Amazing Apartment Returns

[SteveO]

It is amazing to me to look at a spreadsheet of potential returns from apartment investing. The amazement comes from the apparent simplicity.

The spreadsheets are not actually simple in nature. They are not easy to setup. The variables that go into them are not that easy to figure out either.

So, what is so amazing about it?

I remain, years later, amazed by the growth in values with little changes in income and expenses. It is beyond me that if I can focus on just a few simple items that wealth is exponential.

I had an example in my presentation of the fast way to wealth. This was contrasted by a millionaire apartment owner that did it the SLOW way. Since there is interest, I will post it here. Look for the story in another post.

 

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[badtzuman]

As a first time apt owner of 156 units, I'd love read your story!
I can tell you mine and the caveats in apt investing. In the long run I can see it happening in the short run, its a sucking us dry.

 

[BeingChewsie]

Thank you very much Steve!

 

[Runum]

I'm all ears!

 

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[John]

I remain, years later, amazed by the growth in values with little changes in income and expenses. It is beyond me that if I can focus on just a few simple items that wealth is exponential.

Great post, rep++.

I haven't done any apartment investing (yet), but I've seen the same thing with my websites. Making small tweaks to your system can lead to exponential changes in profit. The larger we grow, the more I realize that success depends on setting up systems and monitoring and improving them rather than getting bogged down in the day-to-day operations.

 

[SteveO]

We will start with income related to an improving market.

I have talked before about the merits of finding the right location. Apartments are valued primarily on income. Improving that income while managing your expenses is the key to wealth building in this business. Read Vollucci's book on "How to Buy and Sell Apartment Buildings" for more details on this process.

If your homework on an improving market paid off, the rental income should be on an upward pattern. Cap Rates should be in an improving pattern as the area creates more attention. For the sake of our examples, we will hold cap rates steady.

Income improvements come in a few different forms. The primary increase that is usually talked about is rent increase. What we care about is the rent increase for the area.

Rent loss is not talked about as frequently and is usually tossed around as vacancy. There is more to the rent loss though. Delinquency and move-in concessions need to be looked at as well. All of these line items typically reduce in an improving rental market. They are also a target that should be focused on.

Taking a look at what those increases mean to us. The attached file is a simplified analysis of the calculations used to determine returns on an investment. The rent increase, rent loss decrease, and corresponding return are labeled in red. It includes income from cashflow, value increase and depreciation tax savings. They are all totaled and displayed at the bottom of each section. The cap rate used for the calculation is at 7%. For simplicity, the debt service was calculated as interest only. The expenses were increased at 3%/year.

As you can see, the returns look pretty good. Four percent rent increases are not easy to get. This is why it is valuable to be able to move to markets where the increases are targeted to occur.

 

[bflbob]

Steve, your analytical skills always amaze me! This principle is really neat. I've always been a big proponant of driving off the cap rate, but I can see where it would make me fire right past this one at first glance.

I do have a couple of questions...

First, this assumes that the seller is advertising the property with a 16% rent loss, and pricing at a 7% cap rate based on that. I find sellers in my area would discount the rent loss to, maybe, 5%. (The rest would be "a one-time decrease due to a combination of collection issues, apartment upgrades, and the effects of global warming".)

So, they would price it based on a 7% cap on a 5% vacancy, or what we in the trade like to refer to as "way too freaking much". I'd look at it, throw in a higher vacancy, add some more for management, and a few grand per unit to get it up to date, and come out with a cap rate of about 4% which would blow my mind.

Obviously, the value is closer to the $1 mil you are starting with, but if they are listing it at $1.5 mil due to the difference in rental loss, I'd skip right over it. How do you avoid doing that, or don't you?

Second, since I'm a bit anal, shouldn't the 3% expense increase have affected the first year, instead of just starting in year #2?

Third, in your experience, is it realistic to reduce rent losses by those percentages without investing in upgrades and other expenses to drive the higher occupancy, quicker turn-arounds, and better collection rates? I'm assuming you're evicting the riff-raff, so there has to be some legal fees, unless your sleeping with...oh, never mind. :love1:

Rep++

 

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[SteveO]

First, this assumes that the seller is advertising the property with a 16% rent loss, and pricing at a 7% cap rate based on that. I find sellers in my area would discount the rent loss to, maybe, 5%. (The rest would be "a one-time decrease due to a combination of collection issues, apartment upgrades, and the effects of global warming".)

So, they would price it based on a 7% cap on a 5% vacancy, or what we in the trade like to refer to as "way too freaking much". I'd look at it, throw in a higher vacancy, add some more for management, and a few grand per unit to get it up to date, and come out with a cap rate of about 4% which would blow my mind.

Many are priced like you say. That is why you skip over them and go to the next one. I never said that this is how the setup sheet read. The pro forma may look nothing like this.

If you are buying in a market that has not seen a lot of movement, some of the prices may be more realistic. I usually look at the location and price per unit to key off of. The financials are given a once over to look for anomolies. I then look at the improvements. If it seems like it may work, I setup my own proforma.

The current issues with the financials can be used to bargain with. If they don't get to a realistic number....

It can take a while to find what you want as you well know.

Obviously, the value is closer to the $1 mil you are starting with, but if they are listing it at $1.5 mil due to the difference in rental loss, I'd skip right over it. How do you avoid doing that, or don't you?

Usually I would do like you would in this situation. Pass... But one time I saw a property listed for 5M. I offered 4.1M with an explanation that accompanied the offer. One year later they took my price.

Second, since I'm a bit anal, shouldn't the 3% expense increase have affected the first year, instead of just starting in year #2?

I set this up quickly. My mistake. The file was updated.

Third, in your experience, is it realistic to reduce rent losses by those percentages without investing in upgrades and other expenses to drive the higher occupancy, quicker turn-arounds, and better collection rates? I'm assuming you're evicting the riff-raff, so there has to be some legal fees, unless your sleeping with...oh, never mind. :love1:

Don't forget, you are buying in an improving market. While your intention is to install aggresive management, much of this should occur with improvements in the market. Vacancy, bad debt, and concessions and their associated ratios go hand in hand.

You may need to do improvements. Of course these need to be calculated in.

I do believe that you are looking at this as a value-add type situation. You can find a discussion on that here: Value Add Component :icon_super:

 

[andviv]

This reminds me of the conversation that I had with my co-worker's father. This guy has a bunch of multis in PA and I had the opportunity to talk to him about his experience. He started doing minor rehabs for multis and then increase rents once the fixes were complete.

When I asked him about selling prices, he said he called an agent, ask them for a suggested price and then add a lot more to it (for example, if I recall correctly, the agent told him to ask 1.2 Millions so he went and list it for 2MM and then found somebody that ended up paying 1.7M). He told me the 'secret' is sell when you don't have to. List it, and when it sells, it sells. Don't having the need to sell made all the difference.