Are Small Apartment Buildings A Smart Investment?

Fri, Apr 01 2011 00:00:00 E

By Kathleen Doler, For Investor's Business Daily

Posted 03/31/2011 03:57 PM ET

Recovering rents, rising occupancy rates and low sales prices are enticing investors to become landlords. The sweet spot for smaller investors is multiunit buildings with up to four units, according to market followers.
This size of apartment property can qualify for conventional financing backed by Fannie Mae (FNMA) and Freddie Mac (FMCC) with 20% to 25% down. When a landlord lives in one of the units, financing insured by the Federal Housing Administration may be available with as little as 3.5% down.

"I'm seeing rents go up in the markets where employment is strong: New York City, Seattle, Washington, D.C.," said Lesley Deutch, vice president of John Burns Real Estate Consulting, in Lake Worth, Fla. "All markets will be on the positive side this year."

How much rent growth just depends on where you are, Deutch says.
"Financing is starting to free up for more creditworthy investors," said Peggy Abkemeier-Alford, president of Rent.com in Santa Monica, Calif. "So small investors are scooping up multiunits."
In 2003, homeownership was 69% says Abkemeier-Alford. Now it's 66.5%, and "every 1% decline in homeownership equals 1 million new rental households."
Competition Big And Small
One caveat for investors is that smaller rental properties must compete with the many vacant homes now being rented out.
Slammed by a credit crisis and the recession, commercial real estate isn't out of the woods yet. But the apartment sector, which is part of it, is flashing encouraging signs for both big and small investors. In February sales of apartment portfolios priced $2.5 million and up rose 50% from a year ago to more than $2 billion, according to Real Capital Analytics. But it's still just a fraction of the activity seen a few years ago, and distressed properties accounted for 41% of February's sales.

Abkemeier-Alford predicts rents in top markets will rise 5% to 6% this year, and in bottom markets she expects 2% growth.

The national rental vacancy rate climbed to more than 10% on average over the past couple of years. But "in the most recovered markets in 2011 it will be around 5%, a big decrease," Abkemeier-Alford said.
Real Capital's analysis of large apartment deals found investor demand outstripping offerings around Washington, D.C.; Boston; Southern California's Orange County; San Francisco; Raleigh, N.C., and a number of Florida markets.

"In our area, sales of multiunit properties are very brisk," said Al Ricci, a broker at Ricci Realty in the Southern California city of Orange.

Where The Renters Are

Ricci works in an area called Old Town, near Chapman University. He says some parents are now buying multiunit properties to house their students plus other tenants. Rising rents, low vacancy rates, high on-campus student housing costs and low sales prices are bringing parents into the market as investors, according to Ricci.

He says triplexes that sold for $750,000 and up in 2007 are now priced at $600,000. But in his area, due to demand, "rents haven't changed." Ricci is the listing agent on three multiunit properties and expects to move all of them in 60 to 90 days.

Rental properties are an option for hands-on investors. Here, town houses line a Beaverton, Ore., street in 2009. AP View Enlarged Image

In Seattle, new hiring by Amazon.com (AMZN) should reduce rental vacancies and potentially drive rent increases, says Glenn Roberts, managing broker of Lake and Company Real Estate. "Amazon has leased 1.7 million square feet right next to downtown — they're really expanding," Roberts said. "And a lot of their employees won't be homebuyers yet, so they'll need to rent."
Roberts believes multiunit properties near downtown are an investment opportunity. "In the last 30 days, 13 multiunits have sold and closed, but there are 50 pending right now," he said.
The availability of low-down FHA loans for multiunits is often overlooked.

"People have been a little out of touch with FHA financing," said Rebekah Radice, a mortgage planner with Benchmark Mortgage in Colorado Springs, Colo. And some folks think FHA only offers small loans. But it raised the lending limits in high-cost areas, and then extended those raised high-cost loan limits to Sept. 30, 2011, Radice says.

FHA loans require mortgage insurance, paid in monthly premiums. After an April hike, the cost will range from an annual 0.25% to 1.15% of the loan amount atop a 1% upfront fee.

