Eric is a Real Estate investor, founder of MartelTurnkey, and author of Stop Trading Your Time for Money.
Apartment buildings are widely considered to be a good investment, but are they right for you?
To answer this, let’s first differentiate between two investment strategies when it comes to apartment buildings: buying turnkey properties versus value-add properties.
Buying turnkey apartment buildings offers a way to build wealth without having to renovate anything or build from the ground up. You simply collect the rent from tenants each month. If you’re thinking long-term, this is a great way to build equity and a solid investment. As a passive investment, the returns are not as high as a value-add strategy, but this may work better for investors who don’t wish to spend a lot of time managing their properties.
So why would someone buy a turnkey apartment building? For those who don’t have time to manage construction projects, turnkey investments are great because they are tenanted and have cash flowing from day one. Turnkey apartment buildings are a great way to build multi-generational wealth with steady appreciation.
Leverage is one of the key strengths of real estate. To buy an apartment building, you would apply for a commercial loan. These loans have significant advantages over your typical residential mortgage. Banks don’t look at your W-2 when underwriting commercial loans, but rather look at the intrinsic Net Operating Income (NOI) of the building, which can open up more opportunities than if you were trying to purchase a single-family home. Some of these commercial loans are accessible with a non-recourse clause, which protects you in the event that something happens to the building that impacts your ability to pay the mortgage. The bank cannot claim the debt from you personally, making this a great option for protecting your personal assets.
Turnkey apartment buildings are not completely devoid of opportunities for value add. You can slightly increase rent, provide additional services (e.g., WiFi), tweak building expenses and pursue various other renovations and strategies to increase the building’s net operating income, and therefore its value.
The second investment strategy is to seek an apartment building that requires significant renovations. Value-add apartment buildings are very time intensive. You have to be involved on a regular basis with contractors, property management and various other players who keep the building operational and manage the tenants during the construction. A lot of coordination is necessary; it doesn’t become a passive investment until the renovations are complete and the building is fully tenanted. It’s similar to the “buy, rehab, rent, refinance, repeat” (BRRRR) strategy, but on a much larger scale. A bridge loan would be used during the renovation. The building would be refinanced with a long-term commercial loan once the building is fully occupied and showing its highest value.
The value of a building is determined by its NOI and the cap rate for its neighborhood or comparable buildings in the area. For example, if the NOI of a building is $100,000, and the cap rate for the area is 10%, then the value of the building is $1,000,000. So, if you can increase the NOI — whether through renovations, increasing rents, reducing expenses or more — by $10,000, then you’ve added $100,000 total value for the building. As you can see, the cap rate is a strong multiplier on your investment. As long as the cap rate outpaces your renovation costs, you’ll enjoy a tremendous value add to your building. These types of returns are difficult to achieve with residential properties because their values are typically determined by comparable sales in the area without taking the rental revenue into consideration.
So should you consider investing in apartment buildings? The short answer is yes. Turnkey apartment buildings provide an opportunity for passive income and long-term wealth building. If you want a more active and time-intensive type of investment, a value-add apartment building will increase your equity. Obviously, investing in apartment buildings requires more money, including everything from the down payment to loan fees to maintenance. If you’ve never owned rental property, apartment buildings are probably not the right entry point for you. Instead, I’d recommend you start with turnkey single-family rentals.
It’s important to make sure you enjoy the responsibilities of being a landlord and working with tenants. It may not fit your personality! However, if you find you do enjoy it, you can then move your way up to more complex properties like apartment buildings.