Why Buy Apartment Buildings
I wanted to get into real estate a long time ago, I didn’t. Now I am buying apartment buildings, at least that is the plan. Right now I want to share with you what I have learned as I start my journey into commercial real estate investing. Specifically, investing in apartment buildings. Specifically, buying buildings and complexes as a beginner with little or nothing down. In the past, I may have thought this impossible. But with the help of an investor friend and some deep online research I see that it is very possible. So in 2018, I have a goal of 12 deals… That seems like a challenging goal.
As far as, why apartment buildings, that is pretty simple. New land is very slow to materialize and people keep having more people. Echo-boomers or Millennials have taken over the economy according to Business Insider. I notice things and try hard to listen and see trends. Some things I have seen, younger people don’t really care about the American Dream. The house, the lawn, the car and the 2.5 kids. Don’t get me wrong, they seem to still like sex and still want somewhere to live but it is more like they are looking for their place instead of “the” place. I see plenty of coming of age people choosing to live in apartments and renting condos near places they like instead of busting their asses for a 20% down payment in the suburbs. And the split is really apparent. All the wealthy and financial well offer people I encounter in the older demographic stick to that dream. All the upwardly mobile doctors, med students, professional writers, artists and the rest are staying near the hubs of creativity.
Echo-boomers have cars but are just as likely to über or Lyft. Millennials have dogs, but small ones because they are in an apartment. And they spend their disposable income on trips to Egypt and $7 coffees. Not Briggs and Stratton lawn mowers.
So there are strong behavioral reasons for buying apartment buildings. For me, there is an emotional side. Which I will temper but I will definitely tell you about. My mom works in real estate in NYC. And I have always seen myself as being able to do the same. Plus, I love the idea of owning an investment that helps people. May sound silly but it is what it is. Now, all that said when investing I look at the deal, the numbers. That is the only way to be a great investor. Learn the numbers, know your blind spots and plan accordingly.
I am more concerned with the return of my money than the return on my money
– Will Rogers
So there you have it. People keep making more people. Land doesn’t grow on trees, quite the opposite actually, people are renting more and longer than ever before and there is a strong personal desire to own apartments. In a nutshell, my reason for buying apartment buildings.
Apartment Buildings Versus Other Types of Commercial Real Estate
Before I get too crazy, there are other commercial real estate investments out there.
- Shopping Centers
- Office Buildings
- Mobile Home Parks
And for my purposes, I include warehouses with self- storage. So let me break down the pros and cons of each and why I passed on them.
Self Storage As An Investment
You have seen these places, I know I have used a few of them. They actually are considered quite recession proof. The behavioral reason is during a boom, people buy stuff, don’t want to part with existing stuff so they put it in storage. During a bust, people have stuff, need to downsize, so they put it in storage. Seems like a good market to be in. As I thought about buying apartment buildings self-storage can in a close second.
As explained to me, location and size are the key factors here. You need to have a great location and it is big enough to support a manager. A manager that is not you. Having worked in the city manager office and spent quality time with the planning and zoning people I can tell you they aren’t in love with these places. Nor are the police. It is more a matter of optics… Storage places are just big boxes. And from an economic development standpoint, they don’t bring in jobs. So it is what it is.
For me, the prospect of hunting down these properties, negotiating the deal, building the management team and executing the marketing strategy is not ideal. However, they have no toilets! No one lives in them. The maintenance and operational costs will be substantially less than any equivalent apartment building. I will definitely keep these on my radar for future investing opportunities.
Where I live there is a guy who has shopping centers almost everywhere I look. He even has a couple movie theaters. If I was getting into this business, I would interview him. He clearly has a system and works it to perfection. That said shopping center contracts are very complex. The maths, yes I said maths, involved can be very tricky. The marketing, not easy. And I am new here. You don’t learn to swim in the English Channel. I am skipping shopping centers.
Here, the bottom is this, I understand buying apartment buildings, I don’t understand what it takes to buy, market and manage shopping centers. And right now, I don’t want to learn.
First, there is the matter of size. Much like buying apartment buildings, office building investing attracts REITs. REIT are real estate investment trusts. Think, big money getting together to create bigger money then finding real estate to invest in. The best low cap office buildings are going to be controlled by those guys. The smaller office buildings are still an opportunity. But like shopping centers these contracts are complex. Marketing tricky. And I would have to find a sweet spot between minimal cash flow and appreciation and small enough to make it worth my time. Nope.
The complexity of juggling all that isn’t worth it. Compare that with buying apartment buildings, I just have to figure out the numbers and direct the property manager to do what they do.
Plus, I have seen the ups and downs of this last boom and bust cycle and there are two huge things I remember. Empty houses and empty office buildings.
