The majority of investors are hard wired to focus on the short-term benefits and returns of an investment, while not appreciating or understanding the multitude of other benefits that an investment can provide. In this article, I am going to highlight the benefits of investing in multifamily and how much money an owner can make.
Let’s start with the three metrics that every investor should focus on in an investment vehicle:
Let’s take multifamily and see how powerful the asset can be when compared to these metrics. Multifamily provides one of the best assets to be able to leverage, that is, using other people’s money, whether it is money from a bank or from investors. In some cases, Jake & I have been able to utilize 85% of the bank’s money to control the asset. We only need to provide 15% of the asset’s price as the down payment.
For example, if an asset costs $1,000,000 to purchase, the bank will provide $850,000, and we need to contribute only $150,000. Now that is sweet! There are very few assets out there that provide this type of leverage. Why would our banker do this? The loan is backed by a real asset, the property, and if we decide not to pay, the banker will take back the property and go after us personally to make the loan whole. They’re getting their money one way or another.
Real estate is now known for liquidity, the ability to exit the investment. Have you ever heard the adage “Don’t wait to buy real estate. Buy real estate and wait.” The investor who plans to invest for the long term is the one who is rewarded, and not being able to cash in your chips can be a benefit. But there is a way to access liquidity from multifamily, the Refi & Roll. We will discuss this strategy in a bit.
Now onto control, one of our favorite reasons to buy multifamily. If we want to raise rents, sell the property, refinance the property or hire staff, we are in control and can do it. Good luck trying to fire an employee at Apple, or raise the dividend at Exxon. You have no control of decisions of the company when investing in stocks, and if their focus is on short-term profits at the expense of the long term, oh well. Every entrepreneur and investor craves to have control when investing or building a company.
Let’s dive into how apartment owners make money:
Revenue is vanity, profit margin is sanity, and cash is king. Let that sink in for a minute. Most investors focus on cash flow as the primary way to get paid, but as you will see, it’s not the only way. We focus on buying multifamily properties that produce cash flow from day one, and we like to say “If it don’t cash flow, let the grass grow”. We call a property that is negatively cash flowing an Alligator, because it will eat you alive!
In our portfolio, we average around $100 to $150 profit per unit per month, depending upon what market the asset is located, and how much debt is on the asset. For example, a twenty-unit property should deliver around $2,000 per month in positive cash flow. Let’s get the party started!!
In multifamily, the value of an asset is based on the Net Operating Income (NOI), whereas, in residential real estate, valuations rely heavily on the market and the use of the sales comparison approach. For the most part, the investor has much less control of increasing value in residential real estate.
The income approach is utilized in multifamily, where the goal is to raise the NOI by increasing income and or decreasing expenses. Investors target underperforming assets and increase value through either operation or renovation. Some assets may have underperforming management, and yet, other assets may be renovated to a higher class with the expectation of increasing income, thereby, increasing the value.
For example, on our third deal, we purchased a 136 unit apartment complex for $4,075,000. The property was grossing $54,000 per month in total income, and within a year, we increased income to $85,000 per month, as a result of a combination of rent increases, filling vacant units and increasing other sources of income, such as pet fees and late fees.
It was a difficult reposition for us for a couple of reasons. First, we had never repositioned a property of this size. Secondly, we received a significant amount of pushback from residents when we began to raise their rents from $450 per month to $595 plus RUBS (Ratio Utility Billing. We were billing backs residents for their utilities). That isn’t a very pleasant conversation when you tell the resident that the rent is going up 40%, but you need to have it. But, we realized there was significant demand for these apartments at the new price point. We were offering a superior product and much better customer service.
After eighteen months, the property appraised for over $6,000,000, and we were able to refinance $1,600,000. Not a bad payday! This leads us to the third way apartment owners get paid…
Check out the video version:
Refi & Roll:
When an investor refinances a property, they either replace the debt on the property with new debt or add a supplemental loan. We focus on properties that are underperforming, or in today’s jargon value-add, and as we discussed, raise the NOI on the property. This leads to an increase in the value of the property, and we are able to refinance out the gain in equity. Here are examples of refinances of our properties:
We have coined the term Refi & Roll because we refinance the property and ROLL the proceeds into our next deal. We realized early on if we have patience with the process and understand that multifamily is a long-term play, then with that patience comes rewards. In the tune of over $9,000,000 and counting!
