owning and managing a mid size apartment building

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I have personal experience owning/renting/managing single family homes and duplexes.  I have generally preferred the single family homes.  In the neighborhoods I feel most comfortable, these are roughly $100,000 homes that rent at around 1% of that per month.

I was browsing MLS listings the other day and ran across a much larger property that I have no experience with.  For about $600k, there is a 24 unit building available.  Rectangular basic box shape, all brick, built in 1964, total sq ft about 16k, sitting on about 1 acre.

Granted these are small units at 670 sq ft and very plain inside.  But they are kept up, in good shape, and the building is fully leased at around $600/month.  It is listed as "commercial", I don't know what tax implications that brings about.

This is the first time I've even looked at something like this and the numbers look too good to be true.  Even if 4 of 24 units goes vacant, we are talking a monthly rental intake of 2% of purchase cost, double what many here on FW would consider investment grade.

I have the skills to handle all mild to moderate repair and updates myself.  If I quit my job, I would have the time to manage the 24 units.  (Let's leave that angle out of this thread for now.)

I'd love to hear from other people that have buildings in this general size range.  Do you find that the cookie cutter design makes repairs easier, because you know what to expect in each unit?  Do you find that common area repairs (roof, drive, parking), while being more expensive and requiring a lot of cash, are easier to manage as projects, than having several smaller properties to juggle and visit?  Wouldn't the lost income when someone moves out be much lower than a single family home because a smaller fraction of my investment is unrented at any given time?

I'm having a hard time thinking of negatives, besides the fact that the tenants are more likely to be young, single, perhaps careless, and more transient.  But compared to spending $600k on 6 single family homes, we're talking twice the rental income.  Seems worth the potential tenant issues.

Thank you to everyone with experience that weighs in!

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If the numbers look too good to be true then theres a good chance they are too good to be true. I'd examine the financials and expenses and look for deferred maintenance and addded expenses you may not be aware of. e.g. does the landlord pay for heat and utilities with an awfully expensive outdated furnace and poor insulation in a cold Northern state?

If the property is commercial then that means you'd need to get commercial financing rather than a standard residential mortgage. Commercial loans can be harder to get and the terms are not as good. Commercial status may mean the property has to adheree to additional rules, like for example you may might need to have a fire alarm system with annual certifications or similar things you don't have to do with a normal 1-4 unit residential property.

I'd try to find out a bit more on why the owner is selling. For example, you can look up records and see he's an 80 year old and no other property owned = probably just retiring. If he's 45 and owns 3 similar buildings but is only selling this one, that's a red flag

Also, be aware that the property will be valued using an income approach rather than a compareable sales approach & you'll likely need 25-30% down if financed through a bank

What is the return on investment after you factor in the cost of property management? 2% including your salary doesn't tell us much. If you had to hire someone to do this function, how much would it change your monthly rent as a % of the purchase price? Would you be down to 0.5%?

Remember - you can "emulate" this by taking a full time role as a property manager (say collecting 1% of rents as your salary) and also buying a property that yields 1% in rents per month. At that point, you have synthetically created this same opportunity, and you're not working at the one you own.

My only point is to separate what you make as an owner and as a manager.

You're going to find that over 5 units, most lenders will want you to put down 35% (at least in CA) and the longest loan you can get will be a 10-year loan amortized over 30 years (you will have to refi after 10 years). Also, read up on that loan you get. A lot of the residential loan "protections" do not exist in the commercial loan world (ie. prepayment penalties).

How much experience do you have managing properties? Are you planning to manage it yourself or hire someone?

So you wanna be a slum lord eh....plenty of books on that. The problem is the "Roaches in a box" model. People will whine and complain to no end about other tenants.

