Real Estate Investing: Apartment Complexes
Investors who flip apartments realize that they are playing a whole different game. Apartments are valued based on cash flow and net operating income where as houses are valued by fixing physical structures (roof, windows, carpet) and reselling the home similarly priced to other houses in the neighborhood.
When flipping apartments we care about the income statement of the building because cash flow is ultimately what another investor is going to care about when buying the deal from us.
Cash flow is the left over money that goes to your bank account after all expenses to run the apartment building have been paid. It’s the take home profit realized on the invested capital used to purchase the property.
We can use cash flow (profits) to analyze the return on investment (ROI) and this return is what gives the apartment complex value because apartment investors can compare the return of several buildings and decide which building is worth more or less based on the expected return it will generate on the investor’s capital.
So a quick summary of fixing and flipping apartments really boils down to fixing up the income statement of the property to produce greater cash flow / returns on investment.
If you want to flip apartments then you must purchase a complex at discounted price, increase it’s cash flow, reduce expenses, and sell it for the market cap rate. If you are confused no worries this flipping apartment example below should help.
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A Simplified Example Apartment Flip
Suppose you find a 25 unit apartment building for sale. They are all 3 bedroom units renting for $800 on average, which is less than the $900 average for the area you are in.
Last year’s vacancy rate was 8% which is higher than the area’s average rate of 4%.
You believe the higher vacancy rate and lower rental rates are a result of the apartment complex being in run down shape. Also, the current managers are doing a terrible job at replacing tenants quickly costing the complex cash flow.
The gross income for the previous year was $260,000 and expenses not including debt came to $85,000. The net operating income for the previous year was $175,000 before debt.
The areas market cap rate is .10 which means the apartments net income is 10% of its property value.
Using this rate we can divide the net income of $175,000 by .10 to get $1,750,000 as the current value of this 25 unit apartment complex.
You negotiate with the seller and acquire the complex for $1,600,000. While waiting for the deal to close you are busy analyzing every possible way to increase cash flow and reduce expenses. Once the deal closes you get to work.
You spend money fixing up the units so they look clean and up to date instead of run down and old. You have a parking lot developed for tenants to each have one parking space.
You fix up the laundry room so that it functions properly again. You replace lights and other fixtures with energy efficient versions to save money over time on the energy bill.
You also fire the current management company and shop around for a new management company that will do a better job for the same rate.
Since you spent money making improvements to the complex you notify the current tenants of these improvements and also of rent increases for the up coming year to pay for these improvements.
Overall, you have found ways to reduce expenses, you have increased the income through rent, parking fees, and laundry fees, and you have provided tenants with a much nicer place to stay which will attract new tenants and hopefully lower the vacancy rate.
After a few years of earning positive cash flow from the apartment complex you decide to sell it. The complex has had time to reflect the changes made and the financial statements look much better than when you first acquired the property.
25 units x $900/month on average results in $270,000 in gross rental income. The laundry room and parking fees add another $10,000. Adding in other fees let’s say the gross income for the apartment complex comes to $295,000.
You found ways to reduce expenses so that they total just $70,000 compared to $85,000. This puts the net income before debt at $225,000.
At a .10 cap rate the property is now worth $2,250,000 so you decide to list it for sale at $2.5 million. After 3 months on the market it finally sells for $2.35 million.
You acquired it a few years ago for 1.6 million so you’ve increased its value by $750,000 profiting close to $600,000 after closing costs plus earned income the few years you owned it from cash flow. Overall you did well flipping this 25 unit apartment complex.
How to Finance the Purchase of an Apartment Complex
Buying apartment complexes with the intent to hold as an investment or flip for profits is no small purchase. These deals can run hundreds of thousands of dollars, even millions of dollars.
To afford flipping apartment buildings, you’ll need to have a solid financing strategy in place.
Step 1: Determine how much cash you have on hand to invest in the building’s purchase price as well as all of the renovations to make the units more presentable, which in return generates higher monthly rents.
Step 2: Talk with a lender to determine how much financing you’ll need. Find out loan terms, interest rates, and ways to structure the deal to help the property cash flow better.
Step 3: Find an outside investor or business partner if you can’t come up with the funds yourself or you don’t qualify for a loan by yourself. Lending can be strict and require a high net worth and high credit score when dealing with large amounts of money.
Step 4: If you are buying the building as an LLC or similar legal entity, check out this guide on how to get a loan through an LLC.
Step 5: Read our in depth guide on how to finance real estate deals, including creative financing methods.
How to Find Apartment Buildings to Purchase?
We already covered marketing strategies to bring more real estate deals into your pipeline so you can have endless flow of deals to analyze and choose from in the linked article.
But apartment deal hunting can be more challenging as many apartment building sales go off-market.
Traditional methods include:
- Working through a real estate broker
- Looking on Zillow, Craigslist, Realtor.com
- Hearing about deals at investor meet ups
- Shopping for deals on BiggerPockets Marketplace
- Shopping for deals on Facebook Groups, Online Forums, Facebook Marketplace
- Having a real estate wholesaler bring deals to you
I’d recommend communicating with the brokers in your market who deal with commercial real estate and multi-family real estate. They will have eyes and ears on the ground about pocket deals (off-market) and can connect you with private sellers that the rest of the public does not know about yet.
Flipping (improving and then selling) real estate is not easy. But it is doable.
Thousands of average people invest in real estate and if you do your research and properly educate yourself (with this course) then you can be successful.
I spent a year educating before I pulled the trigger and bought my first investment property. I read many books, blog posts, and listened to audio podcasts, as well as took online courses.
How to Buy Your First Investment Property
If today’s blog post and video lesson inspired you to get into real estate investing but you don’t know where to start, check out my brand new course: Real Estate Investing Beginner’s Course to Buying Your First Deal
You’ll learn all the basics plus more advanced topics:
- Why real estate investing is better than the stock market
- How to find deals with large profits in your city
- How to fund your deals if you have little or no money
- How to buy deals with bad credit
- How to analyze deals and know which one’s are worth offering on
- Setting up legal entities like an LLC
- The due diligence phase prior to closing on the property
- 4 ways you build wealth through real estate investing
- And much much much more!