Mobile Home Parks And Nazis
When I first got married I lived in a mobile home. It was in South Carolina and on land owned by my in-laws. That place was freezing in the winter. Freezing. We bought our first house soon thereafter. Much later and in a different state, different city, I was attending a speech by the mayor, he was talking about economic development and somehow got onto the topic of mobile home parks. How he didn’t like them, how he was really happy with a certain developer because they had kept their promise and their park was beautiful. It was / it is! Then that speech went downhill, fast.. There was something about Nazis in the way the other parks were run. And how he hated those owners… It was a shit show up there. I literally looked at the guy next to me and said, did he just compare them to Nazis?…
I say all that to say that mobile homes and mobile home parks may not have the greatest reputation. And just like everything, some of it is deserved by some of the people. None of it by all the people.
All that aside with mobile home parks you have to decide if you are going to control just the land or the land and the units. Mobile homes wear down very quickly in my experience, they are not easy to move and generally can be a ton of hassle. So even if I wanted to fight the perception, I would only ever invest in the land not the land and the units. With all that drama, I am going to pass on mobile home parks.
All that said, I am best suited for buying apartment buildings.
7 Keys to Buying Apartment Building for Beginners
These are keys to any investment. And if you don’t know what an investment is you should read Rich Dad, Poor Dad. Basically, an investment is a thing that you control and returns more money than it consumes. That is why buying apartment buildings is an investment and renting an apartment is not.
When buying apartment buildings you have to have a goal in mind. Else you will make a terrible deal and a terrible deal can ruin a small investor like me. I don’t have family money to fall back on if I don’t use good judgment and protect myself from shadiness and ignorance.
Investment goals vary but fall into 3 main categories. (1) Income producing, (2) capital gains, (3) tax shelter. Knowing your goal going in is key to find the right deal. Too many times I hear people saying, I am just looking for anything. If you are looking for anything you find nothing. For me, I know what my goals are for buying apartment buildings.
I am beginning by wholesaling, I want to do 12 deals this year buying apartment buildings. I will parlay that into master lease agreements on complexes. I am looking for 5 units and greater complexes that cost from $500,000 to $5,000,000. There are other stipulations but those narrow down the field considerably. Narrowing my focus makes it much easier to learn the ropes.
I am staying close to home, using that Acres of Diamonds mentality in my quest to buy apartment buildings. Opportunities for buying apartment buildings are plentiful in my area. There is no reason I cannot make it all work right here in my backyard. The other leverage that gives me is I can help out-of-town owners who are ready to get rid of their apartment buildings. Buying apartment buildings from out-of-town owner could be a niche I can exploit. Maybe they want to retain a small income but no longer want the hassle of ownership. Maybe they have capital gains concerns. Best of all, maybe the apartment buildings I am buying are distressed in some way and I can get in there and make a deal that works for the seller and the buyer.
When I was on the school board, new apartment complexes were a big deal. New complexes, in growing communities, means more kids. Schools are a set size. Too many kids mean you need another school. We hired an economic development consultant to advise us on demographic trends, population flows and the like. Now that I am on this end, I need something similar but from a different perspective, I need to know what the job situation is like in the areas I am looking to invest.
There are three ways I know to tackle this problem. (1) building relationships with property managers (PMs). PMs talk to tenants for a living, they know ebb and flow of the economy. (2) Chamber of Commerce economic development manager. These folks are tasked with helping the economy grow. So they should have the numbers to back what they say is happening. Ask for the data. (3) Economic Development Director, municipality. This is normally an appointed position and they will be part of the Planning and Development office. Again, getting in there and getting the data is the goal.
I do have one more far-fetched idea that I am working on. Google Correlate. Long story short, Google was able to predict flu outbreaks 3-5 weeks ahead of the CDC by looking at searches related to the flu and cross-referencing them by location. Here is the thing. Employment and layoffs act the same way. Whenever a new employer comes to town or an exists employer ramps up people do specific searches. The opposite is true as well when layoffs are coming, certain searches are performed. I have used Google Correlate a little, I am going to explore the keyword tools I have and work with Correlate to see how I can leverage buying apartment buildings with Google Correlate to help me predict shifts in employment.
By the way, buying apartment buildings in places where new complexes are being built will adversely affect cash flow as people will opt for the new and shiny thing. That is why I am coming up with some unique marketing strategies to serve my tenants so they see the value in staying with my properties.
When buying apartment buildings, I am looking for no zero vacancies, no war zones. I don’t know if you are aware but in this great country we live in, there are several delinquent groups. And sometimes these folks create issues. I want no part of that. I also don’t want zero vacancies. A bank considers 80% or below distressed. What would I do with 0%? Right now, I have no desire to build a rent roll from scratch. No way.
Walking the property, even before I involve professional inspectors is the key here. Some investors get PMs to do this, some people secret shop the property, some leverage relationships they have with owners, brokers and the like. Whatever it takes to see the property is what I will do. When buying apartment buildings exterior paint, landscaping, balcony, and depending on the location, the roof is all things I can take a look at externally.
