Taking your real estate investing to the next level by buying an apartment complex may seem daunting and complicated. Especially if you have been focused on investing in single-family homes, you may be hesitant to buy larger multi-unit properties. Yet investing in an apartment complex can be a savvy and lucrative move.
Major Advantages of Investing in an Apartment Complex
It is true that making the decision to buy an apartment complex is a big step in your property investing development. However, this decision can give you multiple advantages that purchasing a duplex cannot provide. These valuable benefits include the following:
Less Investment Risk
Although apartment complexes are costly real estate investments, they are low-risk properties. Buying an apartment complex also offers the potential for increased profits. When you purchase a complex consisting of five to twelve or more units, you can count on raising your profits. Owning multiple-unit living spaces also lowers your investment risk.
If one tenant vacates an apartment, you still have income from the other tenants’ rental payments. With a general mixture of tenant types, ages and occupations, you can add some protection to your yearly revenue. If you stagger your tenant lease agreements and renewal dates, you can also balance your rent roll.
Lower Maintenance Costs Per Rental Unit
With more living units in your investment property, you will have lower total operating costs per unit. The individual apartments in many older multi-unit buildings are not equipped with utility meters. By using a Ratio Utility Billing System (RUBS), you as the landlord can determine each tenant’s accurate utility bill.
This is calculated according to the square footage of each unit. In addition, you can purchase unit appliances and renovating materials in bulk at a discounted price for significant savings. By having several apartments upgraded at the same time, you can also save on labor costs.
Tax-Efficient Investment
Apartment complexes are commercial real estate, yet they are used for residential purposes. With tenants living their daily lives in the units, these apartments generally have a faster rate of depreciation than most commercial properties. This means more frequent renovating costs and lower tax rates for you as the landlord-owner.
Rental Rates Based on Inflation
Rental rates for apartment units typically increase with inflation. In addition, the majority of apartment leases are for one year, which enables landlords to monitor market rental comps. In contrast, most commercial property leases are fixed for from three to five years, or they may have an annual rental increase of one percent.
Loan Approval According to Property Profit Potential
The profit-making potential of an apartment complex investment is more important to many lenders than the investor’s financial status. The lender’s main focus is on whether the property can generate sufficient income to surpass the investor’s required repayments. The Gross Rents of the property minus Expenses equals the Net Operating Income (NOI). The NOI amount must cover your loan payments plus enough funds to make income distributions to investors or co-owners.
Supplemental Income Opportunities
Owners and investors for apartment complexes have multiple opportunities to collect supplemental income from various property amenities. These amenities may include a gym or health club, a swimming pool, a laundry room and tenant office space use. Tenants are accustomed to paying regular fees for the use of these facilities.
Different Apartment Complex Types
As a new investor in apartment complexes, it is essential to have a good understanding of the four primary types of complexes. These include the following building types:
- Class A Buildings. These buildings are usually less than ten years old and offer an attractive selection of amenities.
- Class B Buildings. These complexes are less than 20 years old. Although they are in good condition, they offer less amenities than Class A properties.
- Class C Buildings. Thirty years old or slightly less, these complexes have few, if any, amenities, and they may need renovating.
- Class D Buildings. These multi-unit complexes are older constructions, often in lower-income areas. Offering no amenities, they may need substantial repairs.
Financial Aspects of Selecting an Apartment Complex for Investment
When you start viewing apartment buildings for investing, you should keep certain financial aspects in mind, such as the following:
- Rent Rolls. When you create and constantly update a document that enables you to determine future issues pertaining to cash flow, managing your property will be easier. This document will take into account the rental history of your tenants. It lists the current rents for each unit as well as the number of beds and baths. It also includes tenant names, the terms of every lease and the amounts of the security deposits.
- Unit Occupancy Rates. This percentage reveals the amount of time during the year that your apartment complex is occupied by rental tenants. It also details your building maintenance expenses, which frequently equal 40 percent of the income produced from rents and additional sources.