Michael Simpson, a multiplex property investor in Sacramento, Calif., advises new landlords to screen tenants, keep an eye on their properties and keep detailed books.

Simpson also says that potential landlords should research how their city or town treats multiunit properties. In Sacramento, any property with more than three units requires more extensive permits for remodels than a single-family building, he notes.

How to Hire a Property Management Company

Somewhere along the line of your real estate investment career, you may outgrow your ability to manage the number or properties you acquired. Or you may find that managing your own property is not a skill that you are gifted in or are good at. In those cases, you’ll have to locate, interview, qualify, hire, and manage a property management company.

Searching for a Property Management Company
• The absolute best method of finding the best property management companies is by referral. Get a referral for a property management company from someone who is happy with theirs or knows of someone who is happy with theirs.
• The second best method is by asking your broker or agent if they know of a reputable property management company.

Interviewing a Property Manager
Here are 13 questions to ask professional property management during your initial phone calls.

1. What is the general vacancy rate in your area? “Your area” could be a city, town, neighborhood, district, street, etc.
• This information is crucial in studying feasibility of owning property in this area.

2. How many units do you currently have under management? What type?
• If you are looking for them to manage your 4-plex, see it to that they at least manage 4-plexes. If you have a 20-40 unit or larger apartment building, see to it that they have under management the same. A property management company that manages 400 single family homes is not the same company that manages 400 units of apartment buildings.

3. How long have you been in business?
• If they have less than a year of experience, don’t use them. They need at least one cycle (spring, summer, fall, winter) completed to know what’s going on.

4. Do you have a start-up or account setup fee for new landlords?
• Know this upfront.

5. What are your percentage management fees? What other ways are you compensated?
• Plug these fees into your property cashflow analysis.

6. What is your policy on who keeps the late fees collected – the landlord or the management company? Or is it split?
• Know this upfront.

7. Do you have your own maintenance staff or do you use independent contractors?
• Gives you an idea of their sophistication.

8. What is the cost for an eviction process from start to finish?
• In San Francisco, it costs about $5000 per eviction. In NY, it costs about $300.

9. Is there a per new lease charge to the landlord?
• Know this upfront.

10. How do you advertise your vacancies? Who pays for advertising?
• Typically, good property managers will have a referral system in place.

11. What are your business hours?
• Know this upfront

12. How are tenant emergencies handled? Weekend calls?
• Gives you an idea of their sophistication.

13. What monthly reports do you typically send owners?
• Know this upfront

NOTE: This interview is not for telling them what you want from every question asked. It is merely to gather information in order to make a decision on if you want to continue.

Character Traits You Want In Your Property Manager:
1. Tough-minded leader yet a people person, diplomatic
2. Creative and entrepreneurial instinct
3. Excellent communicator
4. Good negotiating skills
5. Capable organizational and administrative skills
6. Basic mechanical skills to verify contractor work
7. Local market and in-depth industry knowledge
8. Decisive
9. Integrity and honesty

Qualities and Capabilities You Want the Management Company to Have
1. High quality staff and support personnel
2. Confirmed reputable name in the marketplace and govt. offices
3. Reliable and modern reporting system for financials, operations, and maintenance
4. Excellent tenant relations that are visible and apparent
5. Licensed to manage and posses industry certifications

Components of a Sound Property Management Agreement/Contract:

1. Leasing
• Use best efforts to keep property rented by procuring tenants for the property and negotiating and executing on behalf of the owner.
• All leases for the property shall not be in excess of 12 months without written permission from the owner.

2. Rents
• To collect the rents and revenues from the property and serve or cause to be served all notices for the collection of rent and other charges.
• To initiate actions for evictions and when necessary, to settle, compromise, or release such actions or suits and reinstate tenancy.

3. Service Contracts
• To execute in the owner’s name for utilities and services for the operation and maintenance of the property.