Now I know that you can do this too. Focus on multifamily, and abandon the shiny object syndrome, jumping from one idea to the next. Once Jake & I did this, success started entering our lives.
When Jake & I bought our first property, we had no idea the tax benefits involved with multifamily. Tax benefits, along with the 1031 exchange, in my opinion, have fueled the boom in multifamily valuations. We can look to demographics, and the willingness for the population to view renting as a favorable option, but the tax benefits can’t be overlooked. You always hear the rich not paying their share of taxes, and many of these rich folk invest in multifamily to lower their tax obligations.
We recorded this short video with Rich Dad Advisor Tom Wheelwright, who discusses the tax advantages of multifamily real estate and the tax strategy of cost segregation:
I don’t invest in multifamily for the tax benefits only, but they are the cherry on top of that hot fudge sundae!
As governments across the world continue to print money, they create inflation, which is an increase in the money supply. Inflation leads to an increase in prices. A small amount of inflation is healthy for the economy, but what we are witnessing currently has many investors worried with where pricing will go.
We view owning apartments as a hedge against inflation. What do I mean by that? For example, when a maintenance technician receives the benefit of inflation by an increase in his or her salary, what follows is that rents will rise. As prices rise in the economy, rents have followed suit.
The other hidden benefit is that as the governments have been printing money like drunken sailors, hard assets, such as real estate, have benefited from an increase in the valuations. Another way landlords get rich in their sleep!
Economies of Scale:
The main reason why I skipped single family home and fix and flips and went straight to multifamily is that I already had a full-time job, my restaurant. I did not want to create another job, I was striving to create a scalable business and enjoy economies of scale.
How do apartment owners benefit from economies of scale? I will use our first deal, a twenty five-unit property as an example to describe the various benefits. The first obvious benefit is that all twenty-five units were contiguous, that is they were all located in the same location. No running around town trying to collect rents from twenty-five different locations. When you are working a full-time job and trying to grow your portfolio, time is one of your most important assets, and being able to visit one property instead of twenty-five is a home run.
Secondly, the cost savings were tremendous. One lawn to take care of, one garbage bill to pay, less structures to maintain, less transactions to execute. The cost savings were immense. What a nightmare it is to send your maintenance technician to twenty –five different homes, and since each house is different, how much time and energy is wasted to locate a hot water heater or the electrical panel. An apartment unit is basically a shell, and they are all the same. Just the time saved by having your maintenance tech drive around each house is a game changer.
And third, the ability to create a scalable business with multifamily allowed us to quit our jobs. At around the seventy five-unit mark, we were able to hire full-time staff and begin to focus on not only the property management, but also the asset management. We were able to hire out many of the lower paying tasks and focus on tasks that created wealth, such as deal sourcing and creating systems to run the business.
Now, you may be saying to yourself, cycle resiliency is not a way that apartment owners get paid. I agree with you, but it is a way that apartment owners stay competitive in a down economy and can continue to grow their operations with sound operations.
As many investors have noticed during this pandemic, several asset classes are experiencing a more challenging market, such as office and retail. People need a place to live, and for many, buying a home is not an option. Jake likes to say that there are three basic human needs:
Food, Clothing and Apartments
We recorded an informative podcast with the co-author of the book Big Shifts Ahead, Chris Porter, who dives into the demographics of the country and the shift in living preferences. The podcast is imperative for all investors and business owners who want to understand how demographics will affect businesses and buying preferences in the future. Click here to listen:
Chris does an amazing job showing where people are migrating to, and how demographics is contributing to more people renting versus owning a home. The demand for apartments will continue to drive occupancy and rent increases, and apartment owners will continue to get paid.
When we first started our journey into multifamily, we thought cash flow was the only way to get paid owning apartments. We couldn’t have been more wrong, and the benefits of owning multifamily contributed to wealth creation. And we haven’t even discussed the various businesses that have been created through multifamily, such as an education company and a syndication company.