Understanding how profits are generated from investing in apartment buildings might not be immediately apparent to the average person. Unlike businesses like corner stores or restaurants where the sale of goods generates revenue, apartment buildings operate in a more nuanced manner. Many individuals may not even realize that apartment buildings are considered businesses, and are considered a strong investment decision with looking to expand and diversify your investment portfolio.
Most people don’t realize that apartments can be a strong investment opportunity, or even that they are an entire business all on their own. Even after having residential real estate investments for over a decade, it wasn’t until recently that I comprehended how the apartment building business operates. The revelation occurred when I recognized the superior advantages of apartment investing over single-family rental properties, with the primary factor being the number of units under a single roof and operational efficiencies.
This article aims to provide a commercial real estate education so that the next time you pass by an apartment complex, you’ll see it not just as a multifamily building but as a profitable piece of commercial real estate.
Apartment Investing Provides Rental Income
The most evident way apartment buildings generate revenue is through rental income. The monthly rent paid by tenants constitutes the primary source of income for an apartment building. After collecting rents, the gross income is determined, from which the mortgage and expenses are subtracted, resulting in the Net Operating Income (NOI). This NOI is distributed among investors as passive income in apartment investing partnerships.
For instance, consider being part of an investment group in a diverse real estate portfolio that includes multiple multifamily properties. Let’s take the scenario of a collective investment in a range of properties. Suppose one of the properties is a 150-unit apartment complex with an average rent of $1,200 per unit, resulting in a total gross monthly income of $180,000. If the collective mortgage for this property is $60,000 and the combined expenses, covering maintenance, repairs, utilities, and management fees, amount to $90,000:
$180,000 (gross income) – $60,000 (mortgage) – $90,000 (expenses) = $30,000 (NOI)
In this collective investment, the Net Operating Income (NOI) for this specific property is $30,000. If the investment group owns several multifamily properties, each contributing to the overall NOI, the excitement lies in the potential combined rental income. Even with the income being distributed among various investors, the prospect of a substantial and diversified rental yield becomes compelling, particularly for passive investors not directly involved in on-site management responsibilities.
Apartment Investing Provides Ancillary Income
In addition to rental income, apartment buildings can generate ancillary income through various sources such as lock boxes, laundry services, covered parking fees, and more. These additional services and amenities, like a coin-operated laundromat or reserved parking spaces, contribute to the overall profitability of the property. Property owners can creatively provide services that enhance the lives of tenants while generating extra income.
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Property Appreciation Provides Lump Sum Returns
Unlike single-family homes, the value of apartment buildings is not determined by comparables in the area but by the income they generate. Property appreciation in the apartment world is tied to the amount of income the complex produces. Increasing the Net Operating Income through strategies like occupancy improvement, rent adjustments, and expense reduction directly enhances the property’s value. This increase in value, often substantial, is realized when the property is eventually sold.
Consider a scenario where you recently acquired a small commercial complex, consisting of retail and office spaces, producing a Net Operating Income (NOI) of $15,000 per month. Collaborating with a professional property management team, you embark on strategies to enhance tenant occupancy, align rental rates with current market standards, and implement cost-cutting measures. After a diligent effort spanning a year, the monthly NOI experiences a commendable uptick, climbing from $15,000 to $25,000.
While the incremental increase may seem modest at first glance, that additional $10,000 in monthly NOI translates into a remarkable boost in the overall value of your commercial property. To be precise, the property’s newfound value is now $1.5 million more than its initial valuation. Yes, you heard it right – a substantial $1.5 million increase attributed to the strategic efforts in optimizing the property’s financial performance over the year.
In the realm of commercial properties, a similar principle applies, where each additional dollar of Net Operating Income (NOI) contributes substantially to the property’s overall value:
$1 (additional NOI/month) x 12 months x 10 (applying a 10% capitalization rate) = $120 added value
Therefore, your $10,000 monthly income, when multiplied by $120, results in a noteworthy increase of $1.2 million. It’s important to note that this additional $1.2 million isn’t immediately accessible, unlike the regular monthly cash flow derived from rent. Instead, it represents an increase in equity, realized only upon the property’s eventual sale.
This phenomenon elucidates why commercial real estate properties often undergo transitions in ownership. Each proprietor enters the scene, executes a strategic plan to enhance the property, and subsequently sells for a profit before moving on to enhance another commercial complex. Achieving these escalated property values necessitates a collaborative effort between the property owner and manager, consistently optimizing operational efficiencies to drive NOI higher and maximize profits upon the eventual sale of the commercial property.
Other Multifamily Investment Advantages
Generating revenue through investing in apartment buildings involves various strategies, with renovations, or value-add opportunities, being a significant contributor. Improving units enhances the living environment, making it cleaner, safer, and more appealing. The outcome is the ability to charge higher rents, attracting tenants willing to pay more for improved living spaces. This increase in rent results in higher gross income, elevating the Net Operating Income (NOI) and subsequently boosting property appreciation. Renovations, both in individual units and common spaces, not only enhance cash flow returns but also contribute to increased equity by fostering tenant pride and attracting more referrals.
Depreciation for Tax Advantages:
Investing in apartment buildings offers tax benefits through property depreciation. Each year, the property depreciates, and these depreciations can be deducted from annual taxes. This results in valuable tax breaks, offsetting annual income from the investment property. We have done various webinars on tax benefits related to multifamily, learn more here.
Investing for early retirement:
Multifamily real estate investing offers a potent avenue to expedite financial goals and pave the way for early retirement. Imagine a scenario where you’ve invested in a 250-unit apartment building, generating a solid monthly income. With the potential to diversify and scale your investments across multiple properties, the cumulative effect of increased rental income, reduced responsibilities, and strategic renovations can significantly accelerate wealth accumulation. The compounding impact of Net Operating Income (NOI) growth on property value becomes a key driver, providing a powerful mechanism to achieve financial independence at an accelerated pace.
How to Invest in Apartment Buildings:
Investing in apartment buildings may seem challenging due to their substantial cost, often in the millions. For individuals with a net worth under the multiple million mark, there are several options:
Real Estate Limited Partnership: Invest as a partner through a real estate limited partnership, partnering with an experienced operator to raise funds, find reliable property management, and conduct due diligence.
Real Estate Syndications: Also known as real estate crowdfunding, these involve pooling investors’ money to purchase large commercial assets like apartment complexes. This allows high-net-worth investors to collectively invest in multifamily properties.
Real Estate Funds: Similar to syndications, real estate funds invest in multiple properties at once. Investors may or may not have the option to select specific properties in their portfolio.
A Note on Making Money from Apartment Investing:
Some may view making money from apartment investing negatively, associating it with greed or exploitation of tenants. However, it’s essential to recognize that property improvements and profits are crucial for maintaining high-quality housing. Apartment owners and investors are generally motivated by providing excellent living spaces and positively impacting communities. Making money from apartment investing ensures proper incentives for property maintenance, creating a win-win situation for investors and tenants.
In conclusion, apartment buildings are not just living spaces; they represent a profitable business. Similar to restaurants and corner stores, they offer a gathering place for people to live, make memories, and create communities. As an apartment investor, one can enjoy financial gains, establish a reliable passive income stream, benefit from tax advantages, and contribute to providing valuable housing services to communities.
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