The Ultimate Guide to Multifamily Apartment Investing
Multifamily Apartment investing creates stability, diversity, cash flow, and long-term appreciation for your investment portfolio. With capital markets, both domestically and internationally, showing signs of weakness Commercial Real Estate has become a great alternative for most investors.
Below are some of the top reasons why investing in Multifamily Apartments should be a priority.
- Income Potential
People invest in apartment buildings because of the attractive returns they offer. A single-family residential investment may only earn as high as 4 to 5 percent a year. In contrast, many commercial properties generate an annual return between 6 and 12 percent of the original price.
The yield of Multifamily Real Estate is even more attractive when compared to stocks, bonds and commodities. A National Council of Real Estate Investment Fiduciaries (NCREIF) report in 2015 estimated an average annual return of over 12 percent with 8 percent average during the previous 15 years. This concludes a 200-basis point over the S&P 500 index average performance at the same time period.
- Regular Cash Flow
Investments in Multifamily Apartment buildings deliver steady cash flow that is distributed monthly, quarterly or annually. You can even be a partial owner with other investors even if you don’t own the entire property. You have two options when investing as a partial owner: Equity Investment and Debt Investment.
Equity Investing is investing as a “principle” owner or partial principle owner. Equity investing capitalizing on the property’s cash flow based on the rents the apartment building generates. This is achieved by buying a minority ownership in the property.
Debt Investing, on the other hand, yields fixed returns through debt collaterals like mortgages or loans on real estate property. Debt investments are usually less risky compared to Equity Investments and typically offer a lower return. You are also not a principle owner of the property. You are the owner of the lien / mortgage / note secured by the property as collateral.
- Hard Tangible Asset
Adding tangible assets to your portfolio gives you more security. Companies can attract you with their high performing stocks but they are not entirely trustworthy and can disappear overnight. Enron was a good example that investing in high performing corporate stocks can sometimes backfire.
Commercial real estate can be very safe and secure. A real estate property cannot just disappear overnight. Unlike the value of a stock that can drop 90% overnight. Although real estate values can fluctuate with the market the overall value remains roughly the same.
- Pay Down Principle Balance
The cash flow of the Multifamily Apartment can help you reduce the principle balance of the loan. The revenue of the property with a fully amortizing loan will reduce the outstanding debt with each month’s payment without you having to do anything. Or you can use the extra cash-flow to pay down the balance sooner. You are in full control of your investment outcome depending on your strategy.
- Depreciation Deduction
Appreciation and capital gains are certainly attractive to commercial real estate investors but so is the depreciation write off. Most assets reduce in physical value over time thereby decreasing the accounting value of a physical structure on a tax basis. However, even if the physical structure of a real state asset is depreciated for accounting purposes it doesn’t affect the market value at all. If you improve the property or increase the monthly rents the value of the property actually increases. The net result of the depreciation deduction is a higher after-tax yield. It’s simply a “paper loss” not an actual loss.
- Appreciation Potential
This is specific to equity investments in Multifamily Apartments and other commercial properties. Opportunistic real estate investors can buy a commercial property in a developing area, fix and improve the property, then sell it for a profit. This is done in a short period such as one to three years. You can also increase the value of the apartment by increasing the rents which then increases the net operating income. The end result is a property with increased value in a short period of time.
- Objective Valuation
Residential value can depend on emotional pricing where a person might sell his property due to emotional attachment or financial burden. In commercial real estate this is almost non-existent because prices are determined by the property’s current income statement. You can negotiate objectively without the owner’s emotional attachment as a distraction. Furthermore, most prices are usually set by using a prevailing cap rate in the location of the property and its classification of type of building (residential, industrial, office, retail, etc.)
Chapter 1: Multifamily Real Estate Overview
Multifamily property is the second largest asset class of real estate holdings at 25% of the commercial real estate investment sector. The Multifamily sector use to be regarded as a residential asset class but is now an extensively held strategic asset class for commercial real estate.
Asset Class Overview
Multifamily real estate includes a wide variety of property types. Theoretically, it includes all structures that have at least two housing units. Multifamily can include townhouses, condominiums, and apartment projects as well. Apartment Buildings are the most frequently obtained properties in this asset class.
The real estate industry rates properties as Class A, B, or C according to conditions like age, amenities, quality, location, rent, and other factors.
- Class A properties are considered the “best in asset class” and get the highest rents in their markets. They feature resort-like conditions with fountains, grand pools, fitness centers, and other luxuries amenities. They are usually found in suburban locations.
- Class B properties usually are meant to be a reasonable housing remedy for average wage earners. They are a step down from Class A. They are a bit older and usually do not have the “luxury” amenities present in Class A properties.
- Class C properties are the most affordable Multifamily properties. They are way older, have obsolete building models, and possibly in great need of repair and restoration. They are usually in older run-down neighborhoods and very inexpensive to rent. They are at the bottom of the rent pool.
Aside from the classes, apartment properties in addition have a wide variety of size and type. There are dense, urban, and high-rise apartment buildings while there can also be resort-type complexes with swimming pools, fitness centers, fountains and other luxury facilities.
Multifamily buildings are categorized as follows depending on their size and type:
- Low Rise or Garden Style: 2-4 stories high and typically found in suburban locations.
- Mid Rise: 5-9 story apartment buildings
- High Rise: 10 stories or higher apartment buildings
Economic Demand Drivers
Households are made up of either homeowners or renters. Homeownership as of March 2016 stands at about 63% while renters are at about 37% in accordance to the U.S. Census Bureau.
Demand drivers will either:
- Boost or reduce of the total number of the U.S. households
- Transition the percentage of renters vs. owners
- Or both of the above
Key Economic Drivers of Multifamily Demand
These are the factors that directly affect the multifamily market in any given area. An increase in one factor can directly increase rental rates in a market. Now imagine what happens when multiple factors increase the demand. The result is a dramatic increase in rental rates and property values.
- Population Growth
Households will develop with the population growth rate. Although the household growth is at a lesser rate there is still an overall increase in new households thus new renters looking for a place to live.
- Rental Household Growth
The last great recession reduced homeownership from 69% in 2004 to about the 63% we have today. This in turn caused an increase of renter households. Thus, driving the demand for Multifamily units to rent.
- Job Growth
Job growth is connected with the overall household growth in the U.S. More people can afford to pay for their own place to live as jobs increase. The majority of the new job growth affects the rental household the most. Since generally people who obtain new jobs are most likely to rent than to buy.
- Cost of Ownership
Cost of ownership can be regarded in two ways. The first one is high real estate prices will work as a prevention toward buying one’s own home because it is too high to afford. This results in a higher rate of renters in places where housing prices have soared.
If the cost of renting vs owning shifts, demand for the cheaper option will increase. Such changes only impact the renter / owner ratio and not the total quantity of households.
Trends in demographics also provide an impact towards the demand for renting apartments. According to a study that was published by the Joint Center for Housing Studies of Harvard University the increase in the population of renter households in the U.S. is the highest it has ever experienced in a 10-year period. Since 2005, the population of rental households increased by 9 million.
One of the key demographic trends that caused the increase in renters was the aging of the millennial generation (millennials are people who are born from 1985 – 2004). This trend has increased the total number of adults in their 20’s. The age at which renting is very common amongst young adults. The Millennial generation is delaying marriage and having children. They usually rent an apartment until they save money to buy a home.
The millennial homeownership delay is pushed even further due to an increase in student debt compared to previous generations. This makes it more difficult for them to buy their own home which in turn causes the rental population to grow even more.
This demographic trend along with other factors like empty nesters who are downsizing and renting have caused a larger number of renters in all age groups, households, and income categories.
Changes in Multifamily Living
Most of the demographic trends that were pointed out above have shifted the development of multifamily usage as a contemporary living experience. Below is the list of the factors influencing the use and location of apartment buildings.
Walkable / Bikeable locations
Due to the urban renaissance, renters now desire their apartment to be physically closer to neighborhood grocery stores, pubs, cafes, and restaurants. Before the trend for multifamily properties was to be hidden away in some protected and exclusive location. Now its all about efficiency and convenience.
Transit Oriented Developments
Related to above, being close to public transportations such as bus stops, train stations, and transit lines equate to higher rents and higher occupancies for an apartment building. This is because the renter sector frequently commutes via public transportation which leads to more apartment building developments along transit lines.
Attractive Modern Amenities
Renters now are also seeking attractive modern amenities within their building complex. These include amenities such as:
- Rooftop lounges
- Bicycle parking
- Bicycle mechanic stations
- Dog washing areas
- Fast internet connections
- Sound proof walls
- In-unit washing machines and dryers
- Package lockers
- Interior storage units adjacent to dwelling units
The newer Class A apartment buildings have become “hotel-like” in terms of service and amenities offered. They are very different from apartments of the past. These newer buildings are adapting and meeting the demands of the millennial renters.
New Development vs. Existing Product
Recent adjustments in the usage of Multifamily properties combined with the difference between the cost to build vs. the cost to buy have induced many investors to seek opportunities to invest in Multifamily development rather than Multifamily acquisitions.
Here are some of the key points you may look into when deciding between development vs. acquisition:
Development Risk Premium
If investors take a greater risk with new development then it’s only fair that they be compensated for it. One rule of thumb to consider is to collect a cap rate premium on development over acquiring an existing property. This is to make taking the “extra risk” worth it. As the spread between the risk and reward narrows or widens it creates less or greater motivation to invest towards new development.
Construction type along with the level of finish is the main basis of price per square foot in building costs. This, in turn, influences the rents a property must collect in order to accomplish its target returns. Multifamily development has many factors in building cost. They vary from high to low as listed below:
- Concrete and Steel
High rise buildings in urban setting need heavy duty structural support in order to strengthen a very dense vertical building. Those structural supports use a mixture of concrete and steel. With the excessive cost of land, construction cost and density in locations where high-rise buildings are constructed, it is typical to find high end amounts of finish in concrete and steel buildings.
It is common to find high to medium levels of finish in podium products because they are usually developed in an urban location with a high cost of land and construction. This style of Multifamily development has a concrete base, also known as the “podium”, on the buildings first one or two stories. The podium has stick built construction up to five floors above the podium. It may also include a basement or underground garage.
- Stick Built
It is common to find low to medium levels of finish in stick-built products. It is the least expensive of all three construction types. This type primarily uses wood beams and stud walls. Similar to how they build single family houses.
Even though Multifamily real estate has its own sophistication and associated risk it is still viewed as the most secure of all commercial real estate asset classes from an investment and risk evaluation perspective. This is partially because of the higher occupancy averages combined with the lower price volatility compared with other asset classes.
In analyzing the previous great recession, the Multifamily asset class is the one that performed the best through the darkest times of the economic crisis. It was also the asset class that lead the recovery. No matter what phase of the economic cycle we are in, whether in recession or recovery, people still need a place to live. That is the advantage to Multifamily investing.
Chapter 2: Market Cycles – When to Buy Multifamily Apartments
Before you buy any Apartment building you must identify the real estate market cycle you are in. This will determine the buying strategy you will have in order to reduce the risk and maximize your profit in the long run.
If you are in an Appreciating Market you can afford to get into a deal that has less equity because you can expect the property to appreciate with the market in time. You can also have a lower amount of cash flow because you can anticipate the rents will increase along with the market.
Your requirements for a deal should be stricter if you’re in a market that is close to its peak or is in a decline. If you expect the market will go down or is presently going down then you will need a lot more equity in the property for added security. A larger cash flow should also be required because you expect the rents will decrease as the market declines.
The only time you should be buying in a declining market is if you’re getting an amazing deal. Something with lots of equity or huge cashflow already built into the price.
Your strategy is to focus on targeting markets that are appreciating. Ride the appreciation wave then sell for a profit and move on to another appreciating market.
3 Objectives When Investing in Real Estate
- Put in as little cash as possible
You will have more leverage and get higher returns on your money the less cash you have in the deal. It also allows you to have extra money to go into other deals should a good opportunity come up.
