Apartment Investing Done Right
In a moment, I’ll explain how students of mine bought a $1,550,000 apartment complex with no money of their own down. Oh, and they walked away from the closing with $32,300 in their pocket, and a spendable income of $51,200 per year. Plus they do not deal with any tenants. If that sounds like something you’d like to learn more about, you’re in the right place.
The ABCs of getting the most out of investing in multi-family properties the way my students did means you should focus on three objectives:
- A. Get the highest appreciation in the shortest amount of time;
- B. Put as little money down on the property as you can; and
- C. Get that money back as soon as you can.
The more properties you control with the least amount of money, the wealthier you will become.
When I first started to buy smaller multi-family properties, I used no-money-down techniques. The reason was simple:
I had no money.
That forced me to do two things: First, I needed to get good at marketing, so I could have a lot of deal flow. That meant I could pick and choose the deals that were attractive enough that I could get other people to put up the money. Second, because I was new at this, I found a mentor whom I could run deals by, and that gave me the confidence to attempt this crazy goal of doing apartment deals when I had no money! Sometimes you need an experienced person in your corner to give you encouragement and also to tell you when you really are doing something crazy and should avoid it.
Conventional Wisdom vs. Conventional Opinion
I’ve found that conventional wisdom sometimes classifies things as crazy when that conventional wisdom is not wise at all, but ignorant of how things really work. I call it “conventional opinion.” One of the secrets to my success has been to ignore conventional opinion and seek “expert wisdom” to guide me.
If we go back to the specifics of apartment investing, you must always remember one crucial point when buying with no money down: the property must cash flow properly. By “properly” I mean the debt coverage ratio must be 1.20 or higher with 100% financing.
The debt coverage ratio is the net operating income (yearly income – yearly expenses) divided by the mortgage payment, also known as “debt service”. This means for every dollar that you pay out in debt service, you have $1.20 being generated in the form of cash flow. This is the same general measure that lending institutions use to determine if they will finance a property. It’s a nice, conservative approach.
Here’s another example of “conventional opinion” being wrong: it’s actually easier to purchase a multi-family property with no money down than it is to buy single-family properties. When you’re dealing with the owner of an investment property, you’re dealing with an investor. Those people focus on the numbers, and if the numbers work, the deal is likely to get done.
When you’re dealing with the owner of a single-family property, it’s often a person who is emotionally attached to the property, and for good reason: you are negotiating on the single-biggest tangible asset they have in their life.
Stitching Together the Financing
Even though multi-family properties are investments, it’s sometimes challenging to get conventional bank financing for them. It really depends on the bank, the specific property, and the current lending environment. Fortunately, many private individuals are happy to lend you money that they may have sitting in a savings account or an IRA, earning basically nothing, provided that you are willing to give them an 8-10% return. Of course you factor the higher interest rate into the deal when calculating the numbers and if it cash flows properly, it’s a buy. If it doesn’t, you should walk away.
Here’s how Kristy and Kevin Frew from the outskirts of Flint, Michigan put this type of deal together. Kristy’s goal was to buy a multi-family property of 50 or more units within six months. She wrote that goal down. (That’s important!)
Kristy and Kevin ramped up the flow of deals they saw by sending out direct-mail campaigns, making relationships with commercial brokers, and cruising neighborhoods. They knew there was not one magic method of finding possible deals, but instead it’s about doing several straightforward, tested, and effective things at the same time.
Soon they heard about a 51-unit building that was for sale in their area. The original asking price was $1,700,000. They were able to negotiate the price down to $1,550,000. When they did the analysis, they realized that the property would cash flow at $32,000 per year with 100% financing and the rents were low. This is known as a “value play”, and you should have at least one value play in every deal you do. Once the rents were raised, the new yearly cash flow (spendable income) would be around $51,200 per year.
Then it was time to structure the financing. They knew they could get 80% from their local lender and they informed the lender that they would be getting secondary financing from other sources. This is important because if the lender prohibits secondary financing, you need to find another lender.
Their first thought was to go to the seller and request owner financing. They asked for the full 20% but the seller countered with only 5%. The Frews made a counter-proposal for 10% but the seller would not budge beyond 5%.
Well at least their original 20% challenge was now only a 15% one. They owned a single-family property and were able to take out an equity line and come up with another 4%. It could just as easily have been an equity line from a credit card or some other asset.
They then talked with friends and family members. After having several conversations, it turned out that Kristy’s father had always wanted to be involved in real estate and never took the time to learn the ropes. When they explained the deal to him, it was obvious they had a deal that worked. Soon Kristy’s aunt wanted in on the deal as well. Between the aunt and the father, they came up with the last 11%.
Within their six-month deadline, Kristy and Kevin Frew bought a 51-unit apartment building for $1,550,000 with none of their own money down. It generated $51,200 a year positive cash flow and they walked away from the closing with a check for $32,300.
Return on Education
How did they get the 32 grand? Kevin had a real estate license and that was his commission. Other people pay $32,000 for tuition at some school; Kevin invested in his education—that license—and it earned him $32,000 for just one deal, not to mention all the other benefits he and Kristy would get.
The transaction the Frews did was a good example of the ABCs of getting the most out of a deal. Time will tell how the ultimate appreciation works out, but when you have no money of your own in the deal, and you’re getting cash flow each month, then waiting for appreciation doesn’t feel so bad.
Isn’t real estate investing great?
1 thought on “The ABCs of Apartment Investing to Maximize Profits”
Nice straight forward article. Nice example of the steps Kristy and Kevin took to land their first deal. Anyone thinking about investing, should have their appetite peaked and want to know more.