How To Buy And Sell An Apartment Building

Why would you want to learn how to buy and sell an apartment building? Because you can make more on one large deal than on a dozen fixer-upper houses. It does take some time though, so this is a long-term investment strategy. It also takes some careful planning.

When you buy, improve, and then sell an apartment building, it is different from flipping a house in two important ways. The obvious one is the size of the transaction. If you flip a two-million-dollar income property for 15% more than you paid, you make more than you could on a string of small houses.

The other difference is in how these properties are valued. How do you put a value on a house? Generally by comparing its various features with those of other houses. Size, location, number of bedrooms, and even the brand name of its appliances are important. With income properties, there is one primary thing that determines value more than anything else: Income. This make buying, improving and selling an apartment building a more predictable process.

Suppose you paint a house, for example. You'll get more for it, but how much more? How much value that painting adds will always be a guess to some extent. Suppose you chose a color that isn't popular now? What about other improvements? Does a deck raise the value of a house by more than it costs? There is a lot of guessing involved in flipping a house.

On the other hand, you can better predict what effect your changes will have on the value of an apartment building. Your buyers will be investors, who look at income more than new carpet. As a result, the basic formula is simple: raise net income, and you increase value accordingly.

Let's suppose investors in your area expect a capitalization rate of .08, which means that they expect a net return (before loan payments) of 8% on the purchase price. You buy a thirty-five unit building that generates $140,000 net income annually, for $1,750,000 ($140,000 divided by .08). Now, if you can get it to generate $164,000 in annual net income, it will be worth $2,050,000, or $300,000 more than you paid.

Once you understand cap rates, it becomes clear how to buy and sell an apartment building profitably. Start by finding a property that isn't being operated efficiently, and perhaps is even selling at a better-than-average cap rate. Buy it, increase the net income, and resell it for a profit a couple years later. To the extent that the increase in income is predictable, the increase in value is also.

How To Buy And Sell An Apartment Building - An Example

You find a 42-unit apartment building. The apartments are all two-bedroom units, and they rent for an average of $600 -definitely below the $675 average for the area (we assume you've done your research). The 10% vacancy rate for the last year is above the 3% average rate in the area, because the place is a bit run-down, and management isn't very quick about getting new tenants.

A dirty community room is generally unused, and there are no laundry machines, so tenants have to go eight blocks to get laundry done. Only a couple places in town rent this cheap. Many get $750 or more for two bedroom apartments, so you can see there is potential for improvement and higher rents.

Gross income the previous year was $272,000, and all expenses (not including) loan payments, came to $76,000, so net income before debt service was $194,000. The prevailing cap rate in the area is .08, so the value is around $2,425,000. ($194,000 divided by .08). Of course, you've been shopping for more than just real estate, but also for motivated sellers. This one is asking $2,175,000, and accepts your offer of $1,900,000.

Before you even close on the deal you make a list of every possible way to reduce the expenses and increase the net income. The moment you close the deal, you start making changes. Minor landscaping costs $1,000 or so, you have $2,000 worth of painting done, and spend another $1,000 on general cleaning of the grounds and buildings.

You clean and repair the community room, and install video games. These are provided by an amusement company at no cost, and you get half of the income from them. Half of of the community room becomes a laundry room, and again, you opt for an arrangement that gives you half of the income without any investment in machines. However, it does cost you $9,000 to have the room plumbed and wired for the washers and dryers

A beverage company puts a pop machine in the community room for 40% of the gross income.

$13,000 gets you ten small storage sheds which you rent to tenants for $35 per month.

For $52,000 you have several carports built, which provide one space for each tenant's car.

For a couple hundred dollars, you replace every outdoor light with low-watt fluorescent bulbs, to cut the electrical expense, and you replace the inefficient heater for the hallways with one that will cut your gas bill by 30%. This costs you $6,500. New fire extinguishers and other minor changes get you a better insurance rate, and cost a couple thousand dollars. You also find a better management company for the same rate s the old one.

After surveying the tenants, you make repairs and improvement desired by them, which costs another $32,000. They were told there would be improvements, of course, They were also notified that a rent increase was necessary to pay for these, but that rent would be close to that of similar apartment buildings.

Now, as the leases are up, you increase rents, and simultaneously start promoting the building as one of the nicest in the area, to fill those empty units. The following year most of the apartments are renting for $700. The rent increase notice sent to tenants included an information sheet showing the rates at other apartment buildings, emphasizing those that were charging $750 and higher. Some tenants leave because of the higher rent, but these units are easily filled, and all of the tenants have a nicer place to live.

Note: It is a lot of trouble and expense to move to a place that is not as nice in order to save maybe $50 per month, so you won't lose many renters.

You wait another year to sell, so that all changes in income and expenses will be fully reflected in the books for a full year. In total your improvements cost around $122,000, and with the original purchase price and closing costs, and you have about $2,200,000 into the property.

Now let's look at that net income. The apartment building is 98% occupied, with rent averaging $700 per month per unit. You had about $345,000 in rental income for the year. Laundry machine income was $2,400. Storage sheds (mostly occupied) brought in $3,600, and video games and pop machines in the community room made you $2,000.

Total gross income, then, is $353,000. The new heater and other changes reduced annual expenses to $68,000, making the net income before debt service $285,000 With a .08 cap rate, the value of the apartment building is now about $3,560,000.

It's in such perfect shape, however, so you list it for sale at four million dollars, and by the end of the third year it sells for $3,730,000.

If we suppose that you invested $500,000 originally, that's a great return. Unfortunately, it is also a taxable capital gain, unless you very quickly make it into a 1031 tax-free exchange. You'll have ask a 1031 specialist how to do that. The important point here is that when you buy and sell an apartment building you make changes that raise the net income to get a quick boost in value.

Copyright Steve Gillman.
69 Ways To Make Money In Real Estate
Want to know the other 68 ways? Visit http://www.99reports.com/make-money-in-real-estate.html

Tips For Flipping A House | Buy An Apartment Building