In the long run having more active investments will net you more income compared to investing all you’ve got into one big property. You should make your money work as efficiently as possible to get the highest return. Rather than putting all your eggs in one basket and risking everything you got.
- Get your investment back as soon as possible
The sooner you get your invested money back the sooner you can use it again to purchase other apartment properties. The more you recycle your money the faster your wealth grows.
- Get the largest amount of appreciation in the shortest amount of time
The faster your property appreciates the wealthier you become. You want to start your investment strategy by seeking out markets that are appreciating faster than other markets.
You then want to sell your apartment building when the market has reached the peak then find another market that is starting to appreciate and repeat the process.
Hidden equity is another way to obtain appreciation quickly. Seek rundown apartment buildings that need repairs and/or have poor management and low rents. After buying it, update and improve the property and increase the rents. This increases New Operating Income and thus increases the value of your property dramatically.
Whenever you are you looking at deals always keep these factors in mind when making decisions. Now let’s talk about real estate market cycles.
Real Estate Market Phases
The real estate market has three different phases. Every cycle is different and relies on the economic environment. The average cycle can last around 10-20 years.
Michael Anderson named these phases:
- Expansion Phase – Positive Real Estate Market in an up swing
- Decline Phase – Negative Real Estate Market in a down swing
- Absorption Phase – Neutral Real Estate market starting its recovery
The efficiency of the markets is affected by supply and demand factors. The higher the demand the higher the prices are driven. The lower the demand the lower the prices drop.
The shorter the supply the higher the prices are driven. The higher the supply the lower the prices will be. This holds true for the Real Estate Market as well.
4 Components of a Real Estate Market
At any given time these components are affecting the real estate market. This is seen at a macro scale as well as a micro scale in specific markets across the country.
Supply – The number of properties available for sale in a market
Demand – The number of buyers ready to buy properties in a market
Seller’s Market – Low inventory of properties for sale (supply low)
Lots of buyers trying to buy properties (demand high)
Buyer’s Market – Large inventory of properties for sale (supply high).
Low amount of buyers trying to buy properties (demand low)
There are two stages that occur within each of the seller’s market and buyer’s market. The first stage is dominated by supply. The second stage is dominated by demand. Below are the four stages where we see all these components come into play creating the type of market we are in.
The Four Stages of a Real Estate Market Cycle
These are the four stages that every real estate market goes through. All stages are reacting to the given markets economy. Some at a macro level as we saw in the last recession where the entire real estate market crashed with the United States economy and some react at a micro level when a large fortune 500 company moves in and creates thousands of jobs in a specific city.
Seller’s Market – Stage 1
Demand is increasing and prices are driven up by increase of demand. This is the transition into a Seller’s Market from the last stages of a Buyer’s Market.
- The supply of property in this market declines
- Properties are selling fast
- Speculation is in full swing after a long period of low activity
- The Unemployment rate is dropping
- Property prices and rents are rising as demand increases
- Demand has reached its highest point
Although this is a decent time to buy, the best time to buy for long-term appreciation is the Buyer’s Market Stage 2.
Since no one knows how long the market is going to grow there is still a lot of potential for profit during this stage. Buy early so you can afford to pay market prices as you expect your property to appreciate in value during this stage.
The strategy here is to buy and hold properties with excellent cash-flow or until the market is entering Seller’s Market Stage 2.
Seller’s Market – Stage 2
Supply begins to rise due to new construction and developers jumping into the market for new opportunities. Demand remains strong and supply is not sufficient to keep up with the increase in demand and new buyers in the market.
- Days on Market begins to increase
- Inventory begins to increase
- More land is being bought for development
- The amount of construction is excessive and overbuilding is very likely
- Construction materials increase in price
- Business and job growth slow down
The strategy in this market is to sell off all assets that you do not plan to hold. Typically, all average or mediocre cash-flowing properties. You should keep only the apartment buildings with excellent cash-flow.
Your profits from the sold properties should remain untouched until the market shifts to a Buyer’s Market Stage 2. Unless you find an amazing deal that is too good to pass up.
Buyer’s Market – Stage 1
There is now an oversupply of inventory on the market. The market has now become a Buyer’s Market overbuilt with properties and investors and buyers are realizing the market is changing.
- Excess supply of inventory
- Prices and rental rates are decreasing
- Demand is decreasing
- Days on Market increases significantly
- New construction is overpriced and inactive
- Unemployment rate reaches an all-time high
- Construction industry starts to struggle
- Foreclosure rate increases dramatically
- Property values drop to the lowest level of all four cycles
- News about the economy is negative
This is the absolute lowest point of the market. It’s better to keep your money in your bank account. In this market, the only deal to buy is a property with huge cash flow. Even though there may be “good deals” in this market the problem is you don’t know how long the market will be declining and how low rents are going to decrease.
You could buy something that one year later goes double negative (negative in value and negative in rents). You won’t be able to sell it to pay off the current loan and you can’t pay the mortgage because the rents don’t cover the mortgage payment. You are now in the worst position you could be in, double negative.
Be very very careful in this market. Wait until you see positive changes in the economy and the real estate market before you buy.
Buyer’s Market – Stage 2
Construction has been completely stopped due to overbuilding. Buyers are entering the market with properties prices being so low. The market is absorbing the excess inventory as the demand for properties begins to increase.
- The market is absorbing oversupply of inventory
- Days on Market begins to decrease
- Job growth begins to increases
- Properties are being renovated again
- Competition to buy Bank Foreclosures increases
- Prices and rents begin to rise as the economy begins to shift
- New about the economy is becoming positive
This is the best time to buy properties. The market has stopped declining and starts to increase slowly. Expect prices and rents to increase slowly. This is the time to buy everything that you can finance that meets your purchasing criteria. You can pay market prices at this stage because the values will increase significantly.
Economic Indicators That Determine Market Cycles
There are key economic indicators in each market that tell you what stage the real estate market is in. Here are a few to look for:
The number of building permits can tell you when the market enters Market Phase Stage 1. You will be able to see this by the increase in the number of permits applied for and granted in comparison to the previous years. In addition, you will see what inventory will be coming on the market in the future.
When you see a drastic increase in construction the market will soon be overbuilt and will transition from Seller’s Market Stage 2 to Buyer’s Market Stage 1.
Search for the following resources to get more info about construction and permits in your market:
- Local building and development associations
- Chamber of commerce
- City planning departments
- Bureau of the Census
- Department of Commerce
- City Building Permit Division
Employment and job growth are the best indicator of a market transitioning from Buyer’s Market Stage 1 to Buyer’s Market Stage 2. Employment and job growth in your area indicate that businesses are relocating into the market.
For every job that a new business brings in there are 3-4 other jobs created in the service sectors in that area.
Search for the following resources:
- Department of Commerce
- Bureau of the Census
- US Employment Rate
- State Employment rate
- County Employment rate
Number of Households
The potential for rents to increase will go up as the number of households increase in any given market. This is caused by the increase in demand for apartment rentals. As demand exceeds the supply, the rental rates increase to meet the demand.
Search for the following resources:
- Bureau of the Census
- Number of households + your city
The income each individual household generates is also a good indicator of rental rates. As the income of each household rise, their ability to pay higher rent also rises. Higher rents mean higher property values as well so it is important to look for areas in which household income is rising.
Search for the following resources:
- Bureau of the Census
- Household Income + your city
When vacancy is high it means the net income for the apartment building is down. When the net income is down the property value is down as well. A basic way to understand this is when the economy is down, less people can afford to pay rent so the rental market drops, which then affects the property’s net income, which then lowers the value of the property.
Economy down = Rents down = Value down
If the market is in a decline it can take a long time to fill vacancies and increase the value of the property. It’s better to wait until the market is coming out of a decline phase.
The best time to sell is when vacancies are at their lowest point because you will be getting the highest price for your property.
Search for the following resources in your market and ask them what the standard vacancy rate is in your market:
- Commercial real estate agents + your city
- Apartment Association + your city
- Property Management Firms + your city
You should also look into the demographic mix of a community to see the number of potential renters. The factors you want to see are
- Higher female to male population
- Higher population of young and old versus middle age
- More singles versus married
- More smaller families versus larger families
- Higher number of renters versus non-renters.
Search for the following resources:
- Demographic trends + your city
An increase in rental rates is an indicator of a good market. Decreasing and stagnant rents mean that the market is in the decline phase.
Search for the following resources and ask them what they think are the rental rates in your market:
- Commercial real estate agents + your city
- Apartment Association + your city
- Property Management Firms + your city
These are just a few indicators to gauge which market phase you are in. It’s always better to get an opinion about where the market is at from commercial agents, appraisers, and property managers who are working in that area. They will have a lot better understanding of where the market is and where it could be heading.
Don’t ever assume that just because your market is down that all the markets are down. Even when the US economy is down there are always a few markets that are booming because of new jobs or geographical reasons.
Always start your investing with proper market research.
Chapter 3: How to Find Good Multifamily Apartments Deals
Your main objective when looking for Apartment buildings to invest in is to buy from motivated sellers. This is where the best deals will be. Sellers that are motivated or “need to sell” are usually the ones that are more willing to negotiate and sell their property at a discount.
You can also look for cities where the market is quickly appreciating because of local economic factors. In locations that are just recovering from an economic recession you can also find owners that have seen little to no appreciation in their market and might be interested in selling at a discount.
These sellers have gotten no offers or low offers due to the economic decline and are more willing to negotiate than sellers in a hot market. They are also not aware that the economy will eventually rise again along with the price of real estate. These motivated sellers will be happy to trade (negotiate) with you and sell their properties for a reasonable price.
Here are some other reasons why a seller is motivated to sell:
- Death of the owner
- Health Issues
- Inherited property
- Condemned building
- Losing Money
- List of Multifamily Apartment Owners
The easiest way to get names of owners and prospective sellers is to obtain a list from an online list broker. You can contact them and ask for a quote on a list of apartment building owners in your area. List brokers will usually charge you .10 cents to $1 per name.
You can start to look for owners in your city or county. Once you have contacted all the owners in your area you can expand to nearby locations or states.
The basic information that you’ll need from the list broker is the following:
- Name of Owner
- Address of the Property
- Mailing address of the Owner
- Number of Units
- Last Sale Date
- Amount of Last Sale
Online list brokers to start your search:
Out of State Owners
For a more targeted list of motivated sellers see if you can get a list of all the “out of state owners” of multifamily buildings in your area. These owners would also be motivated to sell if they are having trouble with an apartment building. Since they live out of state they have less control of their property and more likely to sell if problems arise with their property.
Contact Property Owners
After you have your list the next thing for you to do is to start a marketing campaign. You want to contact owners from your list every 3-4 months. Even if they rejected your offer at first there may come a time where the owner’s circumstances will change. You need to be the one that they will think of when they are finally ready to sell. That’s why it’s important to market to them quarterly.
- Finding REO Multifamily Properties
You can also find apartment buildings through a local bankers or lenders. You will need to find out who is in charge of the bank’s REO (Real Estate Owned) Department. You may either meet them in person if distance permits or you can talk to them over the telephone.
You can send a letter first to establish your credibility and schedule a phone call from there. Don’t get discouraged if you get rejected at first. They get calls from investors all the time. What you need to be different from other investors calling the bank is persistence. The other investors will call once then never follow up again.
Use the Law of Numbers and the Law of Chance in your favor. It is proven that 80% of sales are made after the fourth contact. The average investor quits after the first call. In order for you to succeed just call more times. You might even have luck on your first or second call that they have a property that they’re looking to dispose of.
After your first call put the banker on your contact list and mail him once every month and contact them by phone every two months.
- Finding Apartment Buildings Through Evictions
One of the hardships of being a landlord is when a tenant refuses to pay. The bills are piling up and the landlord is being held back by one of his tenants. At this time the landlord may be vulnerable and going through a financial hardship. This is when he begins to doubt whether being a landlord is really for him or not.
