Making Money in Multi-family and Apartment (5+ units) Investment - Real or Myth

[Anant B.]

Hi I am relatively new to Real Estate Investing and have been mostly buying buy and hold properties for rental income for past 9 months or so in Chicagoland area - primarily in suburb areas. Have acquired a few SFR / Duplex properties with my partner. At this point exploring the idea of investing in multi-unit / apartments with 5+ units. We saw quite a few apartments in last few weeks and and to be honest are attracted by relatively low prices of entry. In few cases some modest to gut rehabs are necessary as well. But the main stumbling block my partner and I are facing is can we really generate decent cash flow by acquiring these 5 - 8 unit buildings. Here are some example numbers we ran through and figured out Cash Flow is really not that attractive at all and probably we are better off sticking to SFR/Duplex investment for Cash Flow.

1. Building 1 : 6 Units ( 5 2BR + 1 1 BR), Purchase Price: 120K, Rehab: 100K

Rental Income: 55K Annual, Taxes: 10.5K, Ins: 2.5K, Utlities: 12K, Vacancy/Reserve/Maintenance: 5% each, Property Mgmt: 8%(about 12K) 

Operating Expenses: 37K

Gross Operating Income without Debt Service 18K, Cap Rate: 8%

Net Operating Income with Debt Service: 6K, CoC Return - 11%

Net Cash Flow Per Unit Per Month: $80/month

2. Building 2 : 7 Units ( 6 1BR + 1 Studio), Purchase Price: 120K, Rehab: 70K

Rental Income: 47K Annual, Taxes: 8.2K, Ins: 2.5K, Utlities: 11K, Vacancy/Reserve/Maintenance: 5% each, Property Mgmt: 8%(about 12K)

Operating Expenses: 32K

Gross Operating Income without Debt Service 15K, Cap Rate: 8%

Net Operating Income with Debt Service: 5K, CoC Return - 12%

Net Cash Flow Per Unit Per Month: $60/month

Compare these metrics to SFR Investment where I can generate about 350 - 600 /month cash flow per unit with Cap rate of 12% or greater and CoC return of 18% or more.

Is there something wrong with my numbers - the way I arrive at them? Or is it the reality in apartment/multi-unit investing that we have to come to terms with.

Thanks for your insight or feedback or experience that you may be able to share.

Anant

[Erik Nowacki]

Hi Anant,

I started with duplexes, triplexes etc. renovated, rented for little cashflow.  Appreciation happened both because of rehab I did and also as a result of the market rising. Then I 1031 exchanged into larger properties, 6, 10 and 14 units, still needing a lot of renovations.  Once those renovations were done, I 1031 exchanged again into larger properties.  It's taken 15 years (with a few ups and downs) to go from 2 to 200 units.  I could have done it faster had I been more focused...   I have three property managers at 3 different complexes.  If I tried to manage 200 houses, I would need a spreadsheet to figure out where they are at and probably more than 3 property managers to keep track of them all.

It takes time, but the growth can be exponential, not one at a time as with single family residences. If you look at the smaller multifamily properties as stepping stones, it may give you another way to look at them. Let's say you buy the 6 unit property for $120K and rehab for $100K. Keep in mind that your building is valued based on the NOI, so make sure every dime of your renovation budget goes toward items that can increase your rents or decrease your operating expenses. Also, don't over renovate for the class of apartment and area. I.e. don't put in dishwashers and stainless appliances, if your competition doesn't have them. That may be worth while in a flip, but overrenovating an apartment is wasting money. Any apartment you can buy for $20K/door is a class C or D, mostly basic stuff in there. To refresh a Class C apartment, I usually spend $4-5K/door. Paint, light fixtures, paint the kitchen cabinets, a new countertop, used appliances and flooring (vinyl or tile). You are proposing to spend over $15K/door, which sounds way to much to me, unless you are doing the foundation, structure and roof at the same time.

With commercial properties, you can use the cap rate to figure out if your improvements are worth while.  Look at your expenses and figure out where your money is spent.  If you are spending a lot of money on water, you can calculate how much you will save by installing water saving fixtures.  Divide your savings by your prevailing cap rate and see how much more valuable your building is with the lower water bill.  

On the other side of that equation, you can also evaluate your proposed repairs and improvements to see if they will generate enough of a rent increase to pay for themselves.  Back to the example, you buy the property for $120K and spend $100K on repairs.  At a 10% cap rate (adjust to your market) those repairs should justify a combined rent increase of $10K/year, $833.33/month or $138.88 per unit per month.  If not, you are overspending on repairs.

Sorry this got a little long winded, but one of the advantages with multifamily over single family is that you can calculate and to a large extent control the value of your property by knowing the prevailing cap rates. Increase rents or decrease expenses and your NOI goes up, divide by the cap rate and figure out how much value you added. With SFR's, you are at the mercy of the comps, over which you have no control.

Good luck and keep looking at deals, the more you look at the better you become at picking out the winners.

Erik