The multifamily investment space has been one of the most reliable markets for investors over the past decade. Investing in an apartment building can be lucrative, but it’s important to do your due diligence and understand what’s involved in the process. As a leading real estate syndication company, we aim to educate anyone who wants to learn more about leveraging shares of multifamily rental properties into a passive monthly income.
In this article, we’ll introduce you to some key concepts that you need to know before investing in an apartment building.
Learn the Basics
Multifamily properties offer enticing opportunities for steady returns thanks to monthly rental income. They can also be money pits if repairs and upgrades are needed. These two details are just the tip of the iceberg when it comes to the benefits and downsides of investing in apartment buildings. When contemplating entry into the apartment building market, ensure you know the basic pros and cons of each project you are considering.
Apartment buildings can offer some major benefits to investors, including:
- Rental Income: Rent collection comprises the lion’s share of possible income from apartment buildings. Other real estate investment projects may have no regular income and only produce returns when the property is sold, so apartment buildings are attractive if you want passive income.
- Supplementary Income: Apartment building owners can charge fees for a variety of amenities and services related to the building. Parking spaces, storage closets, premium pool and gym perks, and party/recreation room rentals all have the potential to bring in extra revenue each month.
- Tax Advantages: Real estate investment brings several tax advantages, like a lower tax rate for passive income and the ability to front-load the depreciation deduction on taxes.
- Equity: In addition to income from rent and supplementary fees, owners will hopefully see an increase in equity in the building as time goes on. Ideally, the property will increase in value during ownership to provide a rewarding payout when the investor decides to sell the building.
With so many benefits of investing in apartment buildings, investors often gain the false impression that they are sure-fire investments. Unfortunately, very few things are, and there are some potential pitfalls investors need to keep in mind as well:
- Tenant Unpredictability: Because tenants are key for revenue, the inability to place or retain tenants can make for a financial disaster. Tenants also bring a human element that can be hard to manage, whether it be through their demands or conflicts with other tenants.
- Building Maintenance & Repair: Just as apartment buildings offer a steady stream of money inflow, they will also cause a stream of expenditures. From regular upkeep of the grounds and facilities to unexpected costs, it’s important to plan for expenses. Additionally, to stay competitive, the building may need upgrades and additional amenities to draw in tenants or prevent attrition to more modern buildings.
- Time Investment: Apartment buildings require hands-on involvement from beginning to end. Choosing and closing an investment property is only the first step. Property management can be delegated to a professional, for a fee, but the timeline for selling the property is also longer than for single-family properties.
Consider Multifamily Property Investment Options
There’s more than one way to invest in apartment buildings, beyond the traditional purchase of a property. If generating passive income while reducing your workload seems interesting to you, consider the following options for investing in apartment buildings.
Real Estate Syndication
Real estate syndication is the process by which a group of investors contributes funds to a sponsor company that purchases and renovates, manages, and then sells the property. Multi-family dwellings like apartment buildings are a popular type of syndication, because the monthly rental payments from the tenants can yield early and regular profits.
Depending on the structure of the syndication, investors may see a larger portion of early returns than the sponsor. This gives a little more certainty about recouping at least some of the funds invested. Investors can search for syndications with a structure that best meets their financial goals and balances their tolerance for risk.
Something to keep in mind about joining a syndication is that you will have little to no control over the major decisions that ultimately impact the outcome of your investment. For this reason, it’s important to do your research and find a sponsor that you can trust.
Real Estate Investment Trusts
Real Estate Investment Trusts (“REIT”s) are companies that own or finance real estate properties that produce income. They then pay out at least 90 percent of their taxable income from those income-producing properties to the passive investors.
Most REITs operate on major stock exchanges, and investors purchase company stock. The stockholders receive dividend payouts.
Many people purchase REIT stock through their 401(k)s or other investment plans. This is a simple way to invest in apartment buildings compared to purchasing an entire building on your own or with a partner. Investing in REITs involves a few clicks on your computer or app.
Purchase Alone or with a Partner
Whether or not an investor has a partner, choosing to buy a complex can be a time-consuming and costly option for multifamily investment. That said, purchasing an apartment building also gives the investor the most control over the investment decisions and comes with the greatest chance for risk and reward.
If you are considering purchasing an apartment on your own, make sure you have a plan for property management, renovations, property sale, and more. If you’re inexperienced in these areas, be sure to work with a partner or partners who you can rely on.
Build Your Own
Building an apartment complex is an expensive project, but just how expensive depends on several variables, including size, finish, and local fees. The benefit of complete ownership and control over their investment is attractive to some who are willing to put in the work. However, this is the least passive option of gaining income from a multifamily property.
Average apartment building construction costs in the United States range from $4.5 million to $50 million. Project costs vary most dramatically based on the size of the completed project.