4. Accounting
• Property manager shall keep proper books of account for the property and books shall be open for inspection by owner.
• Property manager shall furnish to owner a monthly statement on or before the 10th of each month.
• Find out if owner is required to keep a reserve monies account with property manager.

5. Compensation to Property Manager
• In consideration for the services rendered to the owner by the property manager under the agreement, the owner agrees to pay the property manager on a monthly basis.
• Compensation can be a percentage (%) of collected rents, a fixed fee, or a per door fee. The percentage ranges from 4% to 10% typically.
• Find out if there is a per new lease fee.
• Find out who keeps the late fees, or is it split?
• Find out if there is an extra charge at any time during the eviction process.

6. Terms of Agreement
• Initial terms are usually for 12 months. Try to avoid a 12 month initial term. If you are not able to do so, negotiate a 6 month term agreement. Never sign on for more than 12 months at any time.
• Either party may terminate the agreement by giving a 30-day written notice to the other party. Avoid 60-90 day requirements.

7. Terminations
• Immediately upon termination, the property manager shall provide owner with all originals or copies of leases and all agreements and related documents.
• All property financial records in possession of the property manager shall be delivered to the owner.

8. Provisions and/or Additional Provisions
• Delete any clause(s) stating that the property manager will act as real estate agent or receive commission if and when the owner sells the property.

9. Fiduciary Responsibility/Statutory of Compliance
• This is the code of ethics clause.
• States the property manager will perform all duties in the agreement.
• The property manager’s first obligation is to obey and abide by the law.
• The property manager will notify owner of professional opinion matters.
• The property manager shall keep the owners’ information strictly confidential and not shared with the public.

10. Be leery of “hold harmless” clauses.
• Responsibility is a two-way street. This clause relinquishes the property management company from all liability of damages to the property.

Essential Tips for the New Apartment Investor

1 – Proformas - Don’t buy on broker proformas!
To verify what the broker or owner is reporting for rental amounts, do your own quick n’ easy market rent survey. Call the actual apartment complex first to ask what the rents are (pretend you are a potential tenant). Then, call two to three competitors and do the same. The information you gather will confirm whether or not the income that is proposed is viable and achievable.

2 - Operating expenses are ALWAYS underestimated – triple check them.
Investor check #1: have the operating expenses double-checked by an experienced investor or professional property management company.
Investor check #2: get original copies of all utility expenses shown for 12 months.
Investor check #3: be conservative, then check if the deal still works and meets your objectives (e.g. cash flow, return on investment, cap rate, etc.)

3 – New property tax bills that can wipe out your cash flow - Be wary of reassessing property tax bills…know when it happens and at what rate. In California, property tax is re-assessed upon the transfer of new ownership to the higher level. In Ohio for example, taxes are reassessed every 3 years, setting you up for a shocker of a new tax bill if you’re not prepared.

4 – Income and expense statements versus property tax returns – make sure the income amounts on both forms match each other! For example, if the income statement shows an annual income of $100,000, but the same property’s tax returns show an income of $80,000, which one are you likely to believe? The tax returns of course! The question is: where is the missing $20,000 in income?

5 – Watch out for these properties – today especially, watch out for “all-bills paid” or “master-metered” properties. These apartment buildings have one master utility meter for electric and gas and water, although water is typical. The ideal arrangement is for each apartment unit to have individual utility meters. Can you imagine paying the entire electric bill for all 50 units?

6 – Don’t over-pay! Do yourself a favor and convince yourself you’re not over-paying by getting up-to-date sales data of comparable apartments. Make sure sales data is no more than 6 months old.

7 – Yes, location remains important. You can “fix” a property, but you can’t fix a location. Start off by getting simple demographic information for your area. Do this by going online to the city’s Chamber of Commerce and begin researching there. Next, call the Chamber’s office and ask to be connected to the Economic Development Department. Or ask to speak to the Director of Business Development. Confirm that your property’s location is sound by asking for data on the following: job growth, population growth, areas of revitalization, paths of progress, business growth and company relocation incentives.

