Go small or go big?

Question

Hi everyone,

I have done a ton of reading on buying both 2-4 unit properties and I have also done a good amount of research on buying apartment buildings. I believe that the larger apartment buildings is where I want to end up, however, I was wondering if now is really a great time to jump in or if I should be looking for more 2-4 unit properties for now. Here is my thought process:

1. I may not have enough money to get into some of the larger apartment complexes where economy of scale starts to take affect.

2. I can lock in 30 year loans at silly rates right now. I currently have one four-unit building at 4.2% for 30 years.

3. Interest rates are going to rise... I feel like prices may be a bit inflated due to the last 4-5 years of low interest rates. Won't prices fall once interest rates rise?

I would love to get peoples opinions! I would love to get into some 5+ buildings so I can do a value add strategy, but I am definitely worried about the interest rates rising on those commercial loans in the next few years!

Account Closed · Answer

The first question is do you want to be a property manager or an asset manager. What's the difference? The property manager manages the day to day affairs of the property. The asset manager manages the property manager and the investment.

Small deals require you to be daily interacting with the property. Small deals do not fit inside the standard deviation when it comes to ratios and percentages. for example - if you have a 10 unit apartment and you turns just one unit each month, and if you are really good the unit is unleased for only two weeks and your cost to turn the unit is half a months rent, then you are losing 10% of your income every month. Add a market vacancy and bad debt of 10% and you are losing 18% of your revenue annually at what is technically 100% occupancy. (call me if you do not understand the math). Message, - watch every penny.

Large deals have more stable cash flow, Large deals have the ability to hire staff and third party management. Large deals get better financing. Large deals get better economies of scale. Large deals require more asset management skills.

As for me, go big - otherwise you will find yourself working for your investments instead of your investment working for you.

ps. As for the bus analogy - not sure I agree. just because I can drive a car, does not mean I can drive a bus. I would imagine that if all I ever drove was a bus, getting into a car might be very stressful. (apples and oranges) - Property management is a stair step process not a diagonal line. Some one can learn to manage say 10 units but I am not sure that that will prepare them to manage 100+ units or multiple projects.

Dale Stevens · Answer

I attended a group a while back and heard a great analogy there. When starting out, how big should you go. Well, the answer was interesting.

When you are learning to drive or taking your driver's education road test, did you do it in a BUS? A SEMI? A RV? A Conversion Van or a small compact car?

If you are just starting out, imagine if the first time you drove was a School Bus, dealing with the worrying about where to do, the rules of the road, how wide to take a turn, and then dealing with the kids fighting among each other. In this scenario the kids were related to tenants in an apartment building. If you haven't deal with real estate, then you are thrown into the neighbors complaining about noise, garbage, parties, walking loudly, etc. You could be in for a long ride.

But if you get a single family home, to test the water, it is much easier. If you don't like it, it is usually far easier to sell a SFH usually.

I thought that was a great analogy so I wanted to share it here.

John Warren · Answer

Thanks for the feed back everyone! I forgot to mention that I currently own a fourplex, and the management has not been very stressful thus far. This has led me to believe that I could probably manage a larger property just as easily, especially if I could have enough units to cover lawn service, snow removal, etc.

Kevin Yoo · Answer

@John Warren

1. I may not have enough money to get into some of the larger apartment complexes where economy of scale starts to take affect.

Find someone with the money. It is not hard to do.

2. I can lock in 30 year loans at silly rates right now. I currently have one four-unit building at 4.2% for 30 years.

Find someone with the money. With these kinds of rate, it is not hard to do. You can be the credit partner.

3. Interest rates are going to rise... I feel like prices may be a bit inflated due to the last 4-5 years of low interest rates. Won't prices fall once interest rates rise?

Initially, the prices will go up because everyone is going to try to buy before rates go too high. Once rates get too high perhaps close to 10%, then prices will decline. That's my prediction.

I would love to get peoples opinions! I would love to get into some 5+ buildings so I can do a value add strategy, but I am definitely worried about the interest rates rising on those commercial loans in the next few years!

You should always worry interest rates, but you can figure out a way to make money in commercial properties even if the rates go up. Value adding is definitely one of the strongest ways to do this.

Josh Mitchell · Answer

@John Warren

I think you hinted at it in your post.... 2-4 unit properties come with very low interest rates right now, with relatively easy financing options. Also, it will allow you to build up and get to where you want to be. Have you read @Brandon Turner "seven years to seven figure wealth" yet? I would recommend you do if you haven't and follow the model, since that is the direction you seem to want to go. Best of luck!

Michael Tempel · Answer

I agree with everyone here, but believe going as big as possible with a plan is the way to go.   Make sure you have great partnerships in order since managing a larger asset can make or break your future wealth.   I normally act as the partner locating, structuring, value add renovations and overall manage acquisition targets.

Those targets are often bought from owners that bought too big without a plan or partnership in place.  It can be a big mistake if you don't have a good plan in place....if you do, the sky is the limit!

Philip Bashaw · Answer

Hey Guys!

Personally, I'm looking to get my feet wet with a 12-20 unit apartment building in a desirable area of Atlanta where I live. I don't have 2 million dollars to invest, but if I did I'd buy one of these deals, fix it up, manage it, learn and then use it as leverage to buy 2 more buildings or 24-40 units. My first apartment deal is likely to be an owner financed venture with low money down; a distressed property that doesn't seemed distressed on the surface.

(I haven't been in real estate very long, but I do know that everyone has a different reason for selling. Sometimes people just want out. That's what I'm looking for.)

My plan is to own 400+ units in the next 5 years or sooner. I won't get there w/o experience or leverage. Most lenders, private or otherwise want you to have property management experience, especially if you are going for a super low interest commercial FHA loan. This is the route I plan to take, eventually moving into bigger and bigger deals.

@JohnWarren, I'd say you are on the right track. Stay close to your comfort zone, but keep exploring outside of it. Its more fun out there!

Nick B. · Answer

2-4 units are considered SFH and valued based on comparable sales. Yet, they attract similar tenants as apartments do. So, you have the worst of both worlds: higher maintenance tenants (multi) and no forced appreciation via NOI increase (SFH).

Ashley Pimsner · Answer

@John Warren, I don't necessarily think it is a bad idea to get your feet wet with 2-4 units before scaling into apartment buildings.

You should check out this lender in Chicago which lends 80% ltv for commercial units and can also include rehab costs in loan, AND provides a take out fixed rate of rehab loan that is very competitive. Other benefits include low closing costs, however the first deal will take longer to close than normal as they get to know you.

Hope this helps and alleviates your concerns about DP and variable rates and leads to your first apartment purchase!

http://www.cicchicago.com/

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