Dig into the financials hard. I used to work for a brokerage that only sold apt buildings and there really is a lot that they can hide. For example, was it over half vacant six months ago and they offered everyone 2 months free on a 12 month lease so when they went to market it would be 100% occupied at $600/month? Because if so the tenants are going to want another 2 months free or they are going to leave when the lease is up. Also, did the tenants have credit checks and background screening? Do they actually collect the $600/month from everyone or is it full of deadbeats you'll have to evict? How willing is the owner to allow access? Really all units should be physically inspected and all tenant files should be thoroughly reviewed. Is there a property management contract in place and do you have to assume it? What other contracts are in place that you would have to assume? Is there a staff? Do they have full time income plus benefits? Payroll on something like that can be crippling and if there is a management contract in place you could be stuck paying it.

This is in Ohio.

The point about larger buildings needing to meet commercial building fire codes is a great point and a big unknown to me. I would imagine the city inspector's office could help me figure out everything entailed in that, and beyond fire code, what else needs to be met.

Having a large down payment with a short repayment period is not personally a hurdle, but that is great information to others for this scenario.

As far as managing the property, that is essentially a key element to my post and the info I am trying to get. If you were going to invest $600k in rental real estate, and your options were 6 single family homes that each rented at $1000 pulling in $6000 per month, OR, a mid size apartment building that cost $600k and pulled in about $12000 per month, what factors exist that influence this decision that are not something your typical "small time" landlord realizes/considers. Whether I property manage or I hire someone, for comparison purposes, I would do the same for scenario A or scenario B.

I wonder how insurance for a 24 unit commercial building compares to insurance on 6 single family homes. Next step would be to call my agent.

The point about investigating "deferred maintenance" issues is a great one. On a typical single family home, I would be looking at the roof, age of plumbing, siding/exterior, gutters, mechanicals, windows, etc. I assume most of that is the same for a 24 unit building, but I bet there are a few unique aspects too. Those are the specifics I hope someone experienced can highlight for me. Shared plumbing or sewer infrastructure?? Electrical distribution panels??

Thank you.

berlinsmommy said:   Dig into the financials hard. I used to work for a brokerage that only sold apt buildings and there really is a lot that they can hide. For example, was it over half vacant six months ago and they offered everyone 2 months free on a 12 month lease so when they went to market it would be 100% occupied at $600/month? Because if so the tenants are going to want another 2 months free or they are going to leave when the lease is up. Also, did the tenants have credit checks and background screening? Do they actually collect the $600/month from everyone or is it full of deadbeats you'll have to evict? How willing is the owner to allow access? Really all units should be physically inspected and all tenant files should be thoroughly reviewed. Is there a property management contract in place and do you have to assume it? What other contracts are in place that you would have to assume? Is there a staff? Do they have full time income plus benefits? Payroll on something like that can be crippling and if there is a management contract in place you could be stuck paying it.
  
Wonderful post, those are the tricks and nuances I am looking for.  Thank you!

For a SFH, you can have the tenants pay for all the utilities. You'll want to look at what utilities are split and what aren't and the cost to split them.

I'd go door knocking. Hell I'd probably knock on all 24 doors, they will know the condition of the building, terms of the lease, etc.
Just say you are interested in living there.

berlinsmommy said:   Dig into the financials hard. I used to work for a brokerage that only sold apt buildings and there really is a lot that they can hide. For example, was it over half vacant six months ago and they offered everyone 2 months free on a 12 month lease so when they went to market it would be 100% occupied at $600/month? Because if so the tenants are going to want another 2 months free or they are going to leave when the lease is up. Also, did the tenants have credit checks and background screening? Do they actually collect the $600/month from everyone or is it full of deadbeats you'll have to evict? How willing is the owner to allow access? Really all units should be physically inspected and all tenant files should be thoroughly reviewed. Is there a property management contract in place and do you have to assume it? What other contracts are in place that you would have to assume? Is there a staff? Do they have full time income plus benefits? Payroll on something like that can be crippling and if there is a management contract in place you could be stuck paying it.
  Another thing to look out for is for capital items or "extraordinary" items. They get very creative with those as well when they're trying to sell it.

bxd20 said:   This is in Ohio.

