Value Investor's Guide to Apartment Buildings

What is the average annual per unit expense for an apartment building investment? Great reader question answered.

Mike in Milwaukee, WI, that is a great question. Answer: $3,000- 5,000/unit/year. How’s that for an accurate but relatively useless answer? The real question is what is the annual expense per unit of the property you are looking at? If you are a large institutional investor like a REIT looking at national or regional averages like those published in the NAA Annual Survey (See the included charts for results from the 2011 survey) can give you an indication but you can bet the institutional players know their own costs to the penny.

Apartment Building Operating Expenses Per Unit 2011 — Source: NAA 2011 Survey of Operating and Income Expenses in Rental Apartment Communities

In most larger metros there are also companies who collect and publish apartment surveys showing the areas average rents, occupancy, expenses, etc. One thing to make sure of is that the survey is based on properties similar to yours. There are a number of national companies doing multifamily research but they tend to focus on institutional sized properties 100 units and up so their numbers wouldn’t be comparable for a smaller property. For instance the average property in the NAA survey has about 250 units.

The most important number is the actual Continue reading What is the average annual per unit expense for an apartment building investment? Great reader question answered.

The 5 Most Important Property Tax Questions for Apartment Building Investing

Property Taxes can be one of the largest fixed costs in apartment building investing. Properly accounting for them when running the numbers on a potential purchase (called the ‘underwriting’ process) can make the difference between a nicely cash flowing property and an expensive headache. Multi-Housing News has a good article with the five key questions investors should have answered before making an apartment building investment:

How often are values reassessed? Is there an automatic reassessment triggered by a transaction?
What is the exact millage rate? How are they set? How often do they change?
Are there limitations to the increases in assessed values during the hold period (a la Prop 13 in California)?
What is the timing of the assessments and when exactly are bills due?
What is the appeal process and how long does it typically last?

Don’t let this happen to your deal: Continue reading The 5 Most Important Property Tax Questions for Apartment Building Investing

Zero Bound Interest Rates, The Zirp Dimension, Stagflation and #Multifamily

Zero interest rates and apartment building investment.

First my condolences to Bill Gross on the loss of his brother-in-law. Reading his piece in PIMCO’s latest Investment Outlook it is clear that the world’s biggest bond manager is running out of places to generate returns for their investors and by extension this applies to all income investors, especially retired people trying to live on interest income. For those would like to retire soon you may have to delay that decision for “an extended period’ as Edward Harrison over at Credit Writedowns put it in Permanent Zero and Personal Interest Income.

Gross’ points out that the Fed’s zero interest rate policy (ZIRP) which they have just announced to maintain through 2014 and their defacto though opaque continuation of quantitative easing (QE2.5 as he tweeted it) threaten to take us into another dimension where their policies have the opposite effect of their intentions.

“Much like the laws of physics change from the world of Newtonian large objects to the world of quantum Einsteinian dynamics, so too might low interest rates at the zero-bound reorient previously held models that justified the stimulative effects of lower and lower yields on asset prices and the real economy.” – Bill Gross

His bullet points:

Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside.
Most short to intermediate Treasury yields are dangerously close to the zero-bound which imply limited potential room, if any, for price appreciation.
We can’t put $100 trillion of credit in a system-wide mattress, but we can move in that direction by delevering and refusing to extend maturities and duration.

For more views on this and Europe too see also Entering the Debt Dimension from Phil’s Picks on the Phil’s Stock World Blog.

What does this mean for Multifamily?

The Zirp Dimension leads to Stagflation where economic growth remains anemic yet prices on essential Continue reading Zero Bound Interest Rates, The Zirp Dimension, Stagflation and #Multifamily

Converting Cap Rates to Earnings Multiples

After a recent speaking engagement I was asked about how and why I use the earnings multiple concept when evaluating apartment investments. It was a great question and so I’m sharing my answer here in this blog post.

As a value investor two of the fundamental questions I always ask is what am I buying and how much do I have to pay for it. With an apartment investment (or really any investment) I am buying current income and the potential for appreciation so the second question comes down to “How many years of earnings do I have to pay for these returns?” The question can be answered by converting the cap rate to an earnings multiple. The Cap Rate is the return in current income on an apartment investment you could expect if you paid all cash. To convert a Cap Rate into a Earnings Multiple use the formula: Continue reading Converting Cap Rates to Earnings Multiples

Why are Cap Rate explanations so complicated?

If you listen to any conversation about commercial real estate (CRE) within a minute the subject of cap rates will come up. Those who are just beginning to explore CRE are often thrown off by what one is and how it is calculated. A cap rate is really a simple thing that is often made overly complicated by the way it is explained. Let’s walk through what a cap rate is and then we’ll look at how they are used so that the next time the conversation turns to CRE you’ll be right there in sixty seconds when they get to cap rates.

A Capitalization Rate or Cap Rate for short is simply what you would earn on a property if you Continue reading Why are Cap Rate explanations so complicated?