- Unit Vacancy Rates. This percentage is what lending agents, appraisers and underwriters use for determining the effective rents. The Effective Rents amount equals the Gross Potential Income minus Vacancy Numbers.
These different percentages are typically somewhere between five and 15 percent, based on asset class, market conditions and various other related factors.
Location and Cost Factors
When deciding on a location for investing in a multi-unit residential complex, there are several major factors to consider. These factors include the employment and economic data for a potential investing area. Other important considerations are crime-related and safety issues plus the likelihood of increased property values in the near future.
It is also essential to evaluate the following cost factors involved in each area:
Utility Billing System
In apartment complexes that do not use a ratio utility system, some tenants may overuse utilities. This will raise your expenses as the building owner. If you can initiate a ratio utility plan, which divides the monthly utility costs by the number of units, most tenants will not use their utilities excessively. In addition, a tenant’s payment toward the total monthly utility bill is based on the unit size, the number of bedrooms and the number of bathrooms.
Potential Health Risks
Every investment property must be inspected for any possible health risks. Older properties pose more potential health issues, such as the presence of asbestos or lead paint in their construction. As the new owner of any multi-unit residential complex, you are responsible for assessing any possible health hazards.
Building Insurance Costs
You may have an interest in investing in an older apartment complex or a complex that is located in an area that is currently run down. If you choose this type of investment building, your insurance expenses will be relatively high.
When you are considering investing in any multi-unit living complex, be sure to determine the current cost of insurance. Also, take time to compare the insurance rate that the current owner pays with rates offered by other insurers. This may enable you to obtain less expensive property insurance coverage.
General Facility Issues
Other facility issues that should be examined before you invest in a property are the current status of the plumbing and roofing. The building exterior should also be inspected for the presence of any cracks or holes that can cause water leakage. If you are considering investing in an apartment complex with a wooden frame, be sure to have it examined for any signs of rotting or other deterioration.
Obtaining a Commercial Loan
You will most likely need to secure a commercial loan for financing your apartment complex purchase. Good sources for these loans are commercial banks, private lenders and seller financing. Traditional bank loans can be obtained through commercial banks or credit unions. Another option for securing your commercial loan is through agency lenders that are sponsored by the government, such as Fannie Mae or Freddie Mac.
Apartment building loans may vary from a term of a few years up to 25 years. These loans may be fixed or adjustable-rate loans and may also have prepayment penalties. Remember that the lender is your partner and the most reliable assessor of related due diligence. If you obtain a recourse loan, the creditor may seize your personal property if you should default on repayment of your loan. By securing a non-recourse loan, you can avoid this issue.
Be aware that debt increases leverage. By putting down as small an amount of money as possible initially, the higher the relative profit that you can create. In general, lenders require a credit rating of above 660 to qualify for a loan. Most lending agents also require borrowers to put down around 25 percent of the total loan initially. Your interest rate will be calculated with a large emphasis on your credit score and your initial deposit.
Required Documentation for Loan Approval
Commonly required documentation for gaining loan approval include the following:
- Property Appraisal. Prior to buying an apartment complex, you need to schedule a professional property appraisal. There are several methods that your appraiser may use. When the income approach is used, the property value is estimated according to its potential income amount.
Using the sales comparison approach, your appraiser can assess the property value based on the sales rates of similar apartment complexes. When using the cost approach, your appraiser determines the cost estimate for rebuilding the property plus the land value minus depreciation.
- Physical Property Assessment. This valuable report states the property’s current condition. It also includes any necessary repairs or replacements. This gives you an estimate of the funds that you will need in reserve for annual property improvements.
- Phase I Environmental Assessment. This report details a property inspection for the presence of any environmental issues that need correcting. If any contaminating elements are identified, Phase II or Phase III assessments may be necessary.
Conclusion
Although they are not inexpensive, apartment complexes can be wise and lucrative investments. If you are a single-family home property investor who wants to advance to multi-unit complex investing, first perform some due diligence. Then proceed, following the steps recommended by experienced and successful investors in commercial properties of this type. You will then be on your path to a higher level of real estate investing.