Something you hear all the time is that real estate is too expensive.
It appears that investment real estate is selling at seemingly ridiculous valuations.
What if I told you that the more expensive investment real estate is, the better the time to get into the market!
In this blog post, I will show you, step-by-step, how the REITs buy and sell buildings, even in this overinflated market, and still make money.
In fact, in this blog post, I will show you how it’s possible to make an 80% to 100% return on your investment dollar in less than three-years.
Last week, in the blog post Entrepreneur Semi-Retirement, 18-Month Check-In, I mentioned that I was currently investigating purchasing another apartment building. In this blog post, I am going to run through the numbers and opportunity.
My mandate is to purchase a building that fits my investment criteria, which is normally a lifetime-buy and hold strategy, but I have adjusted my mandate with this particular building to a three- to four-year flip. I am expecting an 80% return on my initial investment dollar inside three years, and below, you will find information on the building and my investment analysis.
For obvious reasons, I am not going to publish the building’s location and address. For one, I signed an NDA, and more importantly, I’m not looking for additional competition, but, I will show you the steps on how to buy an apartment building, and make an amazing return in a short period of time.
The building has 32 apartments with a listed asking price of $5,650,000 and a stated CAP rate of 3.6%. It’s close to downtown in a very stable rental market with a current vacancy rate of close to 1%. Normally, I wouldn’t be interested in a building with such a low CAP rate, as I believe I can find better returns with my investment dollar, but I am specifically interested in this building because the current rents are WELL below market.
The current financials of the building are as follows:
Effective Gross Income = $361,516
Total Expenses = $157,975
Net Operating Income = $203,541
The CAP rate is 3.6% ($203,541 ÷ $5,650,000).
It’s more often than not that a listing doesn’t include many of the items that should be included in a proforma income statement, but that’s not the case here. The CAP rate of 3.6% is a real CAP rate and includes vacancy and bad debt of 1.5%, repairs and maintenance of $850 per door, salaries of $350 a door, and management fees of 4%, all of which are inline. Many listing agents are deceitful in the way they market a property and purposely leave out items from the income statement in order to show an inflated CAP rate. Be very careful of those listings and agents.
With regards to the expense side of the income statement, all of the items are fixed (except for the management fees of 4%), so any increase in revenues will go directly toward an increase in the valuation of the building.
Assuming a constant 3.6% CAP rate, every $1 increase in revenues will result in an increase in building valuation of $27.78 (100% ÷ 3.6%). It’s now time to assess what my potential return is on this building.
Current Rent Roll:
The current rental revenue is $26,028 per month, and the building itself is comprised of 12 bachelor apartments and 20 one-bedroom apartments. The average rent in place for the bachelor apartments is $669 per unit, and the average for the one-bedrooms is $940 a unit.
The current revenue looks as follows:
12 bachelor apartments = $669/month × 12 = $8,028/month
20 one-bedroom apartments = $940/month × 20 = $18,800/month
Total monthly revenue before renovations = $26,028
The average comparables for a similarly sized building in the same rental area are as follows:
Bachelor = if redone, approximately $1,190 a unit
One-bedroom = if redone, approximately $1,450 a unit
And the new rental revenue will look as follows:
12 bachelor apartments = $1,190/month × 12 = $14,280/month
20 one-bedroom apartments = $1,450/month × 20 = $29,000/month
Total monthly revenue after renovations = $43,280/month
The monthly difference between the old rental revenue and new rental revenue is $17,254/month or $207,048 per year. At a 3.6% CAP rate, this increase in rental revenue will translate into an increase in building value of $5,751,000 ($207,048 × 27.78) for a new building value post-renovations of $11,401,793.
The building needs work.
I am estimating that the building itself will need approximately $400,000 in capital improvements and approximately $40,000 per unit in renovations. Since the building is under rent control, I will allow an approximate fee of $12,000 that I will have to pay to each tenant to get them to leave the building.
The total cost of unit renovations will, therefore, be $52,000 per unit × 32 units = $1,664,000 and $400,000 for the building itself, for a total of $2,064,000 in total upgrade and renovation costs. The building is a beautiful historic building, in an excellent rental market, with great bones, rents well below market, and lots of upside. The building and apartments need a lot of work, but with the dollars I am proposing to put into the building, there’s a ton of potential.
Your Potential Return When You Buy an Apartment Building, and How to Own a Small Apartment Building?
I estimate I will put down approximately 40% in cash to purchase the building and finance the balance, which means I have to put down $2,270,000. I estimate close costs will be approximately $40,000, which includes legal and engineering fees. With 40% down, the building will cashflow approximately neutral.
Cash into the building on purchase = $2,270,000 with a mortgage of $3,390,000.
I will upgrade ten units in the first year, ten units in the second year, and the balance in the third year. The total upgrade costs, as estimated, will be $2,064,000.
At the end of year 3, once all the upgrades are done, and new tenants are in their suites, I estimate the building will have a value of $11,401,793.
My investment at the end of year 3 will look as follows:
Building value = $11,401,793
Mortgage on building = $2,291,790
Total equity in building = $9,110,003
Total dollars into the building in 2019, 2020, and 2021 are as follows:
Close costs and downpayment = $2,270,000
Repairs, upgrades, and renovations = $2,064,000
Total cash into the building = $4,334,000
In summary, I estimate that I will put out $4,334,000 in cash, and in three years, I will have $9,110,003 in my pocket, for a total three-year profit of $4,776,003, a return of 110% on my dollar, and an IRR of 27% pretax.
At the end of the third year, I expect that I will sell this building and purchase another. Should I decide to keep the building, it will cash flow a healthy $220,000 a year (after allowable rent increases) for a total yearly return of 5% and a healthy yearly recapture. I expect I will free up the capital so that I can do another project of similar size.
For all those considering getting into investment real estate, the above is an example of how you can do your calculations. You certainly don’t need to buy a 32-unit building to start, but the math can still make sense on a much smaller five-plex. The dollars are smaller and more manageable and, if this is your first, is probably a better way to get started.
I hope the above makes sense, if not, feel free to send me an email.
Good luck with your business, wealth creation, and 1,2,3 steps to how to buy an apartment building and make your own amazing returns.