Why buy larger apartment buildings?

Question

Hi All,

I am selling a duplex for 2.3 mil.  I am doing a 1031 exchange.  Based on the 200% rule I can buy as many properties I want as long as they don't exceed 200% of the sale of my property.    I want to split the money into multiple properties mostly higher cash flow and some in areas that have good appreciation (Austin, Houston).      Looking at apartment buildings it appears the bigger the building the smaller your cap rate is.    It appears that the best cap rate is looking at SFR or duplexes.    I know a lot of investors goals are to own big apartment buildings and I am curious as to why?   It would seem to me that they would be harder to resell, wouldn't appreciate as fast, and your cash flow per dollar invested (cap rate) is lower.   They might be a little bit easier to manage but not sure that is a big enough reason to take a much lower cap rate.      Based on my research I can easily get a 10% cap rate on a SFR, however an apartment building is usually only 5-6% in the same area.  For this analysis assume 100% cash.   All of these investments are not local to me.    Thanks in advance for your feedback.

Lynn Currie · Answer

It's tough to be buying rental properties in Austin right now. The ratios of rent to cost don't really make sense. I think Houston still works. Maybe someone from there will jump in.

Unless you're buying a big portfolio, one-off SFRs usually sell based on one of two things:

• Comps
• Rent Roll

In Austin right now, rent rolls have very little to do with the value of houses. The comps are driving the cost. There are pockets in the suburbs that still allow for rentals, but most folks are moving to the tertiary markets to buy rentals.

In Austin, the cap rates for apartment complexes are low and most sellers are trying (and in many cases succeeding) to sell on pro-forma instead of actuals. There is a lot of money here that is betting on the stability of our market, future development, and appreciation.

It's a balance that depends on my strategy. If I can find a complex that can make a little cash-on-cash but is in an area that is appreciating rapidly, I'll take a 5% cap in Austin over a 11% in one of the tertiary markets. If I'm looking for cash-flow and want to hold for a long time, I'll go where the annual rate of return is higher.

Back to your original question though:

• Bigger complexes have economies of scale on costs and management. The obvious is property management, but it flows over into things like vacancies.
• Lending for apartment complexes is different than SFR. I you have a stabilized property, it will likely qualify of a non-recourse loan. Even if you don't get a non-recourse, a value-add property can be re-financed based on raised rents in a short time frame.
• There is a formula for increasing the value of your property because the value is based on income, not comps. If you want to increase the value, you get your Net Operating Income (NOI) up. The two most common ways of doing this are to raise rents or lower operating expenses. [ I was going to give examples with numbers here, but Tom Bucaceck has an in-depth explanation in a BP blog post https://www.biggerpockets.com/articles/924-underst... ]

Hope that helps!

Doug McLeod · Answer

@Connie Stainbrook

As already mentioned, economies of scale in terms of acquisition and management is one reason for apartment investing. Forced appreciation in a value play is another (potential to double your money in 2 years or less). Professional management (less work for you) is another.

The implication for appreciation is that you only get appreciation with apartments if you actually increase the NOI. SFRs will rise with the market and there are limited ways to influence appreciation with your actions.  With apartments you must have a strategy to bring and keep rents at market and reduce expenses and a manager/company who understands and is capable of executing that strategy effectively.

Be cautious investing for appreciation only.  RE still has downside risk. Don't put yourself in a position like the speculators who bet on appreciation in 2008 and lost big time.  Know the local markets AND the most effective business models for the property class you decide to purchase.

I hope you find some good properties to reinvest your nice gain. Good luck!

Connie Stainbrook · Answer

Thanks @Steve Vaughan for your feedback.  I bought 12 years ago in Hermosa Beach.  I paid 850K for it.   I still owe 600K so I will be taking on the same amount of debt.  I plan to use management companies and have included that cost in the cap rate.    The properties I am looking at are not local to me so I won't be maintaining them myself.   However, I am willing to jump on a plane if need be.   Locally the cap rates are way low and I am more interested in cashflow then appreciation at this juncture.  Obviously getting both would be ideal.

Connie Stainbrook · Answer

Thank you all for your feedback I really appreciate it.   Account Closed  I was not so much interested in Austin and Houston for cashflow as for appreciation.   I have read those markets are growing and real estate is forecasted to keep going up.   Based on your feedback maybe looking at San Antonio might be better?    Here in San Diego  the higher end homes are appreciating leaps and bounds.   But no way you can make one cashflow if you just put 20% down.    My house already went up 300K and I have only owned it since February.   To bad I like it so much because I'd love to take that equity and run. :-)    So to my point I'd like to invest some of my money in a "hot" market where I can see some great appreciation.  The rest of it put in higher cashflow markets.

Account Closed · Answer

A price growth of $300K in the value of a house in 8 months depending on what you bought it for isnt shabby.

Account Closed · Answer

If you had a choice between owning 100 different 1 bedroom units/houses which might be scattered across a town and owning 1 100 unit apartment building, which would you choose if each route had similar total acquisition cost? Cash flow or value appreciation -- what matters most to you?

Lynn Currie · Answer

@Connie Stainbrook Austin has historically been fantastic for appreciation. The trick with buying properties here that you want to hold, is justifying the hold in the meantime. There are ways to do it, but buying  residential rentals in the city that kick-off any cash or even are cash-flow neutral right now requires diligence. I know very few people who are picking up rental properties currently.

San Antonio is a good market, but very different than Austin, Houston, and Dallas. You might want to consider San Marcos, too.

I'm not sure if you're familiar with the Texas A&M Real Estate Center, but it has all sorts of great data and articles about Texas cities and towns.

Waylon Themer · Answer

@Connie Stainbrook From a Houston perspective, there is a lot cash available in the large multifamily marketplace and cap rates have compressed dramatically.  Since houses don't trade on cap rates but rather sales comps and fewer institutional buyers purchase houses one or two at a time the price to rent ratio has actually improved in comparison to multifamily in Houston.  With that said, I haven't seen many true 10% cap rate houses in Houston other than class C minus or D markets.  Please be sure to include all property taxes (look for multiple taxing authorities, etc.), insurances, management, repairs, and vacancy in your analysis.  Most of the B class SFR in Houston on the market is closer to a 6.5% cap rate (if you want to attach a cap rate to SFR).

Have you considered other commercial real estate that would be more passive than multifamily as an investment strategy? Such as NNN leased commercial space to good tenants. @Joel Owens of All World Realty is one of the sharpest commercial guys that I have seen post on here.  He may have some ideas for you.

Why buy larger apartment buildings?

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