In recent years, apartment buildings have become quite a popular investment option for real estate investors interested in finding good yields for their money. With mortgage underwriting guidelines tightening up considerably for residential properties (1 to 4 units), more real estate investors have decided to acquire apartment buildings.
As interest rates have fallen dramatically, many apartment and commercial mortgage rates have also dropped to incredibly low ranges somewhere within 3% to 5%+. The lower the rates and the mortgage payments, the higher the monthly cash flow.
Lower Vacancy Rates and Increased Tenant Demand
Ironically, the millions of homes foreclosed in recent years and the tightening up of government-backed or insured residential mortgage loans have forced previous homeowners into apartment units. As a result, apartment vacancy rates have fallen significantly in many regions.
The combination of lower vacancy rates and increased tenant demand has led to higher monthly rental income for apartment owners. The better the apartment owner’s Net Operating Income (NOI) figures, the higher the property valuation at a later date.
Smaller Apartment Buildings Are Easier
It's much easier to purchase and manage a small apartment building.
It is much easier to purchase and manage a small apartment building (10 to 20 units) as opposed to several different rental homes.
There will be less demand in various regions for smaller apartment buildings partly since there should be less competition from larger investment groups such as R.E.I.T.s, Pension Funds, Equity and Hedge Funds, and even wealthy foreign investors.
Annual yields of apartments will offer much higher rates of return than stocks, bonds, or commodities and are attracting more interest from small and large investors, domestic and foreign.
Smaller apartment buildings offer higher cash-on-cash returns to investors than many larger apartment buildings. They are also much easier to manage by the owner or an onsite property manager. And a small apartment investor will typically earn more money per unit each month when compared to larger apartment buildings.
Since there are more small apartment buildings today for sale, there will be more motivated apartment building sellers who are willing to sell quicker at much lower prices. Accordingly, many sellers are more flexible with their pricing and potential seller financing options.
Since mortgage rates continue to hover near record lows, this will greatly improve the monthly cash flow options for property owners. In addition, the lower the interest rate on a mortgage, the faster the debt will amortize so that it pays off much quicker.
One of the better ways to reach early retirement is to own one, two, three, four, or five plus free and clear apartment buildings.
How to Determine the Apartment’s Value
How do investors and sellers best determine the apartment building’s property value today? First, they may begin with something known as the cap rate (capitalization rate). The cap rate is the ratio of a property’s yearly net operating income as compared to the property purchase price or cost to acquire the building.
The higher the cap rate, the higher the perceived risk due to factors such as location, building quality and design features, and other factors. The short explanation of NOI (Net Operating Income) is that one calculates their most recent year’s gross income and subtracts the annual expenses such as maintenance, utilities, management, property taxes, and insurance.
As rents have increased rapidly in many areas these past few years, then both gross rents and NOIs have increased, too. The increased NOI figures then have led to much higher apartment building values for many property owners today.
Lenders prefer that properties have NOIs that will be greater than the proposed total debt service so that the properties do not have potentially negative cash flow. Some lenders consider and allow a 1.0 (“Breakeven”) Debt Coverage Service Ratio. Other lenders want to see much more positive net annual income levels, so they prefer 1.25, 1.35, or higher DSCR numbers.
Ask These 5 Questions
When purchasing small to large apartment buildings today, an investor should consider first asking themselves these questions:
- What type of mortgage loan can I qualify for today?
- Which areas tend to have the most stable vacancy and employment rates?
- What is my true net cash flow per individual unit?
- Is this a better investment than residential?
- Do I want to retire sooner rather than later?
With apartment rates hovering near the 3% to 5% range today, the much improved cash flows will work better than ever for investors looking to find exceptional apartment investment yields with less risk than many other investments today.
Do you want to work for your money, or do you want your money to work for you? Apartment buildings are some of the best ways to generate exceptional monthly cash flow for investors today, especially now that interest rates are near record lows.
*** The article above was written by Rick Tobin, and published in Creative Real Estate Online on February 11, 2013.