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For most new investors, buying an apartment complex seems like a daunting task. They consider it too expensive or too difficult to achieve. In fact, buying an apartment complex can be a great move as long as you remain within your budget.
A good investor always seeks out the best advice and maximum information before diving into the real estate market. From deciding if apartment complexes are suitable for you to the final purchase agreement, you can learn how to buy an apartment building in the following steps.
Before you hit the market for buying an apartment complex, you should make sure whether purchasing an apartment complex is your cup of tea or not? It is a vast game compared to running single or multi-family homes and hence require effort input of equal scale, i.e., more capital, more time, more research. Above all, you should be weighing the pros and cons of buying an apartment complex before making a final call.
Following are the benefits of buying an apartment complex:
The most significant advantage of buying an apartment complex is recurring monthly income. If the finances are sound and the deal is right, a good apartment building will give you regular monthly income as a positive cash-on-cash return.
If you have had the experience of being a landlord, you’re probably familiar with a common vacancy problem. Having no tenants makes you lose all income. However, in an apartment complex, you can mitigate the effects of a vacancy rate. Even if one apartment is vacated, you will still have other units to generate income for running expenses and perhaps for making a profit as well.
The larger scale of maintenance works in favor of the owner. Like, if you are supposed to redo a roof, it’s not just for one unit but all the units in the complex. Similarly, if there is any material left from repairing one unit, you can use it for other units and not waste materials resulting from only one unit’s need.
Owing an apartment complex allows you to add additional sources of income, such as coin-operated laundry facilities, ATMs, and vending machines. You can also look for renting a parking space and space for billboard advertising. In addition to them, you can charge additional monthly rent for upgraded kitchens and bathrooms, upgraded appliances, and air conditioning units.
Financing for apartment buildings is based mainly on the financial performance of the building and not your credit situation and personal finance. Lenders and banks will chiefly focus on the economic situation of the building for approving a loan that goes in your favor.
The value of the investment is determined in significant part by the building’s ability to generate revenue. So, you can increase the value of your holding if you can increase rents.
Management becomes much more intensive for larger units, significantly more than four units. It is hard to run the affairs of the management part-time. Either you will have to take property management as a full-time job, or you will have to outsource the management, which will reduce your profit. If you decide to hire management, it may cost you 8% to 12% of gross monthly rents.
Usually, when tenants are considering a long-term stay, they opt for a single-family unit. They get more attached to the property, like to be involved in a community, and cultivate relations with the neighbors. On the other hand, tenants are much more transient in an apartment complex.
The tenant’s average stay in the apartment complex is less than two years compared to the average stay in a single-family house spans over five years. It would help if you were doing a lot of musings over how to tackle and control tenant turnover.
It is another disadvantage as tenants in a single-family dwelling will treat the property as their own home while behaving differently in apartment buildings. As they don’t attach a similar bond with units in an apartment complex, they tend to care less. As a result, you have to deal with more frequent repair of repairing wear and tear issues than usual.
These are the pros and cons of buying an apartment building. Weigh them and decide whether you should be buying an apartment complex or not.
Before you step into the market, it is essential to understand the different types of apartment buildings:
If you plan to purchase an older building, spare some capital for the renovation work upfront. Though the newer building will require fewer renovations and there won’t be any wear and tear issues in the coming years.
As you have chosen among the buildings types, next, you need to learn these financial factors in mind:
Since apartment purchase involves a considerable investment, you need to consider the return on investment (ROI). Primarily, a building’s ability to generate revenue depends on its size. Return on investment is a factor of how much you have invested in purchasing the property and how much income you are earning from it. Apartment complexes are likely to produce more revenue, but at the same time, they require a more significant upfront investment. Keeping all factors in mind, calculate how much time it will take to return your investment.
In addition to it, consider the following factors as well:
The next important thing is to consider location. Location can make or break you as an investor. Buying an apartment complex to keep the units occupied for the full days of the year will return your investment sooner. For the location of the building, bear in mind factors such as the potential for increased property values in the coming few years, crime and safety data, and the area’s economic data and employment.
When tenants don’t have to pay the bill and utilities are shared, tenants tend to overuse them and increase the operating cost of the apartment. So, one way to handle this problem is to adopt a ratio utility system. So, you divide the monthly utility expenses by the number of units.
Related Article: Utility Cost In the US
You have to take thorough safety measures and inspect the property for potential health risks. You must be extremely careful with the older buildings as they can be exposed to contaminants such as asbestos or lead paint. Being a new owner, you have to address these issues, but at the same time, you will have to decide if that expense is worth it to you or if you should look elsewhere.
When it comes to insurance, older buildings are likely to cost more. So, before you make an offer to the seller, you should always inquire about current insurance costs. Involve a few insurance companies and take their policies for the building and include the price into the operating expenses to calculate the return of investment.
A few other facility issues may cause problems, such as plumbing that needs repairs is likely to increase the upfront expenses. Or there can be issues in the roof like leakage of the top, or buildings with wooden frames are more likely to experience rotting than the concrete or brick exterior. So, when you decide which building to buy, bear all these factors in mind.
Though you can search a building on your own, the real estate brokerage and agents may provide you access to the largest body of properties for sale. Agents have access to the Multiple Listing Services (MLS), and they can find you a building close to what you have been planning to buy.
In addition to the access of Multiple Listing Services (MLS), they know the market inside out and know how to determine values. They cannot only help you find a building but also can help you make an offer to the seller. They are extremely good with their negotiation skills and you can ask them to negotiate the price with the seller on your behalf. Make sure you work with an experienced agent as not every agent is experienced with selling apartments.
Done with the searching part, now you need to secure a commercial loan to finance your purchase. You can approach private loans, seller financing, commercial banks, or government-sponsored agency lenders like Fannie Mae or Freddie Mac.
The duration of the loan may go as high as 25 years. When you are financing your purchase, the lender is your partner and your best advocate to properly assess all due diligence items.
You have almost covered the maximum steps of the process and now is the final phase. Make sure you follow these steps to prepare the required documentation you need to secure a loan.
Before you reach out to the bank for a loan, you should get the property professionally appraised. The methods appraisers may use:
Income Approach: It estimates the value of the property based on its potential income.
Comparable Approach: It estimates the value of the complex based on the sales of similar properties.
Cost Approach: It estimates the value based on the cost to rebuild a property, including the land’s value and minus depreciation.
Related Article: Cost Approach in Real Estate
It will state the current condition of the property. In addition to it, it also determines what needs to be replaced or repaired. You can also estimate replacement reserves, which are funds that you can be expected to need each year for repairs.
Like the physical need assessment, it inspects a property for environmental issues. Environmental issues that could pose a threat to residents and the community should be seriously addressed.
This document records the property’s boundaries and incorporates notes of any title issues that could affect the property’s use.
Though buying an apartment complex is essentially a capital game, it typically best suits more experienced investors. So, it would help if you decided whether purchasing an apartment building is right for you. Then it would help if you moved on to the next steps of how to buy an apartment complex.
It will be an exciting journey, but at the same time, it involves a lot of work. The more hours you put in the planning phase, the less effort you will have to put in the execution phase. When it comes to the real estate business, knowledge is power. So, keep reading and keep empowering yourself.