Real Estate Investing: Apartment Complexes
Investors who flip apartments realize that they are playing a whole different game. Apartments are valued based on cash flow and net operating income (learn more here) where as in houses you increase the value by fixing physical structures.
Read about how to value single family homes here.
If you want to flip apartments then you must purchase a complex at discounted price, increase it’s cash flow, reduce expenses, and sell it for the market cap rate. If you are confused no worries this example should help.
A Simplified Example Apartment Flip
Suppose you find a 25 unit apartment building for sale. They are all 3 bedroom units renting for $800 on average, which is less than the $900 average for the area you are in.
Last year’s vacancy rate was 8% which is higher than the area’s average rate of 4%.
You believe the higher vacancy rate and lower rental rates are a result of the apartment complex being in run down shape. Also, the current managers are doing a terrible job at replacing tenants quickly costing the complex cash flow.
The gross income for the previous year was $260,000 and expenses not including debt came to $85,000. The net operating income for the previous year was $175,000 before debt.
The areas market cap rate is .10 which means the apartments net income is 10% of its property value.
Using this rate we can divide the net income of $175,000 by .10 to get $1,750,000 as the current value of this 25 unit apartment complex.
You negotiate with the seller and acquire the complex for $1,600,000. While waiting for the deal to close you are busy analyzing every possible way to increase cash flow and reduce expenses. Once the deal closes you get to work.
You spend money fixing up the units so they look clean and up to date instead of run down and old. You have a parking lot developed for tenants to each have one parking space.
You fix up the laundry room so that it functions properly again. You replace lights and other fixtures with energy efficient versions to save money over time on the energy bill.
You also fire the current management company and shop around for a new management company that will do a better job for the same rate.
Since you spent money making improvements to the complex you notify the current tenants of these improvements and also of rent increases for the up coming year to pay for these improvements.
Overall, you have found ways to reduce expenses, you have increased the income through rent, parking fees, and laundry fees, and you have provided tenants with a much nicer place to stay which will attract new tenants and hopefully lower the vacancy rate.
After a few years of earning positive cash flow from the apartment complex you decide to sell it. The complex has had time to reflect the changes made and the financial statements look much better than when you first acquired the property.
25 units x $900/month on average results in $270,000 in gross rental income. The laundry room and parking fees add another $10,000. Adding in other fees let’s say the gross income for the apartment complex comes to $295,000.
You found ways to reduce expenses so that they total just $70,000 compared to $85,000. This puts the net income before debt at $225,000.
At a .10 cap rate the property is now worth $2,250,000 so you decide to list it for sale at $2.5 million. After 3 months on the market it finally sells for $2.35 million.
You acquired it a few years ago for 1.6 million so you’ve increased its value by $750,000 profiting close to $600,000 after closing costs plus earned income the few years you owned it from cash flow. Overall you did well flipping this 25 unit apartment complex.
Flipping (improving and then selling) real estate is not easy. But it is doable.
Thousands of average people invest in real estate and if you do your research and properly educate yourself (with this course) then you can be successful.
I spent a year educating before I pulled the trigger and bought my first investment property. I read many books, blog posts, and listened to audio podcasts.
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