Buying an apartment complex is essentially buying a business, and it can be daunting for those inexperienced with the process. Still, apartment complexes offer significant advantages to owners, so it is worth the research to follow through on the purchase. While this article should only be the first step in your research process, it will give you a foundation for the process and key points to consider when buying an apartment complex. Here’s what you need to know about how to buy an apartment complex.
Investing in a real estate syndication can provide an alternative to purchasing an apartment complex on your own. In a syndication, you can join a group of other individual investors to partake an apartment project with lower initial capital—often as low as $50,000. Learn More
Why Buy an Apartment Complex?
Committing to the purchase of an apartment complex will tie up funds for the long-term. So, if you’re considering buying an apartment complex, deciding whether the possible benefits outweigh the drawbacks will be a good place to start. Here are some pros to consider:
Steady, Perhaps Even Passive, Income
The monthly income potential makes the purchase of a multifamily building appealing. This income, of course, comes from the monthly rent payments made by the tenants. Whereas with other real estate investments, such as a fix and flip, there may be no revenue until the property is sold, apartment buildings will yield income as soon as tenants are in the building. For owners of low-maintenance buildings that are professionally managed, the owner may achieve the investment dream of passive income.
Even better, because an apartment complex is comprised of many units, the owner will still see income even if some units are vacant at any given time. Owners can further control this by intentionally staggering lease start-and-end dates so that units become vacant on a rolling basis rather than all at once.
Building Value Can Be Increased
The building valuation will be based on the expected income of the units, and apartment buildings offer solid return on funds invested for the upgrade or remodeling of a building. Owners can increase rents for upgraded finishes, appliances, and amenities and even charge fees for extras like parking, gym access, pool access, and more. Of course, increasing the value and equity of the property can allow owners to profit in the event of a sale as well.
Less Money for the IRS, More for the Owner
Income from real estate is taxed much more favorably than earned income, making the return on investment all the more sweet. Real estate owners benefit from the deduction of depreciation and mortgage interest, no self-employment tax, a lower capital gains tax rate, and the ability to carry over losses.
What are the Downsides?
Apartment buildings can be hard to sell, have higher per-tenant maintenance costs, and require more management, especially as unit numbers increase.
One of the most basic factors influencing the costs and income of an apartment building is the nature of the building tenants. When tenants lack the personal connection that they may have with a landlord in a single-family rental, they also lose the incentive that the personal relationship provides to maintain and care for the unit. This translates to more maintenance needs and higher costs when it is time to turn over the unit for a new tenant.
More tenants also mean more problems—and it is not feasible for most owners to also provide the property management for an apartment building. Leasing, contracting for grounds care, maintenance, and repairs can be a full-time job for multiple people in a large building—or a large operating cost when a property management firm is hired.
One of the draws of investing in a multifamily building by participating in a real estate syndication is that the project sponsor takes on all of the legwork. Individual investors can simply invest and benefit from passive income while the project sponsor takes care of the property management tasks. Learn more about real estate syndication investing with Life Bridge Capital.
Selecting an Apartment Building Type
If buying an apartment building still sounds like a good fit for you, the next step will be to narrow down your search field to find the building type that most suits you. Apartment buildings come in all shapes and sizes, and they are filtered into four classes—A through D. Here’s what you need to know about apartment building classifications:
- Class A buildings are newer, usually less than 10 years old, and have the amenities usually attributed to luxury apartments like pools, gyms, and tennis courts. Older buildings that are renovated to current finishes and amenities can also be Class A.
- Class B buildings are older than Class A buildings but less than 20 years old. These buildings are still in good condition, but are not as modern as Class A buildings. Class B buildings do not always have the same quality of amenities that Class A buildings have.
- Class C buildings are up to 30 years old, obviously and significantly dated, and lacking in the amenities that a modern tenant may expect. The need for repairs may be obvious as well.
- Class D buildings are often low-income or subsidized housing, over 30 years old, and in poor repair. These buildings lack amenities.
Apartment building investors often gravitate toward Class B and C buildings because they do not need intensive repair, but there is more opportunity to increase rents and property value thanks to lower-cost renovations and upgrades.
Use Financial Factors to Guide Selection
When choosing an apartment building to buy, it’s important to consider the possible profitability of the building. Here are some key factors to consider:
- Larger apartments equal more possible income, but they also pose a greater risk due to the more significant up-front investment required and the ongoing maintenance and loan servicing costs.
- Look at the rent rolls to analyze the current rent rate for each unit and the size of each unit to understand the long-term possibility of the building.
- Consider the occupancy rates to learn what percentage of the building is usually occupied by paying tenants. Accounting for vacancy periods can help you understand the attrition and replacement of tenants and the reasonable earning potential of the building.
- Calculate the capitalization rate to understand the value of a building. The capitalization rate can be determined by dividing the building’s net operating income by the market value or purchase price. The higher the rate, the better when buying an apartment.