You can find motivated sellers by contacting landlords that are in the process of evicting their tenants. You can get their names and addresses from the local court house or wherever property owners process their evictions. Troubled landlords who are frustrated with their property can see you as a potential lifesaver and accept your offer.
When contacting them you must first identify the eviction problem, remind them of the hardship they are going through, then present the solution to them by selling the property to you.
- Finding Multifamily Apartments from City Workers
Contact your local Board of Health or Building and Safety and ask which properties have outstanding violations or in need of repair. More often than not, they will be happy to give you the addresses if they think that you will buy the property and fix it. They know who the good and bad owners are so establishing a good relationship with these city workers will help you out in the long run.
You can also go to the property tax office at the city hall to find properties that have been taken back or properties with delinquent taxes. You will find some motivated sellers among those properties as well.
- Working with Multifamily and Commercial Real Estate Brokers
Another option when buying Multifamily Apartments is hiring a commercial broker to help you find them. They can provide you with immense information about local markets, a strong network of professional services, and have their own connections to off market motivated sellers.
A good commercial broker knows the history of all deals done in the local markets. They know the supply and demand of properties, the average and historical rents, and which markets to avoid. Always try to find a broker specializing in Multifamily Apartment buildings.
One good places to find agents in your local market is Loopnet. You don’t need a paid subscription to search but you might for more detailed information about properties. In this case you’re just going to use it to find agents in your market
Start by identifying which market you want to focus on then. Then search Loopnet.com for Multifamily agents in that area.
- Using Classified Ads in Magazines and Newspapers
There are two ways in using classified advertising in real estate. The first one is by looking under the real estate section of “properties for sale”. You may find apartment buildings mixed in with the single-family homes for sale. Usually off market deals not given to a real estate agent to put up for sale.
The other way is advertising yourself for properties.
You can place and AD saying:
“We Buy Apartments. Any Size. Any Condition. John 999-999-999”
This is an effective way to get sellers to contact you. You can reach a specific audience by advertising in a real estate magazine or reach a general audience by advertising in your local newspapers.
Handling AD Calls
Once you have your ADs in place you should be prepared when your phone starts ringing. You need to be the one directing the questions and keeping control of the call.
The questions below are for key information to determine whether or not your going to pursue the deal and to determine the seller’s motivation.
Apartment Ad Call Questions
Hello, how can I help you?
How did you hear about us?
What’s your name and number in case we get disconnected?
How many units are on the property?
How soon are you looking to sell?
Can you tell me a little bit about your property?
What’s the unit mix (how many 1 bedrooms, 2 bedrooms, 3 bedrooms)?
What are you getting for rents on the units?
How many units are vacant at this time?
Who pays for the utilities?
What type of repairs need to be done to the property?
Are the tenants on 30 day or one year leases?
How much are you asking for your property?
How did you arrive at that value?
Is that the best price you can do?
How much do you owe on the property?
Is your loan assumable?
Is there anything else you would like me know before I do my price analysis?
- Multifamily Property Managers
Commercial property managers are small management firms that are hired to manage Multifamily and commercial properties. The mid and large size firms have a fairly large list of building owners they manage for. These property managers can be a great source of referrals to you by letting you know which owners are ready to sell and which owners NEED to sell. Develop a list of property managers in your market and network with them continuously.
Google search: Multifamily Property Management + your city
- Trade Publication Newsletters
Trade publication newsletters and magazines can be a great source of keeping up to date with new developments in multifamily and commercial real estate. These types of publications also include advertisements for properties for sale. You can also advertise in these trade publications / newsletters the same was as magazine and newspaper ADs we mentioned earlier.
Here are some resources for you to look into:
- Commercial Real Estate Service Providers
Commercial real estate service providers provide accounting, advisory, design, marketing or related services. They can be an architectural firm, property management companies or accounting firms.
Make a list of all the services an apartment owner would need and google that service in your market. Once you build a list begin to contact them and let them know you are in the market looking for apartment building owners who want to sell.
Here is a sample list to get you started
- Real estate attorney
- Real estate CPA / accountant
- Commercial property manager
- Commercial mortgage broker
- Commercial real estate agent
- Hard Money lender
- Commercial general contractor
- Commercial property appraiser
- Commercial property inspector
- Commercial HVAC servicer
- Commercial pool service
- Commercial landscape company
Just remember to add “+ City” when you are Googling for these services. You want to focus on your market first before you reach out to outside vendors.
- Real Estate / Apartment / Commercial Networking Meetings
You can attend networking meetings specializing in real estate so you can meet brokers, sellers, buyers, property managers, and other people in the same business as you. Networking meetings can present you numerous business opportunities and new business relationships with people on the same ship as you. Not to mention sellers that want to sell or vendors who can refer sellers to you.
One of the biggest organizers of networking meetings is Meetup. They offer hundreds of real estate networking meetings in each state. Check it out below:
Google search: Real Estate Apartment Networking Meetings + your city
- City Code Violations
Buying properties with code violations can also be good deals. If an owner has a property with code violations they can’t rent it until they repair the property and are issued a certificate of occupancy. To do any major repairs they also must obtain and pay for permits and inspections. Sometimes these owners don’t have the money to make the repairs or the desire to invest more money into the property. Usually the owners of these properties are very motivated and want to sell fast. Even at a deep discount just to get rid of the property.
- Industry Events
Each year there are countless real estate industry events to educate you, gain new insight, grow your business, and expand your expertise. Some of these events attract hundreds of real estate professionals and experts. Attending these industry meetings can even further your network connections and present new opportunities for you.
Search through the sites below for any upcoming events in your area:
- Finding Apartment Deals Online
Truth be told, by the time an apartment building gets listed on these public sites it’s been looked at by all the big players in the market and passed up. Meaning it probably wasn’t that sweet of a deal. Now it’s just a regular sale at the retail price.
In any case, it’s still a good place to find apartments for sale in your area. If its been on the market long enough then maybe you could negotiate a better deal. Here are a few places to look into when your ready to buy in your area.
LoopNet is one of the top online commercial real estate marketplaces. With over 100,000 brokers connecting commercial real estate for sale and for lease with thousands of investors and business’ across the country.
CoStar has access to the largest inventory of active commercial real estate listings on the market. In addition, with CoStar’s research-verified data, you’ll have access to a comprehensive suite of tools, resources and analytics to save you time.
Commercial Real Estate website with hundreds of properties listed nationwide for lease and for sale.
A real estate platform that allows buyers, sellers, and real estate professionals to do their transactions completely online. It has more than 100,000 properties listed.
Provides information to over 400,000 multifamily buildings, farms, and ranches for sale by the U.S. Federal Government.
The Commercial Investment Multiple Listing Service. CIMLS is the leading free commercial real estate data resource online today. They provide commercial property marketing, data and listing management services.
Google search “Apartments for Sale + Your City”
You will probably run into some of the websites above but you might find some off market multifamily apartments on local commercial brokers websites that are not on any of the websites above. Best to always Google search in your city for these off-market deals.
Chapter 4: How To Evaluate Properties
The fastest way to analyze and evaluate a property is to do the apartment analysis explained here.
As a general rule do not buy a property with a negative cash flow. Real estate agents will entice you to buy a negative cash flow property and raise the rents to market rents and then suddenly become wealthy tomorrow. Their reasoning is that the rents are below market and you can easily raised the rents and increase the value of the property dramatically. This of course is an illusion to the rookie investor. If it were that easy the current owner would have already done it.
Always base your analysis on the current rents when buying apartment buildings. The value of the property is determined by the Net Operating Income based on current actual rents. Not on future market rents.
Properties where the cash flow is breakeven may be ok to buy but only at the start or middle of a developing market. A breakeven purchase is a bad investment if the market is at its peak or a decline because the values and rents in that market will be going down and you’ll get into negative cash flow situations eventually.
Ultimate Real Estate Rule: Do NOT buy properties with negative cash flow!
They will bleed you to financial death.
Going Over the Multifamily Apartment Analysis Form
The address of the property. Always save a property file even if you decided not to buy it. It may come up again and you will save time having a file on the property already.
Write down the asking price if the property is currently on the market. Write down the maximum amount you will offer after you are done with the analysis.
Write down who the owner is along with his contact information.
You’ll need this information when you’re negotiating. If the owner has a low mortgage balance he may be willing to negotiate more or carry paper. It may be advantageous for you to assume the loan if it has a low interest rate.
You’ll have an idea of the owner’s financial position by knowing this number and use it to your advantage when you are negotiating with him.
This is the unit mix of the building. Find out how many 1-bedroom units there are and how many 2 and 3 bedrooms units there are. Asking this will make you sound like you know what you are doing.
When it comes to unit mix it’s better to have more 2-bedroom apartments than 1-bedroom. 1-bedroom apartments tend to attract temporary tenants and more turn over.
A general rule is to have 2-bedroom units for every 1-bedroom unit. Although it may never be exact its just an idea to have in mind.
Number of Units
Write down the number of units the apartment building has. Write down the number of rooms and bathrooms each unit has.
The average rent collected for each unit type.
The rent in the market for those unit types. You need to research other similar apartment buildings in the same area. You can use these figures to determine this property’s rent potential. You have upside potential if the current rent on this property is way below market.
Annual Operating Expenses
All of the expenses that the owner is currently paying on the property. These expenses must be verified with bills and receipts to avoid hidden expenses that are not being disclosed.
Real Estate Taxes
You can go to the city website to get this information for use in your analysis.
You need to call commercial insurance agents in the area to find out how much a policy would cost on a property of this type.
Water and Sewer
Find out if the property uses city or private water and sewer. Always get a copy of the last two years bills so you can get an average of the usage. Find out who is responsible for paying the water bill. The tenant or the owner of the building? Some states require the owner of the property to provide water while others separate it off with a metering system.
If the property is located in a state with cold climate you must get all invoices and contracts from the company that is servicing the property in terms of snow removal.
The city will pick up the trash for buildings with 4 units and below. Buildings with more than 4 units must have their own trash removal service. You must get all contracts from the company providing trash removal services to the property
Check if the owner is paying for the tenant’s electricity or do the tenants pay individually. The building owner is the one who pays for lighting in common areas like hallways. You must obtain all the electric bills for the last 2 years.
Research the laws in your state about heating. Some states require the owner to pay the cost of heating and hot water. While others allow the owner to pass the cost to the tenants. If applicable get all the gas bills for the last two years.
Like gas, there are various laws per state regarding oil. Some require the owner to pay while other states allow the tenants to pay the cost. Get the invoices for fuel for the last two years. You can also look at the leases to see who pays for what utilities.
You will eventually have to evict tenants. The eviction rate of tenants increases with the number of units you own. Research about the process of eviction in your location. Some states have laws favoring the tenant and some have laws favoring the landlord.
You need to know about management fees regardless of whether you will hire a management company or not. Normal fees on buildings with 6 units and below range from 7% – 10% of the gross collected rent. While larger units range from 5% – 9% and can usually be negotiated.
Larger buildings and complexes also have the additional cost of an onsite manager. The onsite manager will use one of your units as his/her office and have a salary. They can also live in one of your units for free or for a discount and in return they manage your property.
Repairs And Maintenance
Do not believe a seller if they told you that they have no maintenance and repair expenses. They are either lying or they have deferred a lot of repair and maintenance on the property. Generally, maintenance will cost about 10 percent of the gross annual income. You may want to set a conservative figure at 10% – 15 % to account for older apartments.
Check with the local apartment association for the vacancy rates in the area. A seller that is claiming 100% vacancy is either lying or has set the rents too low. 10% vacancy rate is a conservative rate when evaluating a property.
Every building is different and may have unique expenses tied to them. Put those expenses here when evaluating the property.
Total Gross Income
Total Gross Income is calculated by adding all the rents of the units based on the leases to get a total monthly gross amount. Add conservative market rents for units that are vacant. You will multiply the value of the Total Monthly Rates by 12. This will give you your Total Yearly Rate. Add your “Other Income” that is composed of money earned from vending machines and laundry machines and any other services that they charge to the tenants. The resulting value is the Total Gross Income.
