Investments in apartment buildings
As the residential real estate market continues to slide, many real estate investors have been drawn to what could be the next big financial boom market: apartment buildings. An old Chinese blessing says “may you live in interesting times”. Well, if interesting times are seen as a blessing, then the real estate market must be full of opportunities. We probably haven’t seen such an “interesting” real estate market since the 1950s.
When it comes to investing in apartment buildings versus investing in single-family homes, I have found that it is easier to make a sound financial judgment on investments in apartment buildings than single-family homes. The reason is simply because when you buy an apartment building you have the ability to view the historical financial statements. These financial statements are called operating income and expenses, and the buyer of the apartment building can usually obtain these financial statements that are three years old. The best thing about looking at the financial statement is that you can see exactly what your gross income and expenses have been for the last three years. This allows you, the investor, to roughly determine the value of the property and what the expected rate of return will be.
The operating income and expenses or financial statement of the multi-family investment you are considering is a tool that is the equivalent of an X-ray to a doctor examining his patient. By looking at the income and expenses of your multi-family property, you should be able to determine a number of things that will affect the overall “health” and monetary returns on your investment.
The first task to perform when analyzing income and expenses is to look closely at all of your expenses each year and find out which expenses have increased or decreased from year to year. For example, you may find that the listed expenses for gardening increased from $4,000.00 in year 3 to $7,000.00 in the most current year. This could be because the owner made significant landscaping improvements to the property, which could add value, or it could be because he hired a new landscaper who charges more for the same service. The new apartment investor should examine all expenses listed for each year and make comparisons for all years to ensure there are no discrepancies. When there are differences, the investor must act as a detective to find out the reasons. Sometimes the discrepancies can represent a hidden value. Using the example above, you may know of a landscaping company you currently use that will maintain your landscaping at a lower cost. This difference alone could completely change your financial analysis of the property. This concept is known as forced appreciation. I discuss forced appreciation in much more detail in my “E-Course on Buying Your First Apartment Building” linked at the bottom of this article.
By contrast, when you buy a single-family home for investment purposes, you don’t have a historical record of the rents you can expect to receive in the future. If the house was not formally a rental house, then you should rely on a market estimate given to you by your real estate agent. This estimated rent may or may not be accurate. You also have no way of knowing what your expenses will be for that particular property. Most homeowners do not maintain a separate balance sheet for their household expenses.
