Investing in Apartment Buildings 101

Investing in the multifamily real estate market has been a steady and profitable option for investors in recent years. However, it is important to conduct thorough research and gain a comprehensive understanding of the investment process before diving in. As a reputable real estate syndication firm, we are dedicated to educating individuals interested in utilizing shares of multifamily rental properties to generate a consistent, passive monthly income. This article will provide an introduction to crucial concepts that are essential to understand before investing in an apartment building.

Learn the Basics

Investing in multifamily properties can be appealing due to the potential for consistent rental income, but it also comes with the risk of costly repairs and maintenance. However, these are only a few factors to consider when evaluating the advantages and disadvantages of investing in apartment buildings. Before diving into this market, it’s crucial to have a good understanding of the benefits and drawbacks of each potential project you are considering.

Pros

Apartment buildings can offer some major benefits to investors, including:

• Rental Income: The majority of potential earnings from apartment buildings come from rent collection. This makes them appealing for those seeking passive income, especially when compared to other real estate investment projects that may not generate regular income and only yield returns upon property sale.

• Supplementary Income: Apartment building owners can charge fees for a variety of amenities and services related to the building. Parking spaces, storage closets, premium pool and gym perks, and party/recreation room rentals all have the potential to bring in extra revenue each month.

• Tax Advantages: Real estate investment offers various tax benefits, such as a reduced tax rate on passive income and the option to take depreciation deductions upfront when filing taxes.

• Equity: Although there are many advantages to investing in apartment buildings, some investors may mistakenly believe that they are entirely risk-free investments. However, as with any investment, there are also potential pitfalls that investors should be aware of, including the following:

Cons

Aside from the income generated from rent and additional fees, investors in apartment buildings aim to see a rise in equity in the property over time. The ideal scenario is that the building’s value appreciates during ownership, resulting in a profitable payout when the investor chooses to sell the property.

• Tenant Unpredictability: The financial success of apartment buildings relies heavily on tenants, and if they cannot be placed or retained, it can lead to significant financial losses. Additionally, tenants bring a human element that can be difficult to manage due to their needs and potential conflicts with other tenants.

• Building Maintenance & Repair: Apartment buildings provide a consistent flow of income, but they also require a continuous flow of expenses. Owners must account for various costs, such as maintenance and repairs, unexpected expenses, and potential upgrades to keep the building attractive to tenants and stay competitive in the market.

• Time Investment: Investing in apartment buildings demands constant attention and active involvement. Purchasing a property is just the beginning, and there are numerous tasks that need to be done throughout the process. While property management can be outsourced, it can be costly. Additionally, selling an apartment building may take longer than a single-family property, which requires patience from the investor.

Consider Multifamily Property Investment Options

Investing in apartment buildings doesn’t necessarily mean buying a property outright. There are other options available for those who want to generate passive income and reduce their workload. If you’re interested in exploring these options, consider the following ways to invest in apartment buildings.

Real Estate Syndication

Real estate syndication involves a group of investors pooling their funds to buy and manage a property, typically a multifamily apartment building. The regular rental income from the tenants can generate steady profits for investors. The distribution of profits depends on the syndication’s structure, which can be tailored to meet investors’ financial goals and risk tolerance. However, investors have limited control over major decisions, so choosing a trustworthy sponsor is essential.

Real Estate Investment Trusts

REITs, or Real Estate Investment Trusts, are companies that own or finance income-producing real estate properties. They distribute at least 90% of their taxable income from these properties to passive investors in the form of dividend payouts. Most REITs are traded on major stock exchanges, allowing investors to purchase company stock and receive these payouts.

Investing in REITs can be a simple way to invest in apartment buildings, especially compared to purchasing an entire building on your own or with a partner. Many people invest in REIT stock through their 401(k) or other investment plans, as it only requires a few clicks on a computer or app.

Purchase Alone or with a Partner

Investing in an apartment building on your own can be a daunting and expensive process, whether or not you have a partner. Nevertheless, buying a complex also offers the investor the most authority over the investment decisions and provides the highest potential for risk and reward.

In the event that you are thinking about purchasing an apartment building by yourself, it’s important to have a comprehensive plan for property management, property renovations, and property sale. If you lack experience in these areas, consider partnering with others who have relevant expertise to ensure your success.

Build Your Own

Investing in building an apartment complex is a costly venture that depends on several factors like size, finishes, and local fees. Some investors find the benefit of complete ownership and control over their investment attractive despite the significant expenses. However, this option is the least passive way to earn income from a multifamily property.

In the United States, the average cost of constructing an apartment building varies from $4.5 million to $50 million, and the project cost varies significantly based on the size of the completed project.

On average:

• Low-rise buildings cost $150 to $225 per square foot

• Mid-rise buildings range from $175 to $250 per square foot

• High-rise buildings are the most expensive at $225 to $400 per square foot.