Net Operating Income
The Net Operating Income (NOI) is utilized to determine the value of the property. You can obtain the NOI of the property by subtracting the Total Annual Expenses from the Total Gross Income.
Net Operating Income is used to compute for the Cap Rate with this formula:
Cap Rate = Net Operating Income / Value (price of property)
Debt Service is the amount of mortgage the property can maintain and will determine your cash flow after your financing expenses are paid.
The first and second mortgages are broken down into the following:
After you’re done computing the monthly payments get the sum and multiply it by twelve. Then get the Total Annual Debt Service amount.
Does the property cashflow?
After you get the figures above analyze them to see if you want to buy the property. You can determine the cash flow of the property by subtracting the Total Annual Operating Expense and the Annual Debt Service from the Gross Operating Income. If the cash flow is negative move on to the next deal.
That numbers may be low but remember that you are assuming that the market will appreciate and your tenants are the ones paying for the mortgage.
You can take less Cash Flow if you are in an appreciating market. You will need a larger cash flow if the market you’re in is near its peak. If the market is declining, aim for an even greater cash flow to avoid negative cash flows when the market declines.
Determining the Value of a Multifamily Apartment Building
There are three ways to determine the value for an apartment building:
Replacement Cost Approach
The Replacement Cost Approach determines value by calculating how much it would cost to replace an existing building. This approach requires you to get the pricing for all materials used in the construction of the exact building then calculate the replacement cost. Because of the time it takes this approach is rarely used.
Sales Comparison Approach
The Sales Comparison Approach is the most common approach to determine value of single family properties and 2-4 unit multifamily properties. This approach compares properties that have been sold in the last six months that are similar to the subject to determine value. The comparable properties must be within a certain geographical radius from your property to determine value usually 1-2 miles.
The Income Approach
The Income Approach is used to determine the value of apartment properties that have five units or more. You would determine how much income the property earns and determine the value based on its income.
Investors also use several formulas to determine value. The formula used the most is the Capitalization Rate or commonly referred to as the Cap Rate. This is what most investors use when quickly comparing properties with each other.
The rate in which the Net Operating Income repays the purchase price on an annual basis is called the Cap Rate. (Net Operating Income is the income left after all expenses are taken out.)
The formula for the Cap Rate is as follows:
Cap Rate = Net Operating Income / Value (selling price)
With this formula, you can calculate the third variable if you know any two of the other variables:
Net Operating Income = Value (selling price) x Cap Rate
Value (selling price) = Net Operating Income / Cap Rate
The usual Cap Rates are between 6-8% with lower rates in bigger more popular cities. The higher the Cap Rate the lower the value of the property which means you may be getting a good deal. When you buy properties with more than 8 units then it’s best to use the Cap Rate for determining the property’s value.
Cash on Cash Return
The Cash on Cash Return tells you the cash that will be returned to you for every dollar that you invest into the deal. It determines how much you will get back at the end of the year.
Cash Flow (Net Operating Income – Debt Service) /
Acquisition Costs (Down Payment + Total Closing Cost)
In every market, except a Buyers’ Market, you would want a 15 – 20% Cash on Cash Return. Having that percentage of cash on cash return means that every dollar you put into the deal will get you back .15 – .20 cents of that at the end of the year. Basically 15% – 20% on your money.
Return on Investment
You want to look at your Return on Investment or ROI after your first year of operation.
This is calculated using the following formula:
NOI – Debt Service /
You want to be aware of the ROI so you can compare other investments such as stocks and bonds with your real estate investment. You can also compare properties to each other this way.
Chapter 5: How to Negotiate Multifamily Apartments Successfully
Negotiating Multifamily property is the same as negotiating anything else. Except for the work involved in researching prior to negotiating is more intense. In order to really succeed at negotiating you must be fully prepared with all the information you need to negotiate properly. Below are some of the basic fundamentals you will need before engaging the seller.
6 Factors to Negotiating Better Apartment Deals
- Do Your Research
The more information you know about the property, the market of the area, the neighborhood, and the property seller, the stronger position you will be in to negotiate a better deal and additional terms after your due diligence and inspections.
- Find the Seller’s Motivation
Part of your research is finding out all you can about the seller. That includes his background, his financial position, and what’s motivating him to sell. You are more likely to negotiate better terms when you work with motivated sellers.
Here are the main reasons sellers are motivated to sell:
The seller is tired of managing tenants or management companies. This usually happens when the owners don’t learn how to manage a property.
Needs money to buy another apartment building
The seller might have seen a deal he wants but he doesn’t have enough money to close on it. In order to get that property the seller must sell this one first.
If the seller you’re negotiating with is an active investor he might be doing a 1031 exchange and he needs to sell fast to comply with deadlines.
Seller is done working and investing. He just wants to retire and enjoy life.
The seller has financial issues and needs cash fast.
Life Changing Event
Death, divorce, relocation or a law suit are some of the reasons to sell asap
- Be Flexible with your Offer
The chances of the seller accepting your first offer without making a counter-offer is very low. That’s why your first offer should always aim at achieving plan A.
When it becomes apparent that plan A is not working then move on to plan B. If plan B is not going to happen either then keep going until the counter offer from the seller satisfies you.
- Use the Operating Statement to Negotiate
If the seller’s asking price is too high then use the property’s operating statement to justify your offer. You can also show the seller the price of properties like his own that were sold in the area at a lower price. This is why it is imperative that you do your homework. Always remember that good information makes you a better negotiator.
- Have an Escape Strategy
You should always have in your offer up to 60 days to conduct your due diligence and to decide whether or not you want to continue with the deal. The clause should state you can walk out of the deal for any reason and without any explanations. This will protect you if you find out any bad information regarding the property during the inspection process.
Most experienced sellers and agents will only allow up to 30 days. Negotiate it for 45 days. The idea is to always try and set up the contract in your favor should something go wrong. But be flexible enough to still get into good deals without barring too much risk.
- Be Willing to Walk Away
Rule #1 in negotiating: The one who cares the least is in the strongest position to negotiate.
Set a maximum amount you will pay for the property and do not go over that limit. Do not be the emotional buyer who will pay more for the property. Remember that the person who cares the least wins. The only thing you should care about is the profit you will make buying at the right price and the loss you might incur buying at the wrong price.
If there’s one certainty in life is that there are always opportunities out there. If you stay in the game long enough opportunities will find you. And sometimes without you even trying. I can’t tell you how many times sellers from our past offers come back to see if we are still interested in buying. Only this time at the price I wanted!
5 Mistakes to Avoid in Negotiating Multifamily Apartments
- Offering Too Much at the Beginning
Do not offer the maximum amount that you will spend on the property at first. You should always leave room to negotiate. Start below the price you want and start negotiating from there. Just be cautious not to offer too low that the seller is insulted. In that case he may not counter at all.
- First to Mention Price Loses
There’s a rule in negotiating: the person who mentions price first loses.
Why? Because if you name your price first and it’s more than the seller was willing to sell for then you lost out on a cheaper deal. But if the seller names their price first and it’s lower than what you were willing to pay then you win on a cheaper deal.
One more thing, do not accept a seller’s first asking price. Even if it’s lower than your target price. The reason for this is if you don’t negotiate the seller will think that he sold the property too cheap and will get seller’s remorse.
He will start looking for ways to get out of the deal and cancel. You should always negotiate and make a counter offer. Take the time to go back and forth. Make the seller feel like he had to work for that price. That way he values the offer more and is unwilling to let it go later on.
- Purchasing Based on Market Rents and Not Current Rents
All smart and experienced investors negotiate based on the Net Operating Income of a property. Sellers or Agents sometimes base the price of the property on market rents or what they think the rent should be. They will try and sell you on the potential income of what the apartment building could earn. Do not fall for this big mistake. If it was that easy the seller would have already done that.
You will have a hard time getting financing if you buy an apartment based on future rents since banks base their lending on current rents as well. You have to always consider the risk of a potential downturn in the market. When that happens rents drop. If you buy a property that is barely breaking even you could end up with a property that is underperforming, or worse, costing you money every month because of the negative cash flow.
Move on to the next deal if the seller insists on selling at projected “market” rents.
- Giving Something Without Getting Something
Always ask for something in return whenever you agree to a seller’s request. No matter how small. You don’t want to appear weak or too nice. Otherwise the other side will keep requesting stuff that will add up in the long run.
That “something” in return doesn’t have to be too big either. It might be something like appliances or equipment on the property that was not included in the deal. The goal here is not to make a profit but to send a message to the seller that they won’t get something for free from you.
- Not Being Prepared for Battle
Anticipate any counter offers and objections the seller might make before they are even thrown at you. Be prepared to back up your offer and your answers. The seller will have the advantage if you are not prepared because he is the one that has what you want. The person with the highest desire will be at the disadvantage.
To be “prepared” means you know everything about the market, the location, the competition, other properties in the area, the market cap rates, the property type cap rates, the market vacancy rates, where the city is heading, the economic condition of the city and state, the sellers motivation, what he paid for the property, any defaults on the property, property history, previous owners, other properties the seller owns, etc. Are you getting the picture?
Think about it, when the Unites States of America goes to war, do you really think the only thing they know is where the enemy is located?
We spend billions every year in intelligence and data gathering to know everything there is to know about countries, their weaknesses, what they have, where its at, how much they spend, who supplies them, etc. So if we ever go to war with them we know exactly where to hit them so it hurts. You simply can not go to war without knowing who your enemy is.
That is the mindset you need to have when you are negotiating. The more you know the bigger the advantage you will have.
Chapter 6: How to Finance Your Apartment Deals
When you are structuring your deals remember that your objective is to always put the least amount of money down. This increases your ROI and Cash on Cash return and allows you to acquire more properties using leverage.
Below are some of the different financing methods you can use to buy properties or apartment buildings. Some will be feasible and others not depending on the property and market you are in. When you are dealing with the seller directly your options are endless. When you are dealing with a real estate agent they won’t allow any kind of creative financing.
Low down payment financing (4 units or below)
3.5% down FHA Loans: Primary residence. Owner occupied. 1-4 units.
5% down Conventional Loans: Primary residence. Owner occupied. 1-2 units.
If you’re after 4 units or below you may be able to use an FHA or conventional loan program to buy with low money down. You will have be living there and you can’t have another mortgage loan on your credit. Low down payment programs are reserved for owner occupied and usually first-time buyers.
Once you have one home loan the second property will be considered as an “investment” and will require 20% down. These conventional loans get sold to Fannie Mae or Freddie Mac in the secondary market so they are pretty much cookie cutter loans. Every lender will have the same loan programs and rules for these types of loans, properties and borrowers.
Although you might find some lenders with different portfolio loan programs they will all follow the same methodology. Low down payment for primary residence properties and 20% down for investment properties.
Fannie Mae Multifamily Financing – 20% Down
Fannie Mae is a government entity that offers 20% down financing on Multifamily Apartments. This makes it one of the most attractive loans out there for Multifamily financing.
If your investment strategy is going after prime apartment buildings then this will probably be your best option for financing. Just keep in mind that they only finance stabilized properties and almost perfect borrowers. So if your credit and financial history is not up to par then they probably will require an stronger partner.
The property itself must meet certain guidelines as well. The vacancy rate can not exceed 10% over the last 2 years. The DSCR (Debt Service Coverage Ratio) must be 1.25% or above and the property condition must be good.
For more information check out their site below. Ask your mortgage broker if this will be a good fit when you are ready to invest.
Commercial and Apartment financing
Unlike Fannie Mae these loan programs are more flexible with the property condition and the borrower requirements. Once you get above $5 million you can no longer use Fannie mae financing.
Depending on the type of property and loan program the down payment starts at 20% and can go as high as 40% when you are buying million-dollar apartment buildings.
When it comes to commercial lending the banks and lenders are concerned mainly that the loan can be paid by the cash-flow of the Apartment building. That is how they base the down payment requirement.
