Here are the five important issues to consider when investing in apartment buildings.

1. Cash Flow

Will this property cash flow? This is the most important issue to consider, and it depends on a lot of factors, including:

  • Strength of the local rental market (vacancy and delinquency)
  • Type of market you are buying into (C class buildings usually will have more tenant turnover and higher repairs and maintenance than A or B class buildings)
  • Interest rate on your financing (is it conventional financing or a hard money loan?)
  • Size of your down payment

All of these factors considered, ask yourself, “Will this realistically provide income for me?” Also, ask the question, “How will this property cash flow compared to other potential properties?”

2. Leverage

Leverage is important in investing because the less cash you put down on each property, the more properties you can buy. If the properties go up in value, your rate of return goes up exponentially. However, if the properties go down in value, and you have a lot of debt on the property, the result can be negative cash flow.

Negative cash flow can be either “bad” or “good.” The “good” kind is short-term and makes you money.

“Nothing down” investing is very attractive for the high-leverage investor, but should be approached with caution. If you are a long-term player, leverage will generally work in your favor if the markets in which you invest appreciate in the long run and your income from the properties can pay for most of the monthly debt service.

3. Equity

Does the property you are purchasing have equity or can you create equity? Equity can take a number of forms, such as:

  • Discounted price
  • Fixer upper – “upside” potential
  • Rezoning opportunity
  • Poor management
  • Foreclosure

There are many ways to create equity, but buying into equity is your best bet. Find a seller who wants out of his property and is willing to give up his equity for less than full value. Or buy a property that needs work that can be done for 50 cents on the dollar or less. In other words, if the property needs $10,000 in work, make sure you get a $20,000 discount on the price or better.

4. Appreciation

Buying in the right neighborhoods and in the right stage of a real estate cycle will result in appreciation and profit. However, timing a real estate cycle is difficult and is very speculative. If you buy properties without equity or cash flow solely for short-term appreciation, you are engaging in a risky investment.

Buying for moderate long-term (10 to 20 years) appreciation is safer and easier. Look at long-term neighborhood and city-wide trends to pick areas that will hold their values and grow at an average 5 to 7% pace. Combine this tactic with reasonable cash flow and buying into equity, and you will be a smart investor.

5. Risk

Risk is a consideration that too few investors consider. Ask yourself, “What if my assumptions are wrong?” In other words, do you have a “Plan B”?

If you bought for appreciation and the property did not appreciate in value, can you rent for positive cash flow? If you buy with an adjustable rate loan and the rates go up, will this put you out of business?

If you have a few vacancies, can you handle the negative cash flow, or will it break the bank for you? Expect the best, but prepare for the worst.

 

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