If you're a people-person, owning and managing an apartment building might be the perfect investment for you. It can be a large complex or a building with just a few units. One thing's for sure — dealing with a variety of tenants means you'll never have a dull day, and you'll have plenty of opportunities to practice your negotiation and diplomacy skills.
Are rentals stable in your area? The rental market fluctuates, but knowing how it has performed in recent years will help you decide if an apartment building is good investment choice. What are tenants looking for? Read ads and study the rental market very closely to help you determine which features are in most demand, then set out to find a property that fits the criteria, either as-is or with updates.
How Much Is It Worth?
If you find a building of interest, you'll have to determine how much it's worth. Putting a value on an apartment building is a different process than you encounter when you buy residential real estate. Its value is tied closely to the rental income it generates. If you decide to buy it, you'll eventually have the building appraised, but a quick way to preview its value is to use the gross income multiplier method, or GM for short. The GM is a number that's determined by analyzing the average sales prices that similar apartment buildings have sold for versus the amount of rents they produce.
Can I determine value by using the average asking prices of properties that are currently for sale?
The prices that sellers put on properties are usually inflated enough to allow at least a little bit of negotiation room, because buyers like to feel they are getting a bargain. It's more accurate to use actual sales prices to help you determine value, because they represent the true prices that buyers were willing to pay for similar properties. (For more information about property valuation, refer to Chapter 7.)
Let's look at an example. Consider a building with five apartments, each producing $600 per month in rent, for a total of $3,000 monthly income from the entire building. The building recently sold for $324,000. Here's how you would calculate its GM:
Multiply the total monthly rent by the number of months in the year to find the annual gross income: $3,000 × 12 = $36,000.
Divide the price the building sold for by its annual gross income to get the GM: $324,000 ÷ $36,000 = 9.
Now imagine that the building you want to buy is very similar to the building used in the example, except that its total yearly rent is a bit lower, at $30,000. Turn the equation around and multiply the GM by the building's total annual income to estimate its value.
$30,000 (INCOME) × 9 (GM) = $270,000 (ESTIMATED VALUE)
Calculate the GM for as many apartment-building sales as you can find to help you develop an understanding of the average GM for that type of property in your area. A real-estate agent who is actively involved with commercial sales can give you information about sold properties and offer an opinion of the average GM.
Improve Rental Income to Increase Property Value
Does the building have untapped potential? Updates might allow you to raise rents, resulting in an increase in income
If being a landlord isn't in your plans, it doesn't mean you can't invest in apartment buildings, as long as you don't mind dealing with tenants for a short time. You could buy an apartment building, make improvements, raise rents and value, and then resell the property to another investor. Find out how long it has taken similar properties to sell, and determine whether you can truly rent the property at increased prices before you decide to go that route.
Check the Seller's Documentation
When you buy an apartment building — or any building with rental tenants — you should ask to see copies of all current leases or rental agreements. It is not unreasonable to ask the seller to show you past income-tax returns and deposit slips to verify that the rentals have actually generated the amount of income that is being claimed. Most sellers are honest, but let's face it: It isn't difficult to give a potential buyer inflated income figures in the hopes that verification won't be requested. You should also review utility bills for the past few years if the building owner is responsible for paying them. If the seller is working with a real-estate agent, the agent probably has copies of the documentation you need.
At closing, all tenant security deposits should be transferred to you from the former owner. Make sure that topic is addressed in your offer to purchase any property in which security deposits are held by the current owner.
Study the leases to learn their terms and to find out when they expire. It's best if they don't all expire at once, especially if you plan to refurbish the apartments and raise rents. Your entire tenant base could move out at once, putting a crimp in your cash flow until new occupants are found. Consult a real-estate attorney if you aren't quite sure how to decipher the terms of the leases.