The higher the loan is in the millions the more they will look at the borrower(s) as well. Experience and net worth will become a huge factor. No bank is just going to lend 10 million dollars to someone who’s never owned a multi-family property or never managed an apartment building. They are considering all the risk factors when they lend out millions.
While we won’t get into the details of these programs here just know that if you’re thinking of buying in the millions then you should have access to around 30% down. That’s a good basis to go by.
Google “Commercial Multifamily Apartment Lender + City”
The resource below will also help you find the top commercial lenders in your state.
Commercial Lenders Resource:
Now let’s move on to other ways to get into a property without using a lender, giving a down payment or giving a minimal down payment. These financing methods will only work when you are working directly with the seller and not in a Seller’s Market.
When you are in a Sellers’ Market there are hundreds of buyers the sellers can chose from. Why would they wait to get paid with all these different methods?
The answer: they won’t. They will just skip your offer and move on to a buyer ready to give a down payment and get financing so they can close in 30 days and get all their equity immediately.
These “creative financing” methods work best when:
- it’s a Buyer’s Market
- the economy is down
- the real estate market is slow
- the property can’t get financing
- the seller doesn’t need money right now
- the seller is desperate
- “Subject To” Financing
Buying a property “Subject To” signifies that you are buying the property “Subject To” the current financing that is already on the property. You are basically buying the property with the current loan in place and maybe giving the seller a small down payment to take over the loan and the property.
The current lender might allow for this to happen but often they will not. Look on the Note to verify if there is a clause pertaining to a change in ownership or transfer of deed that will trigger the note to become due.
If the seller is desperate to sell in a slow market he is more willing to work with you on this type of deal. What he wants is to just get out of the property.
The benefits of taking the property Subject To:
No bank qualifying – You’re taking over the current loan so you no longer need to qualify for a loan.
No bank fees – You don’t have to pay bank or loan fees
Reduced closing costs – You can reduce closing costs through an attorney or title company
Faster closing – You don’t have to go through the lengthy loan process and can close in 2 weeks
Possible seller second and 100% financing – Since you are not working with a bank there is no requirement for a down payment. It’s now possible for the seller to give you a second mortgage for the difference of the current loan and the purchase price. Instead of giving the down payment he could give you an interest only second for 12 months and you could refinance in a year to pay off that second loan.
Possible lower interest rate – There is a chance that the interest rate on the current mortgage is lower than the present interest rate in the market. Which means your payment would be lower.
Higher rate of return – Since you came in with less money down the Rate of Return on your investment will be a lot higher.
- Assumption Mortgage
This is almost the same as taking the property “Subject To” but instead you are actually assuming the mortgage and the loan responsibility.
Here are some key differences:
- The loan goes into your name and on your credit
- You will have to qualify for the loan
- You may have to pay lender fees
Lending institutions will most likely charge you for certain fees like processing and underwriting for you to assume the current mortgage loan. This option is seen more for commercial properties and apartment buildings. Most mortgage loans for single family properties will not have an “assumption clause”.
- Master Lease Option
You can Master Lease a single-family home and also small apartment properties as well. This is done with a Master Lease with Option to Purchase contract. The Master Lease and Option to Purchase are two independent components.
You might want to do a Master Lease Option if the seller would need to maintain the property in his name for a certain length of time (prepayment penalty on his loan), when you want to acquire management experience, or if you are uncertain if you wanted to flip the property in the near future.
With a Master Lease Option you do not have to acquire the property. The deed remains in the seller’s name until you exercise the Option to Purchase the property. You are basically leasing the entire property for a fixed monthly amount. That means you get to keep all the income the property generates but you are responsible for all the expenses as well.
You have a predetermined amount of time to purchase the property if you’d like. If the market goes up and the property increases in value then you buy it. If the market goes down and you don’t like the cash flow then you simply give the property back to the seller when the lease expires.
- Second Mortgage as the Down Payment
Another option you have if the seller is willing to help you with the down payment is using a second mortgage as the down payment. Also known as “seller carry back” or “seller second”. On larger apartment buildings where the seller wants to get out of the property you might see ADs where the seller is offering to carry a second mortgage on the property.
This can work in several ways. If the seller doesn’t mind you taking over his first mortgage you can leave the first loan in place. The remainder of what the seller wants can be a second mortgage on the property where you pay the seller monthly payments.
This is how you can get into a property with zero or minimal down. Again, only works in slow markets or with desperate sellers. You will however find sellers offering seconds with larger apartment buildings just to make the sale more attractive or avoid paying crazy prepayment penalties on their first mortgage.
These are the four most common second mortgage structures:
The entirety of your balance will be due at the end of the term and you will only be paying interest monthly. No principle reduction. Best for cash flow purposes.
Principal and Interest
This is the method that most home mortgages and car loans are created with. The monthly payment includes both interest and principle reduction.
A mortgage in which the entirety of the principle is due in its whole prior to the amortization period. Usually a 5 -10 year period. Sometimes Interest Only.
Amortization means paid down over a length of time. The longer the amortization length the smaller the mandatory payments will be. The principal and interest will be determined according to the volume of periods in the amortization period. Most loans are amortized so they can be paid off at a given set period.
Well there you have it. A general scope of the financing world for Multifamily real estate. Obviously this isn’t a detailed explanation but it’s enough to give you an idea of where you need to be in order to start. The best thing you can do is search for a good Commercial Mortgage Broker who can walk you through everything you need to know to get started.
Chapter 7: Multifamily Apartment Buying Process
9 Steps to Buying an Apartment Building
Now that you have already found a good deal, analyzed the numbers, and decided to move forward it’s time to send an offer to purchase the property and begin negotiations.
Below are the 9 steps to close the transaction followed by the explanation for each step.
- Send the Offer
- Negotiate Terms
- Sign Agreement and Give Deposit
- Submit Loan Package
- Conduct Due Diligence
- Property Inspection
- Sign Loan Documents and Wire Down Payment
- Close Transaction
STEP 1 – Send the Offer
Letter of Intent
You make an offer to purchase a by sending a Letter of Intent to the owner or agent when you are buying larger Multifamily Apartment buildings. On smaller buildings (4 units or below), you may send an offer using a standard purchase agreement used for buying single or multi-family properties.
As presented in the example below, the Letter of Intent lays out the basic terms of the purchase offer. The “terms” of the Letter of Intent will usually be negotiated by both parties until both sides are satisfied with the terms. Then transferred to an official binding Purchase Sale Agreement.
Offer to Purchase Real Estate
Below is a sample of a basic purchase agreement. You can use this as a starter offer on smaller properties and when dealing with the owner directly. If you are dealing with a real estate agent they will most likely ask you to use an agreement that is more detailed and standard for the industry.
Standard Purchase and Sale Agreement
Unless you started with this form an official Purchase and Sale Agreement will be produced after initial negotiations. Like the Letter of Intent, the Purchase and Sale Agreement may be edited by both parties’ multiple times until both parties are satisfied with the offer.
Below is a brief explanation of each section in the Purchase and Sale Agreement along with a sample agreement to review.
Sections 1 & 2 includes general information about the property and the purchase price.
Section 3 is the Due Diligence section that request for evidence for what the seller claims about the property. The seller must provide proof of the income and expenses.
Section 3.2 gives you 45 days to do physical inspections on the property. You must be able to go into the property at any time as long as you give a 48-hour notice and not disturb the tenants.
Section 3.3 gives you 45 days to accomplish your financial due diligence. It also gives you the choice to cancel the transaction and refund the deposit in escrow if the seller does not give you the requested information within 15 days of opening escrow.
Sections 3.4 and 3.5 are the disclosures for Lead Paint and Flood Hazard Zones. You should be informed if the property is situated in a 100-year flood zone or if there was possibly lead paint used in the past on the property. Section 3.5 gives you permission to do water testing on the property.
Section 3.6 is the Hazardous Waste section in which the seller guarantees there is no hazardous waste on, below, or near the property.
Section 3.7 states that all equipment such as appliances, heating, electrical, etc. are functional and working. No equipment currently on the property will be taken away without informing the buyer beforehand. All units should be ready for rent unless otherwise specified.
Section 3.8 goes over termite inspections and protocol.
Section 3.9 is the financing contingency section in which the buyer will apply for a loan within 15 days of the acceptance of the Purchase and Sale Agreement. If buyer fails to get a mortgage within 60 days he can choose to either cancel the agreement or ask for a time extension.
3.10 states that if you are not satisfied with the property and you let the Seller know before the Due Diligence period is over the deposit shall be returned and the buyer and the seller part ways.
Section 4 states that the Seller is responsible to provide a good clean title to the buyer. Any title issues must be fixed before the closing and if it is not done the buyer can cancel escrow and get his deposit back.
Section 5 states that the Seller is a citizen of the U.S. and not a foreigner.
Section 6 states that the seller will continue to manage the property and will not neglect the property during the sales process. The seller must also ask for the buyer’s consent before getting into new third-party contracts. This prevents any “favor deals” or contracts from happening during the escrow period.
Section 6.5 should cover any “Risk of Loss” and their consequences from different sources like eminent domain, flood, and fire. This should also let the buyer walk out from the deal if a loss occurs and provide the buyer the right to state the capacity in which he will go on with the deal if he chooses to stay in the deal.
Section 7 includes adjustment for taxes, water, security deposits, utilities, etc. They must be prorated to the new buyer. The Seller must take care of all the outstanding rents. You should always close at the beginning of the month so that you will receive a credit of the rent for that month. This helps lower your closing costs.
Section 8 is a collection of clauses that are in place for the security of all parties.
Section 9 is a fill-in-the-blank for any special conditions the buyer may request that is connected to the purchase.
Section 10 clarifies the agency between the real estate agents, the buyer, and seller.
Section 11 states what needs to be accomplished in order for the contract to take effect. The contract must be signed by both parties before it will be binding and enforceable.
Section 12 states that if either party needs to contact each other for notices and other official messages it must be relayed by email, letter and sent by using personal delivery, U.S. mail, overnight mail, or FAX.
Section 13 explains the handling of the escrow by the broker. It also clarifies the broker(s) that are involved with the transaction.
Section 14 includes the total amount of the sales commission and who is to pay for it.
Section 15 states that the contract will be considered null and void if it is not accepted within 7 days from the date of presentation. This is done so that the Seller doesn’t take his time in accepting your offer as he goes around looking for a better deal.
Section 16 is about 1031 exchanges. It is a common clause that is present in the majority of commercial real estate Purchase and Sale Agreements. Many investors who buy and sell large properties trade through 1031 Tax Deferred Exchanges.
Section 17 is the Effective Date. This is the date on which the buyer and seller have agreed to the terms and conditions and have signed the agreement. The Effective Date is written when the document was fully signed by the last party.
STEP 2 – Negotiate Terms
Once you present the offer it is most likely that the seller will not agree with 100% of your terms. Him or his agent will counter you by sending you a counter offer or by changing the offer directly.
It’s easier to just get the seller on the phone and come to terms but that wont always be possible. When you are buying larger properties you will most likely be dealing with the seller’s agent.
The agent will always want to use their standard agreement forms as well as tip the terms to seller’s benefit. In a “hot” market (Seller’s Market) the buyer really has no choice but to agree to the seller’s terms. Otherwise he loses the deal to the buyer right behind him.
In a down market (Buyer’s Market), when the sellers are desperate, the sellers now have to agree to the buyer’s terms or risk not selling their property for months.
Regardless, there are standard and common terms and periods that most agents will accept. The bottom line, always leave clauses to protect yourself and your deposit should something not be to your liking. Always have a standard period for inspections, due diligence, and the ability to cancel should something arise that you don’t agree with.
STEP 3 – Sign Agreement and Give Deposit
After both parties reach final agreement the purchase contract is signed and a deposit needs to be given. Typically, the deposit would be 1% – 3% of the purchase price. The buyer’s objective is to always come in with the least amount as possible.
