7 Reasons Why We Love Multifamily Apartment Investing?
Regardless of whether the economy is trending up or down, people will always need a place to live.
Apartments can produce passive monthly cash flow (so you can make money without doing more work).
You can force appreciation with the right target market knowledge and expert management.
Apartment investments are inflation fighters and can be a good hedge against economic volatility.
Apartments can make very good tax shelters.
Apartments are easier to scale than other real estate investments.
No day-to-day management by using professional property managers.
Why invest in apartment complexes?
Simply put, the supply/demand equation is greatly in our favor and will remain that way for many years.
Shrinking Supply: There is a housing shortage in the United States of $3.3M units and that shortage is expected to grow at 300,000 units annually. The cost of new construction has risen dramatically over the last 15 years and now it’s nearly impossible to build affordable housing without government subsidies.
Growing Demand: The U.S is a nation of renters. millennials, burdened by student loan debt, are waiting longer than previous generations to form households. Single family home prices have risen dramatically especially since the pandemic. This makes it harder to save up a down payment and makes renting more attractive compared to taking on a mortgage payment.
How does investing in apartment complexes compare to investing in single-family houses?
Economies of scale drive down operating costs. Aggregating 100-300 units into a small area makes it far easier to manage than trying to manage the same number of single-family units that may be spread out over many miles. For this reason, management fees and rehab/repair costs are significantly lower for apartment complexes. The typical 3rd party management fee for an apartment complex is 3-4% of the monthly revenue. Most management companies charge 8-10% of gross rent to manage a single-family house plus additional fees when placing a new tenant. Property managers for apartment complexes typically manage thousands of units in the cities they operate in. This allows them to develop significant expertise and market knowledge. They are able to negotiate more favorable fees with all of their repair/rehab vendors than small property managers of single-family portfolios.
Lower risk. Most people in the finance world define risk as, “The chance that the actual outcome differs from the projected outcome”. Smart investors break risk up into two pieces – frequency and severity, and we put plans in place to mitigate both. Owning a portfolio of single-family houses means that when one house goes vacant the cash flow drops by 20%. Replacing an HVAC on one of those five properties means that you’ve lost 2-4 months of cash flow and a roof replacement means that you will lose an entire year of cash flow. If a tenant has to be evicted or if the deposit doesn’t cover the money needed to get the unit ready for the next tenant then the entire portfolio may go negative on cash flow for a month or two.
Of course, with only 5 properties, you may never deal with any of those issues and that small portfolio may outperform your projections. The problem with such a small sample size you will never know if the portfolio is going to perform, outperform, or underperform compared to your projections. Investing in large apartment complexes mean that when significant repairs are needed or evictions need to be performed (and these things always happen) there are still hundreds of other units that are performing. Larger sample sizes always work in our favor when mitigating risk!
Attractive financing. Financing rates for apartment complexes are typically 1-1.5% lower than rates for single-family properties. Additionally, commercial financing is non-recourse which means that the borrower is not personally liable for the loan. Single-family financing is full recourse and if the loan defaults the borrower is personally liable to make the lender whole. See below for more details on financing.
What is real estate syndication?
Real estate syndication simply means that we pool our money together to invest in larger, higher quality properties than we could purchase on our own. There is typically lead sponsors in the transaction, also referred to as the general partner (GP), and there are passive investors, also known as limited partners (LP). The sponsor (GP) contributes time, experience, and capital while the limited partners contribute capital in their passive roles.
The U.S Tax Cuts and Jobs Act of 2012 made it much easier for ordinary people to buy into real estate syndications and it opened up a lucrative and safe investment opportunity for the general public. Today, 90% of all apartment purchases are done through syndications.
What type of apartment complexes do we invest in?
Our investment strategy is to find Class B & C properties that have been poorly managed or need some moderate rehab work. Apartments are valued just like a regular business where increasing the income will automatically raise the value. Finding these value-add opportunities means that we can force the property to appreciate by executing on a business plan to raise the net operating income.
Due to the rising costs of construction, it’s nearly impossible to build new workforce housing. Meanwhile, demand for this type of housing is expected to rise dramatically over the next 10 years, making B/C apartments a great investment opportunity.
How do we finance our acquisitions?
The capital stack is comprised of two sources, debt and equity.
Equity: The equity comes from private investors (limited partners- LPs) and from the deal sponsor (general partner-GPs). The minimum investment varies by deal but a typical minimum is usually USD $50,000 to $100,000. The general partners (GP) in these investments contribute equity as well, putting their own, “skin in the game”, so that everybody’s interests are aligned. The total equity raise is typically 20-30% of the purchase price plus money for reserves and the rehab budget.
Debt: Apartment complexes are eligible for arguably the most attractive financing terms in all of the investment world. Multifamily housing is typically considered to be one of the least risky investments and there is no shortage of large institutions who lend on this type of collateral. Interest rates are very low compared to the rates given to other type of property and the loans are non-recourse, meaning that there is no personal liability if the loan defaults. (There are “bad boy” carve outs for fraud and gross negligence that can invoke personal liability clauses but only for the active general partners, not for passive investors).
How does an apartment complex valuation differ from a valuation on a single-family home?
Single Family Residential (SFG) values are based on the values of the homes around them. No matter how much rent is generated the home will never be worth more than the surrounding houses. Apartment complexes are valued differently and the valuation is based on a simple formula.
Apartments: Value = Net Operating Income / Cap Rate. If the property produces $100,000 in NOI and the cap rate for that area is 5% then the value of the property is $2,000,000.
If we choose our properties correctly then we can renovate dated units and/or operate the property more efficiently. Both strategies increase the NOI and build up equity. It’s called forced appreciation and it’s a big reason why we LOVE this investment strategy.
What does ‘cap rate’ mean?
Cap rate is the expected rate of return that investors demand in a certain area if buying a property with cash. Like everything in the world of finance, expected rates of return (cap rates) vary based on investors’ perception of risk. A “Class A” property in a booming city will have a lower cap rate than a “Class C” property in a city whose economy is struggling.
Using the prior example, we can figure out the cap rate for this area by dividing the NOI by the value. $100,000 / $2,000,000 = .05 or 5%.