Fortunately, I have a guy that is willing to mentor me along the way. In fact, my buddy is in the midst buying some apartment buildings right now. The deal is due to close soon. He actually changed the deal based on his findings walking through the property! Doing this alone would be much more of a headache. I would still do it. It would be just much harder and much costlier. Again, the deal not the property is my attraction point.
The Numbers for Buying Apartment Buildings
I worked at a division of GE Commercial Financial for a couple of years. Started as an analyst, left as a credit manager. I was in charge of authorizing credit lines for RV dealerships. I would get their financials and figure out if we should increase, decrease or maintain their credit lines. I had all the western US. From the Mississippi River west and Alaska. So looking at numbers kind of became my thing and it should serve me well in buying apartment buildings.
And that comes in handy here because different people have different motivations. The sellers want their price and sometimes their terms. Agents and brokers want their commissions. Buyers want the right deal. And as the buyer, I am kind of that credit manager again, except this time it is my money.
In legitimate cases, pro forma financial statements take out one-time charges to smooth earnings. However, companies can also manipulate their financial results under the guise of pro-forma financial statements to provide a picture that is rosier than reality.
I saw a fair share of pro forma financials, especially when I was an analyst and having to prove myself on small accounts. These financials are garbage. There is no way I am trusting pro forma statements when I am buying apartment buildings. I have seen too many pro formas where the information is flat out wrong. I have seen them where the numbers don’t even balance! Pro forma is the same as no financials at all. And for me, that is just fine. That means there will be an opportunity for me to negotiate. A point of leverage to be used to get the terms and the price I want.
Compiled financial statements, also referred to as unaudited statements, are not audited adequately and no opinion on the quality of the financial statements is given. Statements and guarantees about the accuracy of the financial statements are much less than that given by certified financial statements..
Accountants that compile a company’s financial statements are not required to verify or records and they do not need to analyze the statements for accuracy. However, in the event that an accountant finds erroneous, misleading or incomplete information in the financial statements they must notify management or abandon their involvement in assessing the company’s financial statements.
I dealt with many a compiled statement. In the RV business, you get statements that say compiled but were pulled from some commercial accounting software, so in theory, anyone could have compiled them. I have thought long and hard about statements I will use in buying apartment buildings. Compiled statements will be adequate for my efforts in buying apartment buildings. As long I am getting them directly from the seller. Financial statements are like the food at the dinner table, you might like everyone there but you really don’t want everyone’s hands on your food.
A certified financial statement is a financial statement, such as an income statement, cash flow statement or balance sheet, that has been audited and signed off on by an accountant. Once an auditor has fully reviewed the details of a financial statement following GAAP guidelines and is confident the numbers reported within it are accurate, they certify the documents.
I am not holding my breath on buying apartment buildings where the owner has certified financial statements. It is a matter of time and money it is not a big deal. Thing is I am looking for imperfections so I can negotiate the best terms and price for the buyer and seller. So not that certified is bad, it just is not necessary. In buying apartment buildings and commercial real estate it is buyer beware, so know that going in. The protections from residential transactions don’t exist here. The onus is on me, to make sure the numbers make sense. And listen, Enron had certified financial statements, so there is that.
I will get more into the math of buying apartment buildings later but here are some numbers that are important
- NOI, net operating income
- Cash on cash return sometimes called internal rate of return
- Operating expenses
- Cash flow
- Mortgage payments
- Cap rate
These are the basic numbers I need to look at during the deal. Marketing, reserve and the rest have to be addressed as well. But I cannot get into a deal before I am comfortable with these.
Also, I downloaded a couple of commercial real estate calculator apps for my phone and tested them out on deals on buying apartment buildings for which I had numbers. One was a little less intuitive but they both work just fine and were free.
Here, I have to make friends with PMs. Bottom line. There are too important in the industry to be ignored. Listen to the pros that are buying apartment buildings, and they will tell you that relationships with PMs are worth their weight in gold.
I will never go into a deal for buying apartment buildings without exit strategies and contingencies. Exit strategies are pathways for the deal and contingencies protect me from the deal straying too far from my goal. I will have both and will dive into them in a later post.
Asking Tough Questions
Integrity and going with your gut is paramount in investing. You have to trust when you feel like you are being lied to. Digging deeper into the financials, asking more questions. Being Judge Judy when you have to. Those are all traits of greater investors. And you know another one. Walking away from a deal.
Buying Apartment Buildings Continued
- Areas That Can Go Wrong Buying Apartment Buildings
- Getting Starting Buying Apartment Buildings
- Ways To Enter The Apartment Building Market
- Types of Financing For Your Apartment Building Investment
- Terms An Apartment Investor Should Know
I still have these areas to cover in buying apartment buildings. So I will wrap up this article for the night. And continue it tomorrow. Then start on the sub-topics. I hoped this helped, leave your comments below.