The point about larger buildings needing to meet commercial building fire codes is a great point and a big unknown to me. I would imagine the city inspector's office could help me figure out everything entailed in that, and beyond fire code, what else needs to be met.

Having a large down payment with a short repayment period is not personally a hurdle, but that is great information to others for this scenario.

As far as managing the property, that is essentially a key element to my post and the info I am trying to get. If you were going to invest $600k in rental real estate, and your options were 6 single family homes that each rented at $1000 pulling in $6000 per month, OR, a mid size apartment building that cost $600k and pulled in about $12000 per month, what factors exist that influence this decision that are not something your typical "small time" landlord realizes/considers. Whether I property manage or I hire someone, for comparison purposes, I would do the same for scenario A or scenario B.

I wonder how insurance for a 24 unit commercial building compares to insurance on 6 single family homes. Next step would be to call my agent.

The point about investigating "deferred maintenance" issues is a great one. On a typical single family home, I would be looking at the roof, age of plumbing, siding/exterior, gutters, mechanicals, windows, etc. I assume most of that is the same for a 24 unit building, but I bet there are a few unique aspects too. Those are the specifics I hope someone experienced can highlight for me. Shared plumbing or sewer infrastructure?? Electrical distribution panels??

Thank you.

  
More low cost units are more work versus fewer higher cost units.   But you can scrape better profit margins or returns off mult units.

With single family homes the tenant will generally do the lawn maintenance, be responsible for snow removal, pay all the utilities and is more likely to stay in the house for a few years at a stretch.   You're also charging more rent which rules out low income tenants who often have more money problems and other issues.
With an apartment building, you usually have to pay for most utilities and common lighting and things like lawn care and snow removal.   That can add up.  You're going to have more frequent turn over and with 24 units you've got 4 times as much tenant communication and maintenance calls as you do with 6 SFH.   Lower rents equate to lower income tenants which often have money problems and personal issues (to paint a broad generalization to be sure, of course there are low income tenants who are great and high income tenants who are deadbeats).

A detail like fire code or other rules for commercial properties is likely not a big financial impact but its stuff to be aware of.   It may require commercial insurance which could be a significant cost, you might have entirely different cost structure for some utilities, local taxes might even differ.   Here I'd have to pay a city business tax of 2% if I had a large property in the city, but thats probably not common in most cities.   Variuos local rules may differ to some extent, like our trash service system is different if you're commercial vs residential.   Taxes for the federal level won't really change with a commercial property though, the rules are the same (as far as I've ever seen).
 

Some great answers for op... Id be concerned with that many units if they are all one bedroom. You'd be looking at higher turnover. Even singles like to have two bedrooms these days. Your one bd units wouldn't allow for roommate situations, or couples who want the additional space for family or a child. You wouldn't be able to offer them a two bd unit to keep them as tenants. I owned a 3 bd , 1300sq Ft sf home... but sold, as I found the general market wanting more sq footage. I had an older single person rent for 5 or so years, but was harder to relet once moved out.

Six sf homes likely wouldn't be 15k sq Ft, so though your income may be higher, your maintenance costs and headaches are greater.  is your comparison of six sf homes at same value, even a good comparison for analysis, in Ohio.

JaxFL said:   Some great answers for op... Id be concerned with that many units if they are all one bedroom. You'd be looking at higher turnover. Even singles like to have two bedrooms these days. Your one bd units wouldn't allow for roommate situations, or couples who want the additional space for family or a child. You wouldn't be able to offer them a two bd unit to keep them as tenants. I owned a 3 bd , 1300sq Ft sf home... but sold, as I found the general market wanting more sq footage. I had an older single person rent for 5 or so years, but was harder to relet once moved out.