Obtain Financing Pre-Approval & Find a Broker
At its most basic level, buying an apartment building is much like buying a home. After identifying what you are in the market for, determine your financing and engage any professionals needed to make the transaction happen.
Consider a Mortgage Broker
Many commercial investors turn to the services of a mortgage broker to find financing for apartment building projects. If you know of a lender that you want to work with, then a broker may not be helpful. A mortgage broker who specializes in commercial or apartment building loans will be able to help you find the loan product that best suits your needs
Mortgage brokers also act as middlemen to expedite your paperwork to the lender for lender review. So, rather than completing several individual loan applications to get personalized rates and terms, an investor can instead work with a mortgage broker who does all of that legwork for them.
When Fannie Mae, Freddie Mac, or HUD loans are in the mix, the documentation process can be time-consuming and lack any wiggle room. In these cases, investors often find value in delegating the paperwork to a broker.
Mortgage brokers also provide education regarding the loan products and can introduce investors to specialized financing that the average person does not deal with. Important financing considerations to discuss with a broker include whether you want a recourse or non-recourse loan and how much you are able to put toward a down-payment. Both of these things shape the loans available to you.
Choose a Commercial Real Estate Broker
Those who lack a background in real estate law or experience in high-dollar real estate transactions often engage the assistance of a commercial real estate broker to assist in finding promising parties and in navigating the transaction elements of any purchase.
A broker with expertise in multifamily properties will be able to provide insight into the pros and cons of each prospective building, help negotiate price, and can further educate you regarding the purchase process. Brokers also have access to the Multiple Listing Service (MLS), which gives them a way to easily search and keep tabs on any properties that meet your search criteria.
Meet Lender Requirements to Finalize Purchase
After finding the right building, the next step will be to jump over all the lender hurdles to finance the purchase of your new apartment building. For most transactions, this is where the real challenges lie.
From purchase contract to closing, several reports and milestones will need to be completed to satisfy the lender. Here are some of the most common hurdles to expect when buying an apartment building:
The appraisal reports the likely market value of the property, and the report is prepared by an independent professional. Unlike residential real estate, which relies heavily on the sales comparison approach, an appraisal for an apartment building will likely emphasize the income approach. The income approach for appraisals estimates the property’s value based on its demonstrated and potential income. The third appraisal approach, the cost approach, is based on the replacement cost of the property.
Physical Condition Report
The report of the physical condition of the property may be called the physical needs assessment, property condition report, or the engineering report. This report analyzes the physical condition of the apartment building to determine its worthiness for a mortgage, and it also helps the buyer determine whether or not to follow through with the purchase. Lenders use the report to calculate the replacement reserves, which are funds the lender requires to be set aside to perform needed maintenance or repairs to the building.
The title report ensures that the previous property transactions have led to a fully transferable title with no clouds on the title.
Phase I Environmental Assessment
A Phase I Environmental Assessment (ESA) provides a report on the property’s possible environmental issues that could harm the community or ecology of the surrounding area. If the Phase I ESA demonstrates possible contamination, further assessment may be required by the lender. The reason that this assessment is required is that the new owner can be liable for expensive clean up if contamination is subsequently found, impacting the financial circumstances of the property.
Lenders may also require additional reports specific to the property or community, including surveys to determine boundaries and encroachments, seismic reports to analyze earthquake risk, and zoning reports to clarify any zoning issues or disputes.
Finalize the Purchase with Post-Closing Duties
After the paperwork is signed and money is transferred, the work is just beginning. Don’t forget to delegate and ensure it is taken care of. Most importantly, remember to keep the tenants’ security deposits in a separate account so that it can be fully refunded to them, minus any deductions for damage.
Most property owners engage a professional management company at this stage to handle the financial transactions, tenant communications, and building upkeep and maintenance. Be sure to obtain education and legal advice to ensure compliance with all state and federal regulations regarding treatment of tenants and their funds.
Don’t Forget Real Estate Syndications
If buying an entire apartment building on your own seems like more than you want to take on right now, consider investing in a real estate syndication.
Real estate syndication is the process by which a group of investors contribute funds to a pool managed by a sponsor who purchases and renovates, manages, and then sells the property. Multifamily buildings are popular with syndications, because the monthly rental payments from the tenants can yield early and regular profits.
In a syndication project, individual investors join an investment group, known as a syndicate, which contributes funds toward a real estate project. The project sponsor, or syndicator, proposes a specific project or provides a menu of projects for investor to choose from. Then, they handle the transaction as well as property management and payouts to investors. Syndications usually last 5 to 10 years, and then the project terminates by selling the subject property. Depending on the terms of the deal, individual investors can earn a percentage of rent as regular passive income as well as a percentage of the profits from the final sale of the building.
Just as with the purchase of any business, the purchase of an apartment building will require a life-changing level of financial investment—and a lot of leg work to make it happen. In return, the new owner will hopefully be rewarded with steady income from tenants and a property with ever-increasing value. For those who are interested in buying an apartment building but do not have the full capital needed or the desire to manage the property, investing in a real estate syndication can be a viable alternative.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More