How To Locate & Analyze
An Apartment Building Investment
By Darrell Roberts
The author has permitted the reprinting and redistribution of this
article.
Buying income producing apartment buildings is one of the greatest
wealth building strategies for real estate investors. Real estate
offers investors the ability to acquire ownership with minimal cash
down and benefit from the massive leverage effect which increases
profits by using OPM (other people’s money). Apartment
buildings are on the one most viable investment vehicles and should be
considered as an effective strategy to build real estate wealth.
In this article, we will discuss several steps included in the process
of buying an apartment building. Let’s roll up the sleeves
and have some fun!
Step 1 – Master the Basic Formulas
Before you set out to buy your first apartment building, it’s
extremely important for you to have a solid understanding of the basic
terminology, mathematical formulas, and financing strategies used in
the apartment investment industry. Having a firm foundation in place
will greatly improve your chances for success. Visit your local book
store and browse the real estate section for books on apartment
investing.
Step 2 – Locate Multiple Properties
Probably the most challenging task with apartment investing is locating
the right property that offers solid financial benefits. These sound
investments are sought by many active real estate investors. Assuming
you’re a novice investor seeking to buy your first apartment
building, it’s wise if you conduct your search within your
local community andor nearby neighborhood. Keeping your search within
close proximity of your home base will allow you to monitor your
investment more closely. Start the search by browsing the local
newspapers under the classified section. This is one of best sources
for active apartment listings, but it also captures the most eyes and
leads to more competition. Nonetheless, it’s a great start.
In addition, search other online ads such as LoopNet.com and
cityfeet.com that offer a great selection of apartment buildings for
sale. Contact a local real estate broker to assist you with your
search. If you decide to go this route, look to work with a well
respected and experienced “buyer’s”
broker. Moreover, browse through your list of contacts and begin asking
friends and family members if they know of any accountants, attorneys,
bankers, etc. who may know of local apartment building owners. The goal
is to start expanding your network and quickly informing others that
you’re actively looking to buy apartment buildings. You will
be surprised at just how many contacts this strategy will generate.
Post an ad in the local newspapers classified section under titled
“Wanted – Apartment Buildings.”
Perhaps the best and most profitable search strategy is locating
“off-market” properties owned by motivated sellers.
“Off Market” properties are not officially on the
market for sale. This strategy is generally implemented by the more
experienced investors. It commands the most time, energy and effort,
but also is one of the most profitable strategies if executed
correctly. The major benefit of this search strategy is that you will
be dealing directly with the owner and bypassing the brokerage
community which will show the same property to 100 other active
investors. Just imagine, 100 investors bidding on the same property
that you want to buy! A mass marketed property generates a hyper
competitive bidding environment (as it should) which leads to higher
offer prices. High prices translate to lower returns because you will
be forced to invest much more equity.
Stay focused and work hard and smart at becoming an expert at locating
“off-market” deals because its one of the quickest
ways to build real estate wealth.
Step 3 – Conduct a Detailed Market Survey
Now that you have located several apartment buildings for sale, its
time to conduct an in-depth market analysis in order to fully
understand the market rental rates, occupancy rates and each
property’s position in the marketplace. The first step will
be for you to locate the top 3 to 5 competing apartment properties in
the neighborhood that are of similar size (total units) and vintage
(year built). Once you have identified the rent comparables, contact
each property directly and conduct a market survey. Ask each property
the following questions
What is the age of the property
What year was the property built
How many units does the property contain
What is the current occupancy rate
What has the occupancy rate averaged over the last 12 months
What is the monthly rent for each different floor plan
Are you offering any rental concessions (free rent)
If so, what type of concessions are you offering for each floor
Do the individual units offer full size washer and dryer sets in the
unit Stackable sets Or, washer and dryer connections
Does the community offer any outdoor amenities If so, what are they
Survey the properties, collect the information, enter the data into an
excel spreadsheet, and analyze it thoroughly.