Six sf homes likely wouldn't be 15k sq Ft, so though your income may be higher, your maintenance costs and headaches are greater.  is your comparison of six sf homes at same value, even a good comparison for analysis, in Ohio.

  the one bedroom issue is one of the biggest hurdles that I can think of as well, I have some but find they are vacant longer and the tenants are very mobile. also how new is the roof what about the hvac's, also when its 3:30 in the morning and you get calls for noise how will you handle that, That being said I do like multi housing units better. I find them to be more steady in my area.....Good luck OP

Commercial Real Estate investor checking in here... typical multifamily properties run at 40-50% expense ratio depending on the utility splits, property taxes, management, etc. What you're wandering into here is fairly different from duplexes as a result of the much larger maintenance of common area, landscaping, etc.

Regarding financing, it's most realistic to expect to put down 30-40% financing. Is it doable with less? Yes, but expect to pay substantially more. Ideally, the 35/35 HUD product (35 year term) mortgage that is prepayable, but it usually takes 10 months to close, so you can either get bridge financing or lock up the property with a 10 month closing period.

I'd hire a property management firm and have a short 30-60 day cancellation (not uncommon) and if you think you can do better then the management and leasing.

Full disclosure: I invest in assets worth more than $25M

I own a number of SFH but live in and manage a small 24 unit complex consisting of 3 buildings. As someone pointed out typically SFH do their own lawn and snow clearing. Apartment dwellers do no repairs and want everything done for them as compared to renters in SFH. An apartment complex will also have some utilities such as electricity for common areas and possibly water. It will be pretty hard for you to manage an apt complex with a full time job. I find insurance higher on the apts by quite a bit. All in all I find it is more expensive and much more time consuming to keep up say an 8 unit complex as opposed to 8 separate SFHs. Plus in the complex you will have to baby sit and referee the tenants. And it will be much easier to sell SFH than apts. Commercial buildings can take years to find a buyer for. The nice thing about apts is everything is the same so you can easily keep well stocked for repairs. In our case we usually just buy 6 of anything we buy, complete sets of blinds, sinks, faucets, etc. good luck!

JaxFL said:   
Six sf homes likely wouldn't be 15k sq Ft, so though your income may be higher, your maintenance costs and headaches are greater.  is your comparison of six sf homes at same value, even a good comparison for analysis, in Ohio.
 

6 SFH would probably end up around 8k sq ft in total around here.  In this squarely middle class suburb of Cleveland, I can get 6 SFH, each around $100k.  Certainly not a high end neighborhood but nowhere near slum quality either, I live in the area and it's got benefits and is safe.  Those $100k homes would be in good shape, move in ready.  These small 3 bedroom ranches that families here like, would rent at $900-1000 if I have them take utilities.

cajundavid said:   All in all I find it is more expensive and much more time consuming to keep up say an 8 unit complex as opposed to 8 separate SFHs.
 

That is a real eye opener!  I would not have guessed that.  But the more I think about it, it makes sense.  The indoor repairs (like plumbing) are about equal, even with less sq ft.  The outdoor work, while greater for 8 SFHs, falls much more on the tenants.  With the SFHs it might depend on who is responsible for somewhat gray areas like, outdoor painting, gutter cleanout, hedge and tree trimming, etc.

Good to hear this info, thank you.

Some additional considerations: With the age of the building, is it full of asbestos? Plumbing and electrical are 50 years old and will need to be replaced in the next 10-20 years tops. Appreciation on the apartments compared to the SFH's (much less). Legal and eviction costs, which at the lower rents is more likely to happen. The dated look of the building is probably a detriment to raising rent.

dmlavigne1 said:    Plumbing and electrical are 50 years old and will need to be replaced in the next 10-20 years tops. 
  I'd be curious as to what this involves. All the houses around here are 50-60 years old. The plumbing is easily fixed as they are exposed in the basements and bathtubs have access panels. Electrical replacement is almost always just the panel and service.

harruin said:     Another thing to look out for is for capital items or "extraordinary" items. They get very creative with those as well when they're trying to sell it.
 

  
Ha, ha, so true! I once had a guy who's expenses dropped dramatically about 8 months before he went to market. Turns out he started charging everything he could to his personal AMEX, then paying it with