building is inhabited by paying customers. It also breaks down your building’s upkeep costs, which might amount to as much as 40 percent of your rental and other income.
- Average Monthly Vacancies. Loan officers, valuers, and underwriters use this proportion when calculating effective rentals. Effective rent is calculated by subtracting the number of vacant units from the Gross Potential Income.
Depending on the type of asset, the current market, and other variables, these percentages can range from 5% to 15%.
Location and Cost Factors
Investing in a multi-unit residential complex requires careful consideration of some issues before settling on a location. Employment and economic data for a prospective investment region are two examples. Safety and crime prevention measures, as well as the potential for rising property values, are other crucial factors to think about.
In addition, the following cost considerations should be made for each area:
Automated Billing Process for Utilities
Apartment buildings without a utility rationing mechanism may have tenants that overconsume the building’s resources. As the building’s owner, this will increase your costs. Most tenants won’t waste much money on utilities if you institute a ratio utility plan that divides the monthly expenditures among the units. In addition, the square footage, number of bedrooms, and bathrooms in a given unit also factor into the tenant’s share of the monthly utility price.
Potential Health Dangers
To protect your health, you should have a professional inspect every property you plan to invest in. Properties built before 1980 are more likely to have health risks, such as asbestos and lead paint. As the buyer of a multi-family building, you are legally obligated to conduct a health risk assessment.
Finances for Building Coverage Insurance
If you’re looking to invest in a rental property, perhaps you’d be interested in purchasing an older building or one in a blighted area. Your insurance premiums will be more than average if you opt for this investment property.
Be sure to research the cost of insurance before investing in a multi-family building. Compare the current insurance premium with what is available from other companies. Property insurance premiums could go down if you do this.
Facility-Wide Concerns
Before purchasing a building, you should also check the plumbing and the roof. Cracks and flaws in the building’s façade that could allow water in should also be checked. Before purchase, you should check apartment buildings with wooden frames for rot and other forms of deterioration.
Success in Securing a Commercial Loan
You will most likely need to apply for a business loan to buy an apartment building. Commercial banks, private lenders, and vendor finance are all viable options for securing such a loan. Commercial banks and credit unions are two sources that can provide you with a traditional bank loan. You can also apply for a commercial loan from a government-backed institution like Fannie Mae or Freddie Mac.
Typical loan terms for apartment complexes are 10–25 years. There may or may not be prepayment penalties associated with these loans, and their interest rates could be either fixed or variable. It’s important to remember that the lender is on your side and can provide the most trustworthy evaluation of the due diligence performed. The lender may take your home, car, or other valuables if you take out a recourse loan and fail to pay it back. You can sidestep this difficulty by acquiring a non-recourse loan.
Know that taking on debt will increase your leverage. You may maximize your potential return on investment (ROI) by starting with as little capital as feasible. Lenders typically require a credit score of 660 or higher before considering you for a loan. Lending agencies typically demand that borrowers put down 25% of the loan amount. You should expect your interest rate to be heavily influenced by your credit rating and down payment.
Financial Paperwork Necessary to Get a Loan
The following forms of evidence are typically necessary to secure a loan:
- You are performing an Evaluation of Property. Apartment buildings require a professional property appraisal before you make any purchase. Your appraiser can choose from a few different approaches. The income approach calculates a property’s worth by projecting how much it is expected to bring in annually.
Your appraiser will be able to determine the worth of the property based on the going rates for similarly situated apartment buildings by employing the sales comparison method. Your appraiser will add the worth of the land to the cost of rebuilding the house and subtract the cost of depreciation when using the cost approach to value.
- The Inspection of Real Property. This informative document details the present state of the property. All maintenance and replacement parts are included as well. It should give you a rough idea of how much money you should set aside each year to cover maintenance and upkeep.
- An Environmental Impact Statement, Phase I. The environmental problems that may exist on the land are detailed in this study. They may require a Phase II or III evaluation if contaminants are found.
Final Thoughts
Apartment buildings are a good and profitable investment but are not cheap. Start with the basics of multi-unit complex investing if you’re a single-family home investor looking to expand your portfolio. Then, move forward by adopting the practices advocated by knowledgeable and prosperous investors in commercial properties. And from there, you’ll be well on your way to being a real estate investing pro.
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