It’s very important that you pay particular attention to the
“net effective” rents vs. “quoted
market” rents. For example, if you survey rental comparable
#1 and they quote a market rent of $500 per month for a
one-bedroomone-bathroom floor plan, but they offer a potential resident
one-month free on a signed 12-month lease; the real “net
effective” rent is $458 per month not $500 per month. The
formula for determining the net effective rent is as follows $500 per
month divided by a 12 month lease equals $41.67 in discounts per month
that the new resident receives over the length of their lease term.
Another way to calculate this is to simply take one month free over a
12 month lease as follows (1 month12 months=8.33%X$500=$458). Basically
a tenant will be paying for 11 months but that cost is spread over a 12
month lease term. You got the idea now, right Excellent!
Complete the net effective rent exercise for each individual floor plan
at each property surveyed. This will take a little time getting use to,
but as you call more properties and complete more exercises it will
become second nature. The most important thing to remember is that you
are now performing a more sophisticated level of analysis and this will
give you a competitive advantage in the marketplace. It will also
greatly benefit you once you start your underwriting process as you
will be able to more accurately forecast cash flows and investment
returns. The last thing you want to do as a serious investor is to
overpay for a property based on inflated numbers.
Study the competition’s product, site layout, interior and
exterior amenity package, asking rental rates, specialsconcessions
(free rent offered), and net effective rental rates, and occupancy
rates in order to “fully understand” your
subject’s position in the marketplace.
Step 4 – Analyze Operating Statements
After you have completed your market study, start analyzing the subject
property’s operating statements and rent rolls.
It’s best if you are able to obtain several years of
historical data. This will allow you to properly evaluate the
historical financial performance and stability of the income stream you
will be buying. If you’re talking directly with an owner of
the apartment building, request operating statements in a trailing 12
month (called T-12) format. One of the main benefits of this format is
that it provides you with “detailed monthly”
figures so that you can analyze each month’s operations in
further detail.
A T-12 format will also allow you to detect any “one-time
anomalies” either in revenue collected or expenses incurred.
For example, let’s assume you are analyzing a 30-unit
apartment building and the listing broker provided you with a
year-to-date (YTD) operating statement ending June 2007 (six months of
operating data). Many novice investors would annualize the operating
statement’s data and capitalize the net operating income to
determine a purchase price. Let’s analyze this scenario one
step further. “WHAT IF” the other income line item
was reported at $20,000 If you were to annualize that amount, you would
be valuing the property on the basis that it generates $40,000 per year
in other income (cable revenue sharing, late fee, non-sufficient fund
fees, month-to-month fees, carport rent, storage rent, etc.).
Now, let’s assume that you requested operating statements in
a trailing 12 month format vs. a year-to-date format. Because of the
monthly breakdown, you were able to identify that in the month of
April, the owner reported revenue of $15,000 which was solely
attributed to a “one-time event” for renewing a 10
year cable contract. It’s very common practice for cable
providers to provide apartment landlords an upfront bonus for renewing
long term contracts. If an investor were to pay the seller for this
$30,000 one-time event revenue stream using an 8.0% cap rate, the
implied value would be $375,000. Basically, an investor would have
overpaid by $375,000!
Don’t be fooled into believing just because a year-to-date
operating statement reports a specific amount of revenue the property
actually generates that amount each year. Be certain to request
operating statements in a trailing 12 month format so you can easily
analyze operations on month-by-month basis. This is an absolute must do!
Smart apartment investing requires patience, thoroughness, and a very
detailed oriented mindset when analyzing the rental competition and
operating statements. Make it a fundamental rule to ask the important
questions and never invest a penny until you fully understand the
complete story for each investment under consideration.
Darrell Roberts is the founder of Apartment Analytics Software, LLC,
one of the real estate industry’s leading apartment
investment software firms. Investors can learn more by visiting
httpwww.ApartmentAnalyticsSoftware.com. Ph (800) 853-7255 Email
info@ApartmentAnalyticsSoftware.com
If
you would like to take advantage of the market and learn how to invest
in real estate and you are local to the Dallas Fort Worth area, I know
a really great teacher and mentor here in Arlington Texas. Please take
a look at his web site: DennisJHenson.com,
Dennis has a great Mentoring and training program, I know because I am
one of his former students. I learned a lot from his one on one
teaching technique. - Michael Harman 817-457-7572
mchfun.business@gmail.com
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