Apartment Buildings are the classic Value Investment

With today’s stock and bond markets overrun by insiders and the volume of options, futures and other derivatives dwarfing actual investment in good companies while driving wild swings in their prices what is a traditional value investor to do? What about the accounting trickery that happens when CEOs raid their own companies for the short term results their huge bonuses are based on? Should you shrug your shoulders and be patient, very patient hoping eventually value will be recognized? What kind of income will you live on while you are being so patient? With interest rates so low and the Fed trapped into keeping them that way how can you earn decent current income without taking unreasonable or unknowable risks?

There is an alternative for conservative value investors: Apartment buildings.

What if you could find good value stocks in a market where the price was dictated by the financial results, not market ‘sentiment’, momentum traders, short sellers, high frequency trading programs or what a butterfly did in Shanghai?
What if you could find good value stocks in a market where the cycles were observable and understandable?
What if your favorite value stocks paid annual cash dividends of 7, 8, 9% or higher while at the same time increasing their equity like clockwork?
What if you could walk into the boardroom of your favorite value stock and dictate that they improve their performance? What if you could fire boardmembers who didn’t perform?
What if you could buy a second stock with funds from your first stock without having to sell it or pay taxes on the capital gain?
Plus Inflation Protection: What if the dividend went up when inflation did? Continue reading Apartment Buildings are the classic Value Investment

Why We Like Apartments- Owning them that is.

Recently I’ve been working with several new clients who are conservative investors looking for better returns than CDs and Treasuries but aren’t interested in taking on the volatile market risk of stocks, bonds and derivatives. I was explaining why apartment investments make sense and there are quite a few reasons but the biggest one is how the math of an apartment building investment works. In this post I’d like to share that with you in case you’re also looking for conservative income producing investments with inflation protection and upside potential.

Here’s the numbers on a typical apartment investment:

In this example is a 100 unit building with 850 per month per unit average rents which is purchased with a down payment of 25% and a 30 year loan for the balance at 5.5% interest. Vacancy is 5% of Gross Potential Rent, expenses total 50% of Gross Operating Income and a cap rate of 7.5% is used. Today in some markets cap rates are higher (buildings less expensive) and in a few others cap rates are lower (buildings more expensive).

Apartment Buildings are valued on the income they produce. (This post is about properties larger than 4 units, smaller properties are valued more similarly to single family homes.) There are several ways to calculate the value based on the income but the most common is the capitalization rate, or cap rate for short. The cap rate is the percent of the property value that the Net Operating Income (NOI) represents: Continue reading Why We Like Apartments- Owning them that is.

The Apartment Building Investment Triple Opportunity Is Right Now

For value investors, Demand, Supply and the Cost of Acquisition are the three factors affecting the apartment building investment decision and all are saying the time to buy is now. There is a tidal wave of new renters coming into the market and there has been little apartment construction to meet this growing demand. Outside of the gateway cities the prices of existing apartment buildings remain below the cost of building new. Fixed rate financing is available for apartment buildings at rates lower than we will see again for years if not decades.

“The multifamily sector is probably the only commercial real estate sector that has very positive fundamentals behind it,” said Jeffrey Baker, managing director at Savills LLC, a real estate investment bank that raises capital for multifamily owners and developers. “You’ve got a demographic that is producing more households that want to rent an apartment. You’ve got virtually no new supply that’s been added over the last several years.”^{1 Continue reading The Apartment Building Investment Triple Opportunity Is Right Now}

Top Ten Reasons To Own Apartments Now

I believe that apartment building investment should be a core holding for every successful conservative investor. Briefly here are the top ten reasons for low risk investors:

1. Monthly Income. Properly acquired apartments generate monthly checks in 6-8% or higher annual cash on cash returns.

2. Straight forward, conservative investment strategy. Buying existing apartment buildings with good due diligence means that you know what you’re getting going into the investment. Apartments are not subject to sudden changes in investor sentiment and/or valuations.

3. The numbers determine the value. Apartments are valued based on rents less expenses (Net Operating Income) and increases in rents can go straight to the bottom line increasing the value.

4. Inflation protection. Rents rise with inflation and with 12 month leases every year there is the opportunity to adjust rates. With fixed rate financing your income goes up while your biggest cost stays the same. Continue reading Top Ten Reasons To Own Apartments Now

It’s painful, it’s ugly, it’s what a real estate bottom feels like.

Does the market feel like you are in the opening sequence from Terminator II? Are you fighting amidst the wreckage of the previous boom? Surrounded by foreclosures, scarce money, economic gloom and doom? Real estate going into nuclear winter? That’s what market bottoms feel like and as investors we need to get comfortable with that feeling because this is our time to make solid, reasoned investments that produce good results on improving fundamentals. Conditions like this create the opportunities for savvy investors who were patient through the bubble and have waited for the speculative, greater fool market to come to its inevitable end.

Many great real estate investors got their start in rough times like Sam Zell of Equity Residential for instance. He started out buying properties from distressed owners in the late sixties. Tom Barrack of Colony Capital waded through the carnage of the S&L meltdown to buy properties at a discount. Barry Sternlicht of Starwood Capital also started in the wake of the S&L crisis buying multifamily properties. What will your story be? It’s time get to work and seize the opportunities. Put on your hardhat though because it’s about to start raining real estate, and while not every distressed property is worth pursuing if you stick to your niche and learn your market good deals will surface. Continue reading It’s painful, it’s ugly, it’s what a real estate bottom feels like.