As they say in poker “you can’t lose what you don’t put in the middle.” This is just a safe guard for a worst-case scenario. The contract should provide adequate protection for a safe exit or canceling should something go wrong during the transaction.
When you are working with a seller’s agent, however, they may advise that you need to give a higher deposit. Obviously they are working for the seller’s best interest. In reality the market is what determines an acceptable deposit. What ever is common practice in that market at that time is what most agents will consider.
If it’s a Seller’s Market then the seller or his agent will ultimately decide what deposit they want to accept. If you disagree you lose the offer to the 10 buyers right behind you.
All you can do it start with the lowest amount possible and negotiate from there. Don’t lose a great deal for a deposit. The ultimate objective is to close the deal. Always remember that during the process and negotiations.
Escrow is the neutral third party that holds the deposit and manages the transaction between all parties involved. Depending on your state sometimes this process is handled by attorneys.
If you are dealing with the seller directly talk to a local agent and have them tell you what the process is in your state. If you are dealing with the seller’s agent they will tell you what the next step is and where to take the deposit.
Again, depending on the market you’re in will determine who decides which escrow company to use. Always Google search the escrow company for reviews and verify them with the state or board they are licensed under to make sure they don’t have anything negative or concerning going on. If there is something you don’t like then show the agent and tell them you want to use another escrow company. If they get to decide they would be more willing to cooperate.
Once you give the deposit and open escrow they will walk you through all the required paperwork needed and tell you what and who is involved in the transaction. If you’re new to this process it would be good to set up a meeting and have them explain the process to you so you know exactly what you need to do.
Hiring a Real Estate Attorney
If this is a small apartment building or transaction then you really don’t need an attorney. The escrow company and the title company can walk you through everything and make sure all legalities are covered.
These companies are a party to the transactions so they have fiduciary responsibilities to all parties involved. They will want to make sure everything is done correctly or they can be held liable for closing the transaction without the proper protocols.
When you are buying larger Multifamily apartment buildings then you should definitely engage a professional real estate attorney. Make sure they have worked on your type of building and transaction before.
In fact, most of the big attorneys already know who the escrow and titles companies are. They will already have done business with them. That’s why its important to get an attorney in your area. So you can have someone who already knows who they are working with.
When it comes to larger transactions it’s not escrow or title that you should worry about. It’s the seller and the seller’s agent. If they are experienced and you’re not they will know how to manipulate the process in their favor. Even worse, hide information from you or not give you information you need for proper due diligence.
Another issue that could arise is canceling the contract without losing your deposit. Whether its because you have to cancel, the property’s condition is worse than expected or the seller is not cooperating, then you need to make sure you do it right. One mistake and you could lose all your deposit.
Escrow will not just give you the deposit back because you ask for it. Escrow is a neutral third party. Which means they won’t release the deposit unless both sides agree. If an issue does arise escrow will hold the money until the courts determine who gets the deposit or both parties agree and sign a cancelation agreement.
A good competent real estate attorney will guide you and protect you every step of way. It’s a good idea to engage an attorney before you open escrow. They can make sure the contract is well written and make recommendations on which escrow and title to use. Even better, which companies to avoid.
Step 4 – Submit Loan Package
Immediately after opening escrow and receiving escrow documents you will prepare the loan package and submit to the lender.
You should already have an idea of what loan program you will be using before you even opened escrow. This is not the time to be going “rate shopping” nor checking to see what loan program you “qualify” for. All financing options should have been reviewed before you opened escrow.
You will want to have a good Commercial Mortgage Broker at you side during the process of finding a Multifamily Apartment property. He will inform you of all the different types of programs there are and which is best to suit your needs.
Typical apartment loans can range from 20% down on the low end up to 40% down on the high end depending on the market and the properties financials. The stronger the market and the stronger the property (cash-flow) the lower the down payment requirement will be.
A commercial bank will always be risk-based when making decisions on a property. It’s just about the buyers financials but about the overall market risk and property risk as well. The lender will also give you feedback on whether or not your property is a good deal or not.
Your experience will also come into play as a decision factor for the lender. The larger the investment size the more experience the lender will require.
All these factors should be considered before you even start searching for properties. There is no point in locking up property you can’t close on. Too much is at risk.
You should know exactly what you qualify for. What you need to close. How much down payment will be required. If a partner is needed for extra experience. And what other factors will be required. This is a must to know before you enter into contract.
Make sure you talk to several Commercial Mortgage Brokers before you start searching for Apartment properties.
Google “Commercial Multifamily Apartment lender / Broker / Bank + City”
This will give you a good idea who is active in your market. You can also look at the resource below and see if you find any good lenders in your area.
Commercial Lenders Resource:
Below are all the documents you will need to submit for a complete loan package. Have it ready as soon as you open escrow.
THE COMPLETE LOAN PACKAGE
- Executive Summary – Description of the property, Detailed use of Funds, Critical contract dates, Exit Strategy, 1031 details (if any)
- MAI Certified Appraisal – Lender will order
- Personal Financial Statement
- Property Financials – Last 2 years of property P&Ls and YTD P&L
- Borrower Resume
- Purchase and Sale Agreement
- Escrow & Title documents
- Rent Roll & Leases
- Property Description Details – Capital Improvements, Rental comps
- Complete photos of the property – Inside and Outside
- Location on Map
- Environmental Reports
- Property Management Report – Management Company Resume, Marketing Plan, Retention Plan, 3 year proforma
- Professional Team – Real Estate Attorney, Property Inspector, Appraiser, Mentors, Partners, CPA, Insurance Agents, Management Company, 1031 Specialist
This list covers about 95% of what every lender will want to see. Anything missing they will ask for. Every lender will have their own list of requirements they need. You should have all this ready immediately after you open escrow and start the process of obtaining financing for the property.
Depending on how large the deal is and your contingency clauses it would be smart to also have a second package out to a second lender just in case something doesn’t go as planned with the current lender. If you are dealing directly with a lender then this is a must. If you are using a broker then have them send out a backup package to another lender just in case.
You should not commit to any anything with the lender until you are done with all your due diligence and inspections. This is to assure you don’t spend any money on an appraisal or pay for any application fees until you are 100% sure you want to move forward after you reviewed everything.
While you are going through your due diligence and waiting for reports you are working on giving the lender everything needed to complete their file. This process will be tedious and time consuming. That is why it’s imperative that you package and submit the loan documents to the lender immediately after you open escrow.
Step 5 – Conduct Due Diligence
Once escrow is opened it’s time to start your due diligence on the property. Below is a list of everything you need to verify and confirm. Never accept any claims the seller makes unless he shows you proof.
Here is a list of everything you need to request from the seller immediately after opening escrow. Time is of the essence. He has a deadline to give you everything or you have the right to cancel. And you have a deadline to review everything on time or you lose your right to cancel based on the information. Time is of the essence.
Records and information that you need to request and review:
Real Estate Property Taxes – You can obtain the actual tax assessment from the local Assessor’s office. Once you’re there, also confirm if the tax rates will be going up in the next months.
Insurance – Confirm with the insurance agent if the property is covered. Get quotes from local commercial agents and prices for flood insurance if the property is in a flood zone.
- Operating statements for the past two years.
- Rent Roll – All tenant leases and charges for common areas
- Add up all miscellaneous revenue such as vending machines, late fees, telephone charges etc.
- Confirm all expenses with vendors
- Request for copies of utility bills (heat, electric, water, sewer, trash and cable) for the past 12 months (24 months if available).
- All copies of service contracts.
- Call utility companies that provide services to the property and ask if they will increase rates in the future
Mortgage Terms and Conditions – Get the following information about the loan on the property. The current loan on the property can make or break a deal if there is a pre-payment penalty so it is important to know before you close on the transaction. This also helps in case you want to assume the loan as well.
- Mortgage Loan Balance
- Interest Rate (Fixed or variable)
- Maturity Date
- Original amortization period
- Prepayment penalty
- Collateral used to secure loan
- Transferability of Loan
- Recourse or Non-Recourse loan
- Escrow Requirement Status
- Closing Costs
- Late Charges and Grace Period
- Restriction against secondary financing (if any)
The Complete Checklist of what you need for Due Diligence
Here is the entire checklist of all information that you should know so that you can make the best decision when buying a property.
Copies of utility companies currently servicing the property: Sewer, Water, Telephone, Electric, Gas, Cable T.V.
Copies of all updated service contracts showing: Term of contract, Monthly cost for services, Work to be performed, Termination penalty
Possible servicers: Pest Control, Trash Removal, Landscaping, Elevator, Janitorial Service, Maid Service, Tax Consulting, Window Washing, Parking Lot Sweeping, Snow Removal, Security
Legal Description of Property
Blueprints and specifications of property
Surveys disclosing any improvements to the property
Copies of all leases and rental applications: Rent roll, Security deposits
Copies of all mortgage documents
Copies of all insurance policies
Copies of the operating statements (previous two years)
Copies of tax bills (previous two years)
Copies of all permitted encumbrances on the property; Liens or liabilities on the property that must be disclosed to the buyer before closing.
List of all employees along with current salary history
Letter from current lender(s) that shows the updated terms of the mortgages and their balances.
Complete list of all inventory to be transferred together with the property: Office, Maintenance, Pool, Appliances, Mechanical
Copies of all Warranties: Appliances, Maintenance equipment, Mechanical, Plumbing, Electrical, Roof, Paving, Pool, Tennis Court, General Contractor
It is a really long list but you want all the information that you can find on the apartment building you want purchase. This is to avoid any nasty surprises that may cost you money the first you after you buy the property.
Here is a checklist for due diligence to download below:
Due Diligence Findings
Organize and review every document you receive. Make sure you receive everything you have requested. If the seller states he doesn’t have something call the vendor or company directly to get it or confirm they don’t have it.
If you find anything that does not match what the seller stated at the beginning of the transaction then you will use that to negotiate with the seller. Show them how this will affect your expenses and income when you take over the property.
Step 6 – Property Inspection
Property Inspection Reports
We always recommend ordering a property inspection report from a certified inspector who knows how to inspect Multifamily Apartment Buildings. These inspection reports provide an objective third party report that can be used if you need to go back and re-trade (re-negotiate) the price and terms with the seller because of the property condition was worse than expected.
Inspectors also provide a second set of eyes on the property in case you missed something during your inspection.
Personal Property Inspections
Always always always inspect the entire property and every unit yourself. Either you, a partner, or personal team member. The person with the most detailed personality should be the one inspecting the units. Not the person who hates details and wants to finish fast top get it over with.
You are buying a multi-million dollar commercial building. Anything missed could potentially cost you a few hundred thousand dollars to millions in repairs, damages, or law suits. You want to inspect every inch of the property. That way there are no surprises later on. And so you know what is needed as soon as you close escrow.
Anything not mentioned or discovered during the inspection period will be used to re-trade with the seller immediately. Use any excuse to ask for a price reduction or repair credits to reduce your closing cost total.
Step 7 – Re-Negotiate
As mentioned above, if you find any discrepancies during your due diligence or with the property inspections then its time to go back and re-trade with the seller.
If you discover anything that is hazardous, potentially dangerous, or too expensive to repair you should bring it up immediately and use it as the reason for canceling the transaction.
It’s not just about cost to cure when you run into issues. You have to consider the potential for tenant liabilities. Consider potential law suits that could arise from negligence or long-term damages.
In any case, you either try and negotiate or cancel the transaction immediately. If it’s a large number your dealing with then ask for a price reduction. If it’s a smaller amount then ask for a repair credit on closing cost to help reduce your cash to close.
Remember, the objective is to come in with the least amount down. This reflects directly on your ROI and COC return (cash on cash return rate).
Step 8 – Sign Loan Documents and Wire Down Payment
By this time, you have been going back and forth with your lender. Giving them documents and reports. Ordering the appraisal and inspection reports. Going over fee’s and terms. And finally getting to the point where you are ready to sign docs.
