Investing in Apartments: Pros and Cons
Updated: Sep 4, 2020
Hard-working professionals are seeking ways to diversify their income and create the lifestyle of their dreams. Many seek alternatives to the stock market and consider real estate an intriguing option. Real estate is tangible, proven, and serves a practical purpose. That's why investing in single-family rentals is a popular strategy. And while single-family rentals are a great option, savvy investors are weighing the pros and cons of apartment investing.
It's nice to invest in one unit, but consider the advantages of investing in three...or 300! You might be thinking that this sounds ridiculous and to be fair there are challenges and drawbacks to consider before diving into multifamily apartments. Let's define this alternative investment and address some of the pros and cons.
What Is Multifamily?
As the name implies, multifamily is a building or structure designed to accommodate several families in different housing units. Multifamily can be composed of duplexes, triplexes, quads, townhomes, and apartment buildings. They may be owned by an individual, a business, or an individual who purchased a unit.
Investing in apartments is attractive for the various benefits, especially for high-income earners seeking tax relief, but there are some drawbacks to consider. As you weigh your options, take a look at its pros and cons.
Pro: Favorable Returns on Multifamily
As you might expect, you’ll generate larger cash flow in multifamily compared to a single-family home. Cash flows from rental income is the money left over after all expenses and mortgage payments. Cash flow isn’t just king, it is the cornerstone of multifamily investing.
Effectively managing cash flow can drive impressive returns that are hard to match from other investments. Even conservative returns from apartments tend to be favorable to other asset classes.
Related Podcast: How to Create a Lifetime of Cash Flow with Rod Khleif
Con: Requires A Large Cash Outlay
The acquisition of an apartment building requires a large cash outlay, covering the down payment, closing costs, fees, reserves, and any capital expenditures to stabilize operations. This amount can quickly add up to a sizable figure.
Pro: Control on Appreciation and Value
Unlike single-family homes, which are valued based on comparable home sales, values for apartment buildings are determined by the income they produce in relation to other apartment buildings in the area.
Typically, you’ll have clear comps for rents, sales, and income-producing extras such as parking and laundry to inform operational decisions. This enables investors to force appreciation by simply increasing income or decreasing expenses.
Con: A Non-liquid Asset
Relative to other investments, apartments are not liquid. To get money out of an apartment, an investor typically needs to sell or refinance. Furthermore, it usually takes months to identify a qualified buyer, agree to purchase terms, and then close on the sale.
Pro: Centralize Operations and Efficiency
A major benefit of owning an apartment building over the equivalent number of units in single-family homes is scale and efficiency.
With one building, you can efficiently manage expenses and centralize operations. There is a central location to handle inspections, meet contractors, collect rents, and show vacant units without the hassle of driving all over the city. Expenses are decreased with fewer roofs, mechanicals, and other inefficiencies.
Also, a vacancy in a single-family home provides no income, but with an apartment building, the other units will continue to generate cash flow. As an example, when one of our inherited tenants stopped paying rent, it cost us thousands in unpaid rent and repairs. However, the other units in the building still generated enough for positive cash flow.
Con: Risks are involved
Like any investment, apartments certainly carry their fair share of risks. With larger price points and fewer exit strategies than say a single-family home, it’s imperative to understand these risks and minimize them.
Proper analysis of the local landscape and target property is critical. Specific items that should be considered include tenant demand, existing and planned apartment inventory, local economic factors, and available financing terms.
Related Podcast: From the Best Advice to $175,000,000 with Joe Fairless
Pro: You can keep your day job
One of the best things about apartment buildings is being able to hire a professional management company to oversee it. This provides a passive investment that allows you to benefit from owning real estate, without the hassle of a 2 a.m. call to fix a leaky toilet. And if you invest passively with a sponsor, they will manage all aspects of operations while you simply collect the distributions. Whew!
Con: Less Profit for You
There’s also a downside to professional management. They’re probably not going the extra mile to squeeze out more profit for you, especially if it doesn’t make them more money.
In fact, many property management firms make additional money through unit turnovers, tenant placement, repairs, maintenance, late fees, etc. Therefore, it’s imperative to proactively lead and manage the property management company and align their interests with the optimal operations of the property.
Related Podcast: How to Manage Out of State Properties with Sep Bekam
Pro: Less Tax Obligation, More Money for You
They say it’s not what you make, but how much you keep and the tax benefits of apartment investing make it one of the strongest assets to help you keep more money and minimize your tax obligation.
You can write off all of your expenses (advertising, management fees, maintenance, etc.), which can help you reduce your taxable income. You can defer capital gains and recapture taxes when you sell. You can even depreciate the value of the building and if you use a cost segregation analysis you can accelerate the depreciation schedule for even greater savings.
How to Start Investing in Apartments
Multifamily investing takes work. On top of it all, you need to choose the right property, maintain it and effectively manage residents.
If you’re looking to get started you need to ask yourself a few more questions. How much time can you dedicate to owning and managing multifamily? How do you find good deals? How do you properly and conservatively analyze deals?
We’ve come across many people who love the idea of investing in multifamily for the additional income or tax benefits, but aren’t looking for a second job. Many of them have benefitted from investing in apartment syndications, which allows investors to pool resources together to buy a property. However, in this case, there is a dedicated operator who oversees all operations, allowing the investors to simply collect checks.
Related Article - How Does Real Estate Syndication Work?
Apartment Syndication Example
Let’s say there are 10 people with $100,000 each to invest. Instead of each of them separate buying single family rentals, they decide to pool those funds together through an apartment syndication and use the $1,000,000 as a 25% down payment to buy a $4 million apartment complex. The larger apartment complex produces enough income to hire professional management and still deliver strong returns to the 10 investors. This gives them more free-time to pursue their passions. We used this strategy to partner with investors on over $90 million worth of apartments.
If you've concluded that the pros outweigh the cons to apartment investing, it’s time to learn more about the process and next steps. If you want to manage deals yourself, take the time to educate yourself through books, podcasts, and networking. If passive investing is the route you prefer, check out out the article we penned on evaluating real estate syndications. You can also review some of the frequently asked questions we receive often from investors.
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