The 7 Biggest Mistakes Apartment Investors Make

#1 – Underestimating the Property’s Operating Expenses
• Beware of broker’s proformas. The expenses (as well as income) listed in the broker’s statements or brochures are often best-case scenarios and typically do not depict the true operating state or condition of the property. The expenses shown normally are too low and the income shown normally is too high.
• Ask for the “actual” income and expenses of the property. The owner, the broker, or the property management company will have access to them. Base your final analysis from these figures.
• Examine expenses three ways: expenses per unit, expenses per sq. ft., and expense as a percentage of the effective gross income. These figures become more meaningful when you compare them to other properties that are similar.
• Get a second opinion on what you believe the operating expenses should be from either an established local property manager or someone who has operated a similar property. The popular saying “what you don’t know can’t hurt you” does not apply here.

#2 – Paid Too High of a Sales Price
• Just because “the numbers” work out on paper doesn’t mean that the price you paid is okay. For example, if you put down a 50% down payment, the numbers will most likely work out and the property will cash flow positively. The large down payment may have overshadowed the “too high” sale price you paid.
• Paying too high of a price will “trap” your current and future equity.
• Do your homework first by getting sales comparables. This is sales data from recently closed transactions of properties similar to yours. First look at the price per unit figure and make sure you are not paying way over that. Secondly, make sure the property you are comparing yours too is actually comparable. The following should be similar: number of units, unit mix, rentable square footage, year-built, amenities and utilities and located within a few miles from each other.
• A healthy attitude to have is this: “don’t fall in love with the property. Fall in love with the deal.”


#3 – Lack of Due Diligence or Not Doing the Required Homework
• I’ve heard of some investors who have planned their summer vacations more thoroughly than their latest real estate investments.
• Due diligence is the process of “doing your homework” on the investment property. It is the process of checking, double-checking, and confirming any important information (financial, legal, physical) that was used as a basis on determining if the particular property is a good, average, or bad deal. This process takes you on an information-gathering and fact-finding mission. Proper due diligence takes persistence and weeks to accomplish. Due diligence is not used as an excuse to back out of a deal, but it is primarily a means to protect you financially and legally.
• Proper due diligence will enable you to uncover potential problems with the property or as we call them, “elephants underneath the carpet” before the deal is closed. These potential problems can be very costly (time, money, legal) and can turn a good deal into a bad one very quickly. An educated real estate investor knows and understands the importance of completing their due diligence tasks.
• One sure fire way to lose your earnest deposit is to not keep track of your contract dates such as contingencies for inspections, financing, clear title, and appraisal. If you allow yourself to go beyond the set dates in the contract, you hereby waive your rights to those contingencies.


#4 – Hiring Incompetent and Incapable Property Management
• From my experience, this is probably the biggest reason why investors fail. Unknowing investors “hand over” the responsibility of the property to a property management company to manage the property, but all they do is manage to run it into the ground. Sound familiar? Or know someone? It’s all too familiar.
• One of the most important and valuable strategies is to set up a system of accountability for the property manager you hire. You cannot manage what you cannot measure. You cannot measure what you cannot monitor.
• Make sure the property management you hire is an established leader in the apartment industry, has great local market knowledge, a sound marketing plan and marketing skills, and has a reliable and accurate financial reporting system.
• Think of your apartment building (two units or one hundred units) as a business. A typical business collects income, pays for its expenses, and you should profit from all of your efforts. Your property should be no different. Therefore, your business (the property) will be as profitable and successful as the leader (the property manager) of the business (the property). Hire only the best.

#5 – Failing to Understand That Every Property Has a Lifetime
• Just as human bodies have a lifetime, properties do as well. When properties get older, they start to fall apart and need repairs (just like us!). One of the biggest mistakes that you can make as an investor is to ignore the fact that over time, you’ll have to spend money on the cosmetic upkeep of the building, inside and out. The building may need a roof replacement and the electric or plumbing systems may need to be updated. All of this can cost thousands of dollars. Every building goes through these phases and some more so than others. It really depends on the age and condition. So make sure that you have a long-term plan to handle such repairs. Establish a reserves account or you can call it a savings account for each property. Or refinance the property and pull money out to do these upkeeps.
• The smart thing to do is to have an annual operating budget for the property, where the upkeep and improvements are budgeted and financially prepared for well in advance each year. Remember, this is a business.