Once you have gone over the fees with escrow and the lender you will be ready to “sign docs.” This is where the lender sends over the final loan documents to escrow or whoever is in charge closing the loan. You and everyone that will be on the loan will meet at a location and sign all the necessary documents the lender needs to fund the loan.
After you sign the loan documents you will then wire the amount to close into escrow or the designated account. This amount will be the closing cost and the down payment total. Escrow will be giving you this final figure before or when you sign the loan documents.
Step 9 – Close Transaction
After you sign and wire in your closing funds escrow, title, and the lender gather all the final documents needed to fund and close the transaction. This can take a few days to a few weeks depending on the complexity of the deal.
Escrow or your attorney will ask for any remaining documents needed from you and coordinate the closing of the file. You should keep a copy of every paper you signed and all the documents you have been given. You should be building a property file since you opened escrow. Anything and everything that has to do with this property should be saved into a clean organized file.
Once escrow closes you start the take over process. The management company you hire will help guide you through this process.
Chapter 8: Multifamily Property Management
There are two types of apartment management styles. The first one is property management by the actual owner. The second one is hiring a Multifamily property management company.
Managing your own property will enable you to gain experience and insight in what it takes to manage a Multifamily Apartment building. This way you will know if the management company you use is performing up to par if you decide to hire one in the future.
When you are just starting out you should buy apartment buildings near your area of residence and manage those properties on your own until you fully understand everything there is to know about apartment management. This is extremely important in order to avoid getting ripped off by property management companies when they use their tactics to take more money out of the property.
Having a deeper understanding of a specific property or property management in general will help you catch red flags as soon as they occur rather than find out a year later that you were being scammed by the property management firm you hired.
Staying Profitable While Managing Your Apartment Building
There are two ways to increase profits in managing a property. You can either boost your revenues or reduce your expenses. It’s better to do both at the same time to maximize the income potential of the Multifamily property.
You can improve your revenue by raising your rents and reducing your vacancies. You should always strive to have your occupancy rate at or above 95%. If you have a lower rate then you need to improve your marketing to bring in new tenants. You should always be competitive in raising your rents.
The best time to increase the rent is when there is a change in tenants. Be careful increasing the rents of existing tenants too fast as it may cause them to move out sooner than expected. Tenants that move out will be one of your highest expenses so always strive to keep tenant turnover low.
The best way to increase the rates of existing tenants is by using an incremental increase. You do that by increasing the rent annually by $15 – $25 a month. It is too small of an amount to motivate them to move out.
The benefits of raising the rent are not just limited to increasing your revenue and profits. It also increases the value of your apartment building. If you have a system for regularly raising rents you will guarantee you get the maximum value for your property when you decide to sell.
The second method to increasing profits is reducing your property expenses. A major expense of apartment buildings is repairs and maintenance. You can reduce repair expenses by getting three bids for all repairs you need to done and taking care of them immediately before they get worse.
If you compromise your repair budget in exchange for saving money you may run into the following problems:
- Decrease in your properties’ value over time
- Damage will get worse costing you more money over time
- Tenants will move to a better maintained place costing you more turnover
- New tenants will not rent on a rundown building costing you more vacancies
Train your Tenants to Respect Your Property
Set the expectations up front so everyone is on the same page as soon as they sign the lease. Training starts from the very day they come see your unit. Tell every tenant that applies to lease a unit the following rules that are required to follow:
- Give rent on time by the 1st of the month.
- Respect others who live in the apartment complex.
- Do not vandalize the apartment building.
- Follow quiet hours.
- Maintain inner and exterior unit clean.
- NO drugs whatso ever.
Give them an eviction notice if they did not pay rent on time. This must be done immediately and the very first time they are late. This is the only way they will take your rules serious.
If they break any one of your rules be prepared to evict them immediately. The key to training your tenants is to do what you say you are going to do. If you don’t hold to your words they will keep breaking the rules.
Do not allow any drug dealing tenants even if they pay well. They will cause your good tenants to move out and more of their drug dealing friends will move in due to your tolerance. You will eventually lose power over your property.
The Standard Application Process
Establish a 3-year housing history check for every tenant applies to rent in your building. Talk to their previous landlords. One tip when checking the previous landlord is to ask information that you know is incorrect.
If the applicant says that she paid $500 a month in rent, ask the previous landlord if it is true that the tenant paid $650 per month. If the previous landlord does not correct you and just agrees to everything you say about the applicant then the tenant may have plotted with a friend to act as their reference.
You should also run a background check for your applicant with a tenant check service. National Tenant Network is a quick and fairly priced tenant check service. The cost is usually $20 per tenant. Charge your tenants the cost for the background check as the application process. If they refuse then they may have a reason to be scared of the result of the background check and do not want to waste their money. Do not accept tenants until you do a background check on them. Save yourself time and money later from having to evict professional squatters.
Tenant screening services:
The Lease Signing Process
After an applicant has been accepted notify them for a meeting and signing of the lease. Tell them all your rules that were discussed earlier.
When signing the lease make them initial each page to ensure that they have read it. This is useful to avoid tenants claiming in court that a page was not in the lease when they signed. After that collect a deposit and first month’s rent. Do not accept a check payment for the initial deposit.
Why not accept a check payment? Because there are people who conspire to live in apartments for free. They are called professional squatters/tenants. They will bounce the check, apologize and create another check. After all their excuses run out you will be forced to evict them. You will have an eviction that cost you money and you get no payment from the professional tenant until they are evicted. For some states this is quick and easy but for others an eviction can be held up for 3-6 months in court.
When to Give the Keys
Only give the keys to the new tenant once you completed the following:
- First month and security deposit have been given and cleared from the bank.
- Lease with all required signatures.
- Property Condition Form with signature.
Rules of Property Maintenance
Let every single tenant know from the very beginning that they will pay for the repairs of their unit if they caused the damage. You must respond within 24 hours if a tenant made a maintenance call but make them pay for the repairs if it is clear that the problem arose from their own fault or negligence.
If you do not follow this rule your tenants will consider you their personal maintenance company. They will always call you if any problems arise and will not be more responsible in taking care of the unit.
Have you ever been driven by a tow truck or a friend in their company vehicle? The few times I have I immediately noticed their extreme acceleration and extreme breaking habits. They don’t care about the gas they are spending or the intense pressure on the brakes causing them to wear out faster. The interior of the vehicle was a mess and filthy. They basically do not care about maintaining the vehicle’s condition.
It’s human nature to not care if it doesn’t cost them anything. You can avoid carelessness and irresponsibility by telling them up front who pays for repairs.
Tenant Tracking Software
Use a good property management software to track tenant information. Look for a software that can remind you when someone is paying their rent late. You also want one that will track work orders and maintenance request and can show you a repair history for a specific unit. This will be good evidence if you ever end up in a court battle with a tenant. Google “Property Management Software” or call a few property management companies and ask what software they recommend for your Apartment Building type.
How to Collect Your Rent Automatically
Do not go to every unit to collect rents. This will take a long time and it is also dangerous for you because you might be carrying thousands of dollars at one time. Send them a bill with a self-addressed stamped envelope and an email with an invoice. Some may pay electronically and others by mail. The important thing is the constant reminder that rent is due and expected.
The Right Management Company
Manage your own property for the experience if you are just starting out. However, if you bought properties in other states then you need to hire a solid management company.
You can start your research by going to www.irem.org. CPM is an abbreviation for Certified Property Manager. A designation given by the Institute of Real Estate Management to people who have taken courses and passed tests associated with their certification. The website will give you a list of all management companies that have achieved a CPM designation.
Check references as well. Contact the Better Business Bureau and the state licensing boards to discover if any issues have been submitted against someone you are interested in. Look for reviews on yelp or online for negative comments.
Ask for a list of properties they currently manage. Drive around the neighborhood and physically survey the properties and tenants managed by the management company that you are interviewing. The feedback of the tenants and the property condition is a good way to check if a management company is good or bad.
How to Keep the Management Company on Check
Constantly evaluate the maintenance expenses that are being billed by your management company. They can make more money from maintenance than from property management fees if you do not verify them. Require a written authorization if a maintenance job is over $100. You must keep the amount low until you have confirmed the integrity of the management company.
Require the management company to take a before and after picture of any repairs that they do and send it along with the bill. Require 3 bids when their work requires to be sub-contracted.
Management Companies and Rent Collection
The management company will collect the rent and all other sources of income from the property such as laundry room machines and vending machines.
Be cautious of typical management company scams. The scam involves confirming a unit is empty while pocketing the rent or underreporting a rent and getting the difference. Protect yourself against this by phoning or writing to your tenants for a review on rent information. There are also third-party verifiers than can do this for you if you have a large enough building to make it worth the expense.
The Essential Reports to Keep Your Property Profitable
You should require your management company to give you these reports:
- Monthly Updated Rent Rolls
- Monthly Income and Expense Reports
- Annual Operating Budgets
- Annual Income Forecasts
By keeping your eye on the pulse of the building you will be able to quickly catch anything unusual that may be happening on the property. Having frequent reports allows you to catch something before it become a bigger problem.
Property Management Fees
Since your property managers are one of your ingredients to success you want to pay them fairly for their services.
Keep the management fees of 4-10 unit properties to 7% – 10% of gross collected rents. For large 20-100 unit properties keep the rate between 5% – 8% of gross rents. Adjust the fees based on several factors: the location of your building, the type of tenants, and the usual fee amount collected in the area of your building. With proper research you will know what the standard management fees are in your area.
Hiring A Resident Manager Onsite
You can seek the services of a resident manager if your building is between 15 to 40 units. The resident manager would live in one of your units and take care of your property personally. By using this type of management, you keep control of all income and expenses. The only fee would be the salary of the onsite manager.
The Resident Manager’s responsibilities include but is not limited to:
- Present vacant apartments
- Prepare the apartment for next tenant (turnover)
- Common area service
- Contractor supervision
- Attend to tenant complaints/needs
- Collect rents and manage the building
Disclose the duties of the resident manager in a written contract and do all the research precautions from above with the Resident Manager just like you would for a management company. Proper research avoids headaches and lawsuits. Always research who you are hiring.
Chapter 9: Sell Your Multifamily Apartment for Maximum Profit
The optimal time to list your apartment building for sale is when all of your objectives have been accomplished or if the current market is at its peak. You should always be thinking of your exit strategy whenever you are buying a new property.
Your exit strategy for your apartment building should be formulated before you even close the deal. It should be part of your acquisition criteria and investment strategy.
An investment strategy sets a given amount of time to keep a property and sell when you have made a specific amount of profit. You achieve big profits by taking advantage of an appreciating market along with executing an investment strategy.
One exception to your exit strategy is when you see the real estate market declining. If that is the case then sell the property immediately to protect your profits or prevent from going negative.
Preparing Your Apartment for Sale
Ensure that your property has great “curb appeal”. This can be done by doing the following:
- The lawn must be mowed
- Gardening must be clipped
- Paint should be fresh or in good condition
- The letterboxes must be synchronized and in good shape
- Front doors must be in good condition
- No unused cars inside the parking lot
- No damaged windows or torn screens
- Entry way must be free from any blockages
- In-house lighting must be in working condition
- All common areas must be clean and organized
The property needs to be clean at all times. Doesn’t have to look brand new. It just has to look like this property is well managed and maintained. If that’s not what it looks like now then don’t put it up for sale until its ready.
How to Increases the Value of Your Apartment
The value of a property is determined by the amount of net income it’s generating. Value is calculated with the following formula:
Value = Net Operating Income / Cap Rate
If you increase the amount of the Net Operating Income (by increasing the rents), the value of your property will increase as well. Remember that rental income is not the only income a property generates.
Laundry machines are usually the income generators for most properties aside from rent. You can also use vending machines, parking fees, storage fees, and gym fees to name a few. You can be creative when developing new ways to increase your property’s income.
You should also consider the number of units a property has when deciding to place these amenities. Don’t place a vending machine on a property with only 4 units. There has to be enough traffic to make something worth the expense of bringing it in.
