Buying an apartment building is not the same process as buying a residential property. Even if you have experience with buying homes or even duplexes, triplexes, or quads. If you’re buying an apartment building, you have come to understand the importance of economies of scales and see there is more revenue and bottom line to be made. If that’s the case, then you need to be a lot more informed than a standard real estate investor. Let’s dig deeper and learn the things you should know before looking to buy and finance an apartment building.
Know What Your Purchase Entails
To buy an apartment building, you would need a considerable amount of capital. Capital requirement can range from 20 – 35% of the total purchase price. Most importantly, you must have a clear idea of what building size you’re looking for and the total units in the structure. You are most likely buying an apartment for the benefits it presents, but you should also be aware of the drawbacks as well.
Multi family apartment buildings offer you recurring income and diversify your investment portfolio. However they also come with more intensive property management, tenant turnovers, problematic tenants, and frequent maintenance. Take the plunge only after you have studied and learned all the positives and negatives even speaking to current apartment building owners.
What’s the Cap Rate?
The cape rate is the ratio of the properties Net Operating Income (NOI) to the properties purchase price. The Net operating income is calculated by adding up all the property’s revenue and subtracting all of the expenses. Debt service is not typically calculated just the property’s financials.
Let’s review a simple example. If your NOI came out to $100,000 and you are looking at purchasing the building for $1,000,000 then you would divide 100,000/1,000,000 and get .10 which is read as a 10 Cap. If you would be buying this same building for $1.25 million then the Cap rate would drop to only an 8 Cap. Think of the Cap rate as the rate of return you will be getting if you were purchased the property cash with no mortgage. The higher the Cap rate the higher return on your Investment. Most multi family properties advertise a cap rate or a projected cap rate. Be sure you are looking at the actual cap rate and all the numbers used to reach the NOI are reasonable including sufficient reserves.
Consider Apartment Building Type and Class
There are many variables and options to look at when you are buying an apartment building. First if you are just starting and this is going to be your first first apartment building, be conservative start small within your capital restraints leaving plenty of reserves. Construction type, year built, single story, multi story, garden style, rented month to month, yearly leases, etc.
Building Class denotes the building’s age, construction type, amenities, history, and location. General classes are A, B, C, D. Class A buildings are the properties in prime locations with all the amenities and are the talk of the town while class D properties are properties in the not desirable areas with a long list of deferred maintenance. Class A is usually 100% occupied with long term tenants even with a waiting list and Class D usually has a tough time with occupancy and high turn over. The better the class the less percentage return on your investment but the investment is more secure. Choosing a good balance between the property class and the cap rate is an important decision you must make.
In Summary: Class B and C properties are the most popular categories, for they strike the right balance between price, structural integrity, and return on investment. Class A buildings are usually on the expensive side, and Class D buildings aren’t always in suitable condition and are more likely to be situated in areas with lower socioeconomic values.
Wait what is unit mix? Unit mix is important and refers to the combination of mix of 1 bedrooms, 2 bedroom and 3 bedroom units a building is made up of. A good unit mix is important to meet the demand of your market and attract a wide range of families. In a some commercial property types, the unit mix may not be important lets say you are near a military base, offering student housing, or acquiring an assisting living facility. Having a standard unit mix of lets say all studios or 1 bedroom units may then be ideal.
Consider Value Add or Deferred Maintenance
There are two general types of investors, those looking for a property which is already stabilized and an investor looking to add value. The later is called a value add investor. You can add value by increasing rents, minimizing unnecessary expenses, managing a project yourself, adding amenities, building additional units, or just purchasing building under occupied or completely vacant. The last two have a considerable amount of deferred maintenance and could take several months to raise the occupancy rates back up to 95 – 100%. If your a beginner you may lean more towards a stabilized to moderate value add opportunity then a fully vacant value add opportunity. Consider your expertise and what works best for you.
Locating a Building
Location, Location, Location. You can look for potential properties yourself, or seek professional assistance from business brokers and commercial property agents. If time is a constraint and you want to buy a property as soon as possible, hunting for the right property without external help won’t be the most sensible thing to do. If you need a recommendation please reach out to us.
However, if you have prior experience shopping for properties on your own, then go ahead and do so. Direct interaction with the seller may also help you get a better deal as the seller may not need to pay any broker commissions.
Corporate Ownership Structure
Creating a new corporation for each commercial property purchase is important. It not only protects you from any liability but can also lower your tax responsibilities. This will also keep all your financial records in order to just this specific apartment building and will prove to be advantageous the day you sell to purchase a larger commercial property. Please consult with your CPA or attorney to assist you in forming the right corporate structure.
Financing Our Purchase
Financing is last on this list but the first step before even looking for a property. You have to know what you qualify for and have a term sheet/pre-qualification in hand when submitting an offer. Make sure you know the details of your financing before making an offer. Remember, apartment building financing is not straightforward, and there are different options you should take into consideration and research before making a final decision.
Lender requirements vary dependent on your specific situation and capital needs. Your mortgage payment may not only consist of your principle and interest payment. Lenders typically set up reserves for insurance, taxes, operating costs, and repairs so there are no unforeseen situations.
The apartment’s net operating income, location, condition, unit mix, borrowers credit score, credit history, experience, capital infusion, and loan to value determines the loan approval and terms. Lenders look favorably upon properties that have high occupancy rates, good market potential, long-term tenants, ideal location, with a strong buyer. Consider these aspects if you’d like to swift past the apartment building financing stage so you can start looking for the right property.
Speak With An Apartment Building Loan Advisor
Don’t wait for loan eligibility to be an issue, get in touch with us today for all your commercial capital needs. Whether you are buyer an apartment building or you are considering refinancing/cash out refinancing your existing commercial property we would like to speak with you. We don’t provide denials, only solutions. Free consultation.