The Financial & Tax Benefits of Multifamily Apartment Investing

Two common benefits of real estate investing are:

1. 1. Principal pay down - your tenants are paying your mortgage and your equity grows
2. 2. Leverage - using other people’s money (the bank or mortgage lender) to buy the property.

How great to have people give you money to purchase the property you want while other people pay your mortgage!

With multifamily real estate in particular, the benefits are even more remarkable.

Cash Flow - You Receive Money From Your Money

Multifamily can give you passive income.

Financial freedom is achieved by having multiple streams of income and creating enough cash flow to exceed all your expenses.

Owning apartments is great way to get you to this goal and is one of the best cash-flowing investments available.

Multifamily gives you current income.

After expenses have been paid (of which, the renters are paying!), the net distributable income becomes yield for the investor. This can be monthly, quarterly, or annual cash in your pocket.

As the chart shows, real estate investments have a far better return than most other asset classes. And compared to high yield corporate bonds, real estate poses far less risk and is much safer.

Cash is king and multifamily reigns strong.

Appreciation - Your Money Grows

This may be the most powerful benefit of multifamily investing.

With multifamily, the apartment owner has the ability to directly control increasing the value of their investment.

Read that again.

No other asset offers an investor the ability to increase the value of their investment like multifamily does!

Appreciation is one of the ways the real estate investor’s property grows in value.

In residential real estate and single family homes, value is largely determined by the comparable properties in the area, the overall market, and often, the passage of time.

In multifamily, value is a product of the income the property produces. Increase the net operating income (what is called NOI) and you increase the value.

Increase the NOI and you increase the value.

The owner of a multifamily apartment has influence over the NOI and the ability to create what is called forced appreciation.

Let’s walk through this to better understand. It’s going to get a bit wonky. Hang in there because this is huge in creating your wealth and financial freedom.

NOI or net operating income, largely determines the value of the multifamily property.

Net Operating Income / NOI: The difference between gross operating income and operating expenses.

If the NOI goes up then the property appreciates in value.

The owner of an apartment has the ability to increase income by raising rents, creating new income sources, increasing retention, etc.

Also expenses can be decreased by water conservation, energy conservation, better management, etc.

Optimizing NOI does also helps your cash flow (which we already love), but its biggest advantage is in appreciation.

As was stated, the value of the property is a product of the income the property produces.

Here’s how NOI drives up the value of your property:

NOI / Cap Rate = Property Value

What is Cap Rate? In very basic terms: 

Capitalization Rate or Cap Rate: The rate of return an investor would expect to receive if they paid all cash for the property. It is expressed as a percentage.

The higher the cap rate, the better for the buyer. The lower the cap rate, the better for the seller. Cap rates are market specific and determined by the area.

The cap rate for an apartment in Los Angeles (1-3%) is very different from Dallas (5-6%). Cap rates also can be affected by economic cycles and demand.

Now, let’s do a simple example to see how to increase the value of an apartment.

Let’s say we are new owners of an apartment that has $300,000 in income and $200,000 in expenses. Our NOI is $100,000.

Income:$300,000 - Expenses:$200,000 = NOI:$100,000

For simplicity, we’ll say the cap rate when we bought was 10%. So the value we paid was a million dollars.

NOI/Cap Rate:$100,000/10% = Property Value:$1,000,000

Let’s say we’ve be able to increase income by $50,000 and decrease expenses by $50,000. We now have an income of $350,000 and expenses of $150,000.

Income:$350,000 - Expenses:$150,000 = NOI:$200,000

We now have a new NOI of $200,000.

Let’s look at what we did to our property value. Using the same cap rate of 10%:

NOI/Cap Rate:$200,000/10% = New Property Value:$2,000,000

We’ve increased the value of our property by $1,000,000!

By increasing income and decreasing expenses, a skillful owner can maximize their NOI, thereby creating forced appreciation, and raise the value of their property.

This is the magic of Multifamily.

We have the ability to increase the value of our investment thereby accelerating our wealth!

The stock market will not give you this opportunity.

Tax Benefits - You Keep Your Money 

It gets better yet.

With real estate, there are incredible tax benefits that allow you to keep more of your money

These benefits include tax-free refinancing, deferring taxes on your gains by a 1031 Exchange, and legacy wealth transfers to heirs.

In my next posting, the tax benefits we’ll look at more closely in regard to multifamily are:

1. 1.Deduction of expenses before taxes 
2. 2. Depreciation
   3.Bonus Depreciation

See you soon!