- Low-rise buildings cost $150 to $225 per square foot
- Mid-rise buildings range from $175 to $250 per square foot
- High-rise buildings are the most expensive at $225 to $400 per square foot.
Cost of building can be divided into hard and soft costs. The hard costs are the things that first come to mind: building materials needed to frame and finish the building, creating a foundation, and turning units into homes with kitchens and bathrooms. Hard costs also include the labor needed to turn those materials into apartments and the cost of the land that the project sits on.
Soft costs are less obvious expenditures that are just as important if you want a habitable building. These include factors such as architectural fees, legal fees, and permit/development fees.
Do Your Research
Apartment building investors need to devote significant time to evaluating and researching potential buildings or investment opportunities. Regardless of how you want to dive into apartment building investment, you will want to be familiar with the different classes, structures, and potential risks of apartment buildings.
Classes of Apartment Buildings
Apartment buildings come in all shapes and sizes, and they are filtered into four classes:
- Class A: newer, usually less than 10 years old, and have the amenities typically 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: 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. The new has worn off of Class B buildings.
- Class C: 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.
- Class D: often low-income or subsidized housing, over 30 years old, and in poor repair. These buildings lack amenities.
Investors often gravitate toward Class B and C buildings, because they do not need intensive repair, but there is still opportunity to increase rents and equity thanks to lower-cost renovations and upgrades.
Structural Types of Apartment Buildings
In addition to identifying multifamily property investments by their condition or class as described above, we can also separate apartment buildings based on structural type:
- Low-rise apartment buildings are four or fewer levels high. These are most commonly found in suburban areas or in smaller cities without significant population density. They require less expense and are easier to build, but they do typically offer less ability to make large profits.
- Medium-rise apartment buildings will be five to nine levels high. They are in both urban and suburban areas, and can be a good compromise size to balance risk and benefit. They may also provide supplementary income from parking, vending, laundry, and other amenities.
- High-rise apartment buildings have 10 or more floors. These buildings are expensive to build and are subject to many regulations. The increased number of tenants provide greater income possibilities. These buildings offer the best return of investment in areas where land is in short supply and is very expensive.
Common Multifamily Property Risks
Here are a few things to keep in mind as you weigh the possible risks and benefits of each opportunity:
- Building Size: Larger apartments equal more potential income, but they also pose a greater risk due to their more significant up-front investment and the ongoing maintenance and loan servicing costs.
- Rent Rolls: 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.
- Occupancy Rates: Consider the occupancy rates to learn what percentage of the building is usually occupied by paying tenants. Be sure to take into account vacancy periods to help you understand the attrition and replacement of tenants. Also take note of the reasonable earning potential of the building.
- Capitalization Rates: It’s important to determine the capitalization rate to understand the value of a building. To find the cap rate, divide the building’s net operating income by the market value or purchase price. The higher the rate, the better. Sometimes, buildings with a greater asking price end up posing a better deal than a similar building with a less expensive list price based on the cap rate.
Become an Apartment Building Owner
If you are ready to take the plunge and become an apartment building owner, here are the main steps to start the process:
Obtain Financing Pre-Approval
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.
Mortgage brokers can make this step much easier by doing the legwork for you. They can research and present loan products to you based on your specific circumstances. Then, they will facilitate the paperwork to ensure that you jump through all the needed hoops.
Meet Lender Requirements to Finalize the Loan
Finally, closing the loan usually involves several reports to satisfy the lender’s need to evaluate the risk of the loan and the creditworthiness of the purchaser. In addition to an appraisal, an apartment building purchase will likely require a title report, a Phase I Environmental Assessment, and a physical condition report.
Lenders may also require additional reports specific to the property or community. Reports include surveys to determine boundaries and encroachments, seismic reports to analyze earthquake risk, and zoning reports to clarify any zoning issues or disputes.
Establish Management of the Building
After purchasing an apartment building, the real work is just beginning. If you are inexperienced, it’s important to hire a professional, experienced property manager that has both the ability and knowledge to coordinate all the needs of the building, the tenants, and the owner. Alternatively, if you will be doing your own property management, you need to be aware of the legal requirements regarding safety and financial management to avoid incurring major penalties or legal liabilities.
Apartment buildings remain a popular investment thanks to the revenue provided by tenants’ monthly payments. As many markets experience record-low single-family housing inventory, apartment buildings continue to hold their own in the housing industry.
Ultimately, there are many paths for investing in apartment buildings to fit each investor’s goals and resources. While some choose more traditional methods, many investors opt for syndications and REITs for the advantage of apartment building investment without the major time and financial commitment of owning a building outright. 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. If you are interested in learning more about the freedom that LBC can offer your investment efforts, get in touch with our team today.