#6 – Taking on Too BIG, Too Quickly
• The allure and excitement of real estate investing can be enormous. Human nature of ‘wanting more now” often times causes us to commit to more than we can actually handle. And that’s what gets us in trouble and in over our heads. The solution to this is an easy one: get good advice from someone who’s been doing what you want to do. Some investors have too much pride to ask for help. But the old saying, “pride comes before the fall” is so true.
• It’s not a good idea to purchase a 100 unit apartment building when the only experience you have is renting out your single family rental homes. However, it is possible to do this successfully with the right assistance and instruction of someone who has direct experience.
• Get a real estate investment advisor. That person could be someone you hire (like us) or it could be an experienced associate of yours (or a referral).

#7 – Being in Denial When Property Problems Appear and Won’t Go Away
• One of the great life lessons I learned in business is “what you do not confront, will not change”. When property problems do surface, it is actually human nature to see if it will go away by itself. But much deeper problems occur when it is not dealt with in a timely manner.
• Because of all the moving parts in any investment business, disaster can be the result if the problems are not swiftly dealt with at their root causes.
• Whether you know it or not, you are not the only person who has or is experiencing property problems. Odds are someone who is more experienced than you may have solutions for you. Acknowledge the problems and seek help until you find answers.

The 7 Habits of Highly Successful Apartment Investors

#1 – They Only Invest in Apartments...The Power of Focus!
• The best and the brightest apartment owners are the best and brightest at one thing – buying apartments. They don’t stray away from their specialty, but rather focus on apartments only. They don’t try to be “jack-of-all-trades”. Neither should you if you want to be one of the best and brightest.

#2 – Not Over-Leveraging DEBT…Cuz It’s a 4-letter Word!
• Heavy debt is a cash-flow killer. Even though debt is pretty much the norm on most deals, be smart about it. Having high debt is a trap that snares cash-flow and equity. Proverbs says that the “borrower is slave to the debtor”.
• An easy way of measuring your “debt-safety” level is to figure out your breakeven-occupancy percentage. To do this quickly, simply add up all of your annual operating expenses plus your all debt. Then, divide that number by your potential gross income. You’ll find that your operating expenses will typically not vary much, but that your debt can have a huge impact on your breakeven point in occupancy. The higher the debt load, the higher the breakeven point in occupancy. For example, if your breakeven occupancy point is calculated to be 60%, then after that, it’s all cash flow. But if your calculation comes out to be 90%, that spells trouble. You have no room for error and must keep your apartments 90% occupied just to pay the bills.
• Even though there are financing programs available that allow you to perhaps finance an investment with no down payment, it may not be a good idea. Run your numbers. Be prudent.

#3 – Properties Are Managed Effectively and Professionally
• Having top-of-the-line property management, whether you do it yourself or hire a company to do it for you is a major key to success.
• In a nutshell, a top management company’s ultimate goal is to maximize potential rental income, reduce operating costs, strengthen tenant retention and relations, enhance visual appeal of property, and increase property value. If they can do this, you have a winner.
• Apartments that have the best reputation in the community have the highest rents, the lowest turnover, and have sound and solid property management.

#4 – Patiently Acquiring and Having Tolerance for Mistakes
• Rome was not built in a day. Building a good-sized and wealthy portfolio requires years to build and is built one property at a time. Successful apartment owners take their time and strategically plan out their acquisitions over a period of years. The real estate cycle and market conditions have to be just right in order to make the best buying/selling decisions. Time and timing are the keys.
• Have you noticed that life tends to have built-in provisions for the mistakes we make? The most successful apartment owners that I personally know, made huge mistakes in the past that have brought them literally to their knees, but the most successful ones bounce back to do even bigger deals.
• Allow yourself room and grace to make mistakes. It is the highest form of learning that we know of.