The expenses associated with constructing a building can be categorized into hard and soft costs. The hard costs primarily refer to the building materials required for framing and finishing, laying the foundation, and converting the units into livable spaces, along with the labor costs and land expenses. On the other hand, soft costs are the hidden but crucial expenditures that involve architectural and legal fees, permit and development charges, among others.

Do Your Research

Investors interested in apartment building investment must allocate ample time to evaluate and research prospective buildings or investment opportunities. It’s crucial to understand the different classes, structures, and potential risks associated with apartment buildings, regardless of how you intend to invest.

Classes of Apartment Buildings

Apartment buildings come in all shapes and sizes, and they are filtered into four classes:

• Class A: newer, usually less than 10 years old, and have the amenities typically attributed to luxury apartments like pools, gyms, and tennis courts. Older buildings that are renovated to current finishes and amenities can also be Class A.

• Class B: older than Class A buildings but less than 20 years old. These buildings are still in good condition, but are not as modern as Class A buildings. The new has worn off of Class B buildings.

• Class C: up to 30 years old, obviously and significantly dated, and lacking in the amenities that a modern tenant may expect. The need for repairs may be obvious.

• Class D: often low-income or subsidized housing, over 30 years old, and in poor repair. These buildings lack amenities.

Class B and C buildings are commonly preferred by investors because they don’t require extensive repairs, yet there is still potential to increase equity and rental income through cost-effective renovations and upgrades.

Structural Types of Apartment Buildings

To categorize multifamily property investments, we can also consider the type of structure that apartment buildings have:

• Low-rise apartment buildings are four or fewer levels high. These are most commonly found in suburban areas or in smaller cities without significant population density. They require less expense and are easier to build, but they do typically offer less ability to make large profits.

• Medium-rise apartment buildings will be five to nine levels high. They are in both urban and suburban areas, and can be a good compromise size to balance risk and benefit. They may also provide supplementary income from parking, vending, laundry, and other amenities.

• High-rise apartment buildings have 10 or more floors. These buildings are expensive to build and are subject to many regulations. The increased number of tenants provide greater income possibilities. These buildings offer the best return of investment in areas where land is in short supply and is very expensive. 

Common Multifamily Property Risks

Here are a few things to keep in mind as you weigh the possible risks and benefits of each opportunity:

• Building Size: Larger apartments equal more potential income, but they also pose a greater risk due to their more significant up-front investment and the ongoing maintenance and loan servicing costs. 

• Rent Rolls: Look at the rent rolls to analyze the current rent rate for each unit and the size of each unit to understand the long-term possibility of the building.

• Occupancy Rates: Consider the occupancy rates to learn what percentage of the building is usually occupied by paying tenants. Be sure to take into account vacancy periods to help you understand the attrition and replacement of tenants. Also take note of the reasonable earning potential of the building.

• Capitalization Rates: It’s important to determine the capitalization rate to understand the value of a building. To find the cap rate, divide the building’s net operating income by the market value or purchase price. The higher the rate, the better. Sometimes, buildings with a greater asking price end up posing a better deal than a similar building with a less expensive list price based on the cap rate. 

Become an Apartment Building Owner

If you are ready to take the plunge and become an apartment building owner, here are the main steps to start the process:

Obtain Financing Pre-Approval

When it comes to purchasing an apartment building, the process is similar to buying a home. First, you need to identify the type of property you want and then figure out your financing options. To simplify this step, you can work with a mortgage broker who will help you find the right loan products based on your financial situation. They will also handle the paperwork to ensure that you meet all the necessary requirements.

Meet Lender Requirements to Finalize the Loan

Before closing the loan for an apartment building, it is typical for lenders to request multiple reports to assess the loan risk and creditworthiness of the buyer. Apart from an appraisal, a title report, a Phase I Environmental Assessment, and a physical condition report are usually necessary. In some cases, lenders may request other property or community-specific reports, such as surveys to identify boundaries and encroachments, seismic reports to assess earthquake risk, and zoning reports to resolve zoning-related disputes.

Establish Management of the Building

After purchasing an apartment building, the real work is just beginning. If you are inexperienced, it’s important to hire a professional, experienced property manager that has both the ability and knowledge to coordinate all the needs of the building, the tenants, and the owner. Alternatively, if you will be doing your own property management, you need to be aware of the legal requirements regarding safety and financial management to avoid incurring major penalties or legal liabilities.

Conclusion

Investing in apartment buildings continues to be popular among investors due to the steady income generated by tenants’ monthly rent payments, especially in markets with low single-family housing inventory. There are various investment options available for apartment buildings to suit different investor goals and resources, ranging from traditional methods to syndications and REITs that offer the advantage of investing without the significant financial and time commitment of owning a building outright. As a top real estate syndication company, Life Bridge Capital provides investment partners with the opportunity to leverage shares of multifamily rental properties for a passive monthly income. If you’re interested in exploring this investment avenue and the freedom it offers, don’t hesitate to contact our team today.