The Secret to Increasing Net Operating Income
Another way of increasing the net operating income is by lowering the overall expenses of the property. The following expenses can be lowered by improving their efficiency:
- Install low wattage lighting
- Install timers for lights in the common areas
- Set up motion sensors for lighting in the hallways and corridors
- Regulate the thermostats
- Lower the temperature of the water
- Use devices that save water in the sink, showers, and other facilities
- Use water saving toilets
- Put a brick in the toilet tank
- Use automatic door closing devices to save on air conditioning and heating
- Always check water pipes for leaks and repair as soon as possible
- Consider solar panels if you pay the electricity
- Get new quotes every year from other vendors on all your contract services
- Every month look at your expenses and ask what don’t you need
Selling Your Multifamily Property Through An Agent
After you increased the income of your property and decreased the expenses the value of your property will be at its peak. Now is the right time to sell for maximum profit. You can sell your property by advertising it yourself or by hiring an agent.
You can go to real estate websites to find commercial Multifamily real estate agents. One site is www.CCIM.com. This website offers a designation that few brokers and agents have. Getting a CCIM designation is a very hard and rigorous process that requires months of training and exams.
Be sure to do your research on whichever agent you chose before you decide to hire them. There are many sites like Yelp where you can see what others have said about a specific agent.
Here is how using a commercial agent might benefit you:
- Assist in evaluating the value of your property
- Brings you potential buyers in the market for your property
- Connects you and the buyer to the best available financing
- Deals with all the paperwork and legalities
- Recommends appraisers and inspectors for your property type
- Shows you other properties you may be interested in purchasing
- Provides effective ways to prepare the property for maximum profit
- Markets the property online and offline for sale
Warning: Real Estate Agent Tactics
In efforts to get your listing agents will excite you with an overpriced sale amount on your property. 1 month after they put the property for sale they start requesting for a decrease in price. The initial price was just to get you excited to sign the listing agreement with them. This is a common practice from agents to get listings.
You need to know how to compute the value of your property yourself. This will eliminate any unreasonable expectations you may have. This will also insure you know when an agent is misleading you or maybe doesn’t know what they are talking about.
Make sure that the agent your hire immediately puts your property up for sale on their MLS (Multiple Listing Service), Commercial real estate websites like Loopnet and Costar, and other relevant sites in your city.
Commercial real estate agents are infamous for holding on to “pocket listing”. Which means they don’t put the property up for sale to the public. They try and sell the property themselves to their list of buyers in order to pocket the entire commission. Not making it available to the market will limit the number of potential buyers and can reduce the price you could get for your property.
The agent you use should be experienced in selling “Multifamily Apartments”. Make sure they have been selling these types of properties for the last 10 years. This will insure they have the experience and the buyer’s network to sell your property as quickly as possible.
Avoid signing a listing agreement that exceeds 90 days. This is to prevent you from being stuck with an agent that you are not satisfied with or is not marketing the property effectively. This also puts more pressure on them to sell the property quickly or they lose out on the listing commission.
Selling a Multifamily Apartment Yourself
Below are some easy and effective strategies in selling your property yourself. If you are in a hot market it should be fairly easy if you put it on the right sites. But if your in a slow market or it’s a specialized “different” property then using an agent might be the best way to go.
- Put together an Apartment Analysis Form to provide for potential buyers
This helps the buyers see the property objectively and also lets them know you know what you are doing. Now both of you can negotiate objectively based on the financials.
- Decide if you are willing to provide a 2nd mortgage to help sell the property quicker.
Second mortgages are widespread in restricted lending markets or during slow markets. If you’re in a hot market you don’t need to do this. There will be plenty of buyers that will pay full price and have loaded pockets.
If you decided to offer a second mortgage make sure the following is tied into the mortgage:
- Balloon of 5 years or sooner
- Principle and interest paid out monthly
- Higher than the market interest rate
- Acceleration clauses
- Late fees
- Research which websites are ideal for marketing your property
Google your “City + Apartments for Sale”. This will provide you a list of the websites you should pay to place your property for sale. You only need to be on the top 2 or 3 sites to capture 80% of the buyers in your market.
Loopnet, Costar, and maybe another top site on Google is all that is needed to find buyers quickly.
If you live near a major city then placing it for sell in their top newspaper real estate section wouldn’t hurt either. It’s all about exposure to the right buyers. Put your property in front of buyers who are looking for your property type. Easy as that.
- Contact property owners and property managers in your area
Apartment Owners in the Area
You can get a list of Apartment Owners from a list broker, a title rep, or the county office. Fastest way is to find a real estate list broker online and ask them for a list of “apartment owners” in your city or state.
Once you have the list you can mail them a letter or flyer showing them the details of your property and how to contact you.
Property Managers in the Area
You can get a list of Property Managers by doing a Google search for your area:
Google: “City + Property Management”
This will bring up a list of property management firms in your area. Call them and tell them you have a property for sale and if they know anyone who would be interested in buying it. Both groups above (Apartment owners and Property managers) have access to apartment owners who are interested in your type of property.
You should focus all your efforts on contacting these two groups. This will really be the most effective use of your time in terms of trying to sell your property on your own. Networking to all the real players in your city will give you the fastest result possible.
Opening Escrow and Starting the Process
If you are using an agent then they will take care of all this and manage the entire process for you.
If you are selling the property on your own then you will need to do some research. Depending on your state you will either use an escrow company or an attorney to open escrow and hold the buyers deposit.
The easiest and safest way it to use a title company’s escrow. That way no matter what happens the title company is held liable. Since you will need to order and pay for a title policy anyways you might as well use them for escrow as well.
Title then will take the buyers deposit, open escrow, order the title policy and manage the entire process for you. This way you only need to work with one party the entire time. If they need anything from you they will guide you along the way and give you all the paperwork you need to close on the transaction.
Which title company should you chose? Well that’s part of your research. You can start with the big ones like First American Title Company. They are probably one of the biggest in the world. So I’m pretty sure they are already in your city.
But please do research title companies in your city. Check out reviews and call some of them up on the phone. Ask them if they work with Commercial Properties and if they can handle the escrow on selling your apartment. Get their fees and call the next title company.
Once you decide on a company they will walk you through the entire process and make sure all legalities are covered. Again, since they know they are liable you can feel safe that their attorneys and experience are making sure everything is done properly.
Once you closed your transaction then rinse and repeat the buying and selling process.
Chapter 10: Passive Investing with Real Estate Crowdfunding
Crowdfunding is a group of investors (the crowd) who combine their money to invest in (partnership) a real estate property. Usually a commercial building like an apartment building, an office building, a retail center, or an industrial building.
Online crowdfunding maximizes opportunities by connecting investors across the country with some of the best commercial investments throughout the U.S. Investors can now produce high rates of returns with online crowdfunding alongside real estate sponsors and developers.
Top Reasons to use Crowdfunding Platforms
Here are some of the top reasons why investors all over the world are implementing crowdfunding into their investment strategy:
- Ease and Convenience
People like the efficiency and convenience of using the internet to buy almost everything they need in life. They seem to like the idea of being able to research and compare their options quickly while being at home or at a Starbucks. Now real estate investors like yourself also have the same convenience. There are many crowdfunding sites offering quality commercial real estate that you can view, research, and invest in anytime you choose.
- Nationwide Opportunity
With the rise of the internet investors are no longer limited to real estate deals in their area. There is no longer a need to be driving around town or looking at newspaper ads.
Back then, the old method of real estate investing depended on finding a good property in the newspaper, driving around town, or by word of mouth. All very unproductive and time consuming. Online real estate investing revolutionized the access to opportunities and delivered transparency to real estate investing.
Online platforms like Ultra Crowd offer information on a wide selection of active deals across the U.S. By using these platforms, investors can access investment opportunities in any city or state just as easily as in his or her own neighborhood.
Investors now can invest in any market of their choosing. This leads to the development of a national investor base rather than just a local one.
One of the main reasons investors like online platforms is the access and information of a deal immediately rather than spending countless hours doing the research themselves. Almost every investment opportunity has all the information you need to make a decision immediately. Obviously, you should consult with an attorney before investing in any real estate opportunity.
- Access and Research Multiple Investment Opportunities
Once you have access to these real estate opportunities the next step would be to analyze and evaluate them side by side.
A high-quality investing platform will give you detailed information in an easily comprehensible format. This will allow you to promptly compare and contrast real estate offerings and search for your own personalized investment criteria.
- Invest Directly in a Real Estate Property
Crowdfunding allows you to directly invest in a commercial real estate property. You are not investing into a publicly traded real estate company that has other numerous properties or real estate companies.
Direct real estate investments enable you, the investor, to have a share in a specific property with a specific investment emphasis and ROI. This is a great way to be more specific in what you are investing in and maximizing your rate of return on your investment.
Direct investment permits investors to pick a specific property type, specific location and the sponsor / operator that best suits their own investment strategy.
- Piece of the Cash Flow
Generally, private real estate offerings give the investor some of the cash flow that the property generates monthly. These distributions pay around 6% – 9% rate of return yearly and are usually paid quarterly. They can sometimes hit double digits returns and increase within three years. These investment opportunities offer an appealing alternative that can enable you to get a strong yield along with good equity appreciation upon the sale of the property.
- Lower Investment Amounts
Before online investment platforms exploded a minimum of $100,000 was required for investors to have the ability to invest in a real estate private offering. Online platforms have changed real estate investing to be more accessible to smaller independent investors with offerings going as low as a $10,000 minimum investment. This gives the ability to reach a greater amount of investors base.
- Investment Diversification
Modern Portfolio Theory suggests that diversification is critical to reaching your ideal returns. Diversification will also give you some security against vulnerability to market risks. The lower minimum investment amount as mentioned above allows individual investors to use the Endowment Model of investing. This allows you to quickly build a varied real estate portfolio. Rather than investing all of your money into one big property and waiting for it to mature, investors can now invest into multiple properties with a wide variety of locations, sponsors, asset classes, risk profiles and holding time. This reduces your risk exposure dramatically and allows you to average out your rates of return.
- Comprehensive Reporting
Online real estate investing platforms provide you with dashboards that are filled with useful information that will help you organize your investments. Whether you own a piece of a single property or a large portfolio of real estate assets our dashboard keeps you organized and in control.
Our online platform has a range of features in the dashboard like access to quarterly reports, storage for investor documents, receiving and storing K-1s, and viewing distributions. Ultra Crowd is an innovative investing platform that continuously provides new tools to our investors.
- Disappointing Equity Markets
Another factor that is appealing investors to engage into direct real estate investing is a developing dissatisfaction and concern over vulnerability in equity markets. From local markets at all-time highs to worldwide distress over uncertainness in foreign countries like China, investors have been getting out of the U.S. equity markets and redeploying capital into direct real estate investments. With higher than average rates of return and backed by a tangible asset commercial real estate investing looks like an appealing alternative.
- Syndication in its Optimal Form
The last and maybe the most essential reason is that the rise of online real estate investing platforms did essentially modify and efficienize the structure of real estate investing. It’s the same structure as before but made significantly better.
One common doubt in online real estate investing is the myth that it is different and riskier than offline real estate investing. Online investing is just syndication. Syndication, in layman’s terms, is a gathering of individuals to invest collectively into a property that no single investor can invest in on his own.
Syndication as far as history is concerned has been around for centuries. Before the passage of Title II of the JOBS Act in September of 2013, U.S. security regulations created a requirement that syndication is managed privately in compliance to Section 506(b) of Regulation D. After the passage of Title II, syndication can now be carried out publicly pursuant to Section 506(c) of Regulation D. Thus the explosion of online real estate investing platforms.
Investors who invest their time and effort to analyze and use online real estate platforms are beginning to realize the capabilities they have to revolutionize their portfolio strategy.
Well there you have it. If you got the money and the time then maybe look into buying an apartment yourself. If you’re looking for a passive way to invest in apartments and still capitalize on the great returns then crowdfunding is your way to go. For more information on our opportunities click the link above and become a free member today.