#5 – Effectively Partner
• Proverbs 15:22 states, “plans fail for lack of counsel, but with many advisors they succeed.” Throughout history, no one has achieved impossible dreams or built amazing companies without effective partnering and/or outside advice.
• The apartment investment business can be very dynamic with lots of moving parts to it. Don’t be average over a lot and master of none. Do what you do best and hire out the rest to the best.
• Successful apartment owners know the value of relationships. Success is a relationship business. Finding the best deals, solving the biggest problems, and finding the money for your deals come from relationships.

#6 – All Business Systems are Accountable
• Well-run and profitable apartment investments seem to go under the radar. But what you will hear more of are the apartment communities that are failing or are in deep trouble. Upon deep inspection, you’ll find that the troubled apartments have a key component to their operation that has stopped working. And that failed component has caused or will cause other facets of the operation to fail down the line soon. Nonetheless, a profitable apartment business has nearly every business component running at good to satisfactory levels.
• Successful apartment owners have excellent internal communications and accurate financial and operational reporting. Their systems allow them to hold their apartment’s business systems accountable to those responsible. Here is a sampling of typical apartment business systems: accounting, revenue, internal controls, property staff, marketing system, maintenance, and marketplace.

#7 – Well-insured and Entities are Set Up For Maximum Protection
• “Plan for the worst and be happy if it doesn’t happen” is the attitude and habit of the most successful apartment owners.
• Their goals are to build a legal fortress with insurance coverage and with the use of entities such as LLCs, LLPs, Corporations, TICs, etc.
• A poorly protected investor may not only lose his or her properties to a real or frivolous lawsuit, but personal property as well. As of 2006, there are over one million attorneys in the U.S., all wanting to deploy their skills (on your property).
• Before doing any of this on your own, consult an attorney and tax strategist first.

Apartment Investing Builds Retirement Nest Eggs

Dear Apartment Building Investor,

This is not meant to scare you, but according to The Wall Street Journal, the average 35 year old person in the United States will need to have saved a nest egg of at least 3 million dollars by the time they retire at age 65. That may seem like an astounding number and it basically leaves investors a few choices to build a nest egg of that magnitude.

The first choice would be to play the lottery and hope. Unfortunately, right now this is the plan that many millions of Americans are undertaking right now. You might be one of them.

The other, and more common route, is to contribute to your 401k and maximize on your employers matching contributions. This has worked for some people in the past but as good, high paying, professional careers become more scarce in the United States this route doesn’t appear to be a wise choice for most people. Most people’s 401ks are mostly invested in a basket of stocks, mutual funds and bonds. The problem with putting your nest egg into a 401k is the fact that you are basically counting on the fact that the stock market will be in a bull market when you are ready to retire. If not, you will end up like many people who in 2008, when the stock market nose dived, were forced postpone their retirement by another decade because the value of their retirement nest egg had dropped so dramatically.

So what is the answer to securing your retirement future? It just might be a strategic apartment building investment. Here’s why:

1) Other People’s Money. As oppossed to invesments in stocks apartment buildings offer the opportunity to invest with other people’s money. In fact, investing in apartment buildings allows you to purchase the building with up to 100% other people’s money by using a combination of partnerships and traditional bank financing. In addition, the balance of the mortgage is paid off over the life of the loan using other people’s money in the form of rent payments made by your tenants.

2) Scarcity and Demand. A record low number of multifamily units will be completed this year. The increase in rental housing demand is being met by a sharp reduction in the supply of new apartments. Just to put this into perspective, over the 10-year period from 1998 through 2008, there’s an average of about 240,000 new rental completions per year. Last year, there were 160,000. And this year, completions are expected to be below 80,000 units, which would make it a 50-year low. This level of new completions is actually less than the estimated annual loss due to obsolescence, meaning that we’re seeing essentially a net zero increase in the stock at a time of strong demand. New starts are not expected to approach historical levels until late next year, 2012, which means it would likely not be until late ‘13 and into ‘14 that we’ll see completions return to historical levels. And obviously it’s the completions that are what’s important in affecting the supply demand fundamentals.
3) Demographics. Roughly 3 million young adults had been living with family during the past five years, according to data from the Census and real-estate investment brokerage firm Marcus & Millichap, and housing experts estimate that they now generate about one-third of rental demand.

4) Instant Returns. Factoring in maintenance costs and other variables, an investment property should produce at least a 6% return on the initial cash investment in the first year after it is purchased. For example, an investor who puts down $250,000 in cash on a $750,000 property would need to clear at least $15,000 in the first year.

What does all of this mean to you as an investor? It means that the time to begin buying apartment buildings is right now. I am not promising that you will be the next Donald Trump but I certainly believe that apartment building investing now offers one of the safest and securest ways to secure the comfortable retirement that you deserve.

The next step is to get started. But don’t go out today and begin buying apartment buildings unless you are properly prepared. You need to arm yourself with all of the tools, information and market knowledge to ensure that you are investing in the right property that will not only continue to pay for itself over the years but also offer you a hefty monthly cash flow that will put money in your pocket.

If you are truly serious about learning to buy profitable apartment building then get started today by enrolling in the “Buy Your First Aparment Building E-Course”

Investing in apartment buildings is a lot easier than you probably think but the most important thing is not to jump into the market blindly. Enroll Today in my “Buy Your First Apartment Building E-Course” and you will have instant access to all of the information that will allow you to properly analyze a property to ensure that it becomes a cash cow and not a money pit. Remember, the risk is all mine. If you don’t find the information or if you simply decide that apartment investing is not for you, then I will happily return your entire tuition, no questions asked. So get started today and I guarantee you will not regret it.

Sincerely,

Ted Karsch,

Small Multifamily Properties = Big Profits

by Spencer Cullor on October 15, 2011

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Many real estate investors overlook some of the most profitable investment properties because they don’t understand how smaller properties can equal big profits. They get caught up in the “bigger is better” mentality and miss out on some of the most profitable investments right in their own backyards. Contrary to what some real estate gurus say, you don’t have to buy multifamily properties of 150 units or more to make a big profit. Smaller multifamily properties can provide an investor some of the strongest investment opportunities if you know what you are looking for. You can find them everywhere, and often times can buy them for much higher immediate returns and at better purchase terms than larger properties.
We define smaller multifamily properties as those having four to 100 apartments or units. This size of property can be a great fit for individual or a small group of investors. At this size, the income can adequately cover the expenses of the property and factor in management, debt service, and vacancy expenses.

Some of the advantages of investing in smaller multifamily properties are:

• Smaller properties usually have less competition than larger properties. When acquiring smaller properties, you are usually competing against individual investors instead of large companies, institutional investors, or investment groups.
• You can find properties with higher cash on cash returns. Often times you can buy smaller properties that provide higher cash on cash and internal rates of return on your investment dollars.
• They take less equity to purchase. Because they are smaller, they don’t require millions of dollars in equity to purchase, allowing you to purchase them individually or with a small group of investors, and own a higher percentage of the property.
• With smaller properties, you can often make more money per unit each and every month than with bigger properties.
• There are more of them in your backyard. There is a larger number of smaller properties than large apartment complexes which makes them easier to find.
• Many have more flexible sellers. These properties are normally owned by private individuals who have the ability to get creative if they want to and don’t have to go to a large ownership group for approval.
• They are often managed by less sophisticated investors who are scared to raise rents, fearing that their tenants will move out. This provides more opportunities for hands-on owners to achieve management improvements and value creation.
• They can be closed on quicker than larger properties.

As you can see, there are many advantages to investing in smaller properties, where some of the biggest returns can be found. It’s easy to get caught up in the game of trying to compete with larger investors who own more units, but like a mentor of mine told me early on in my investing career, “It’s not how many multifamily units you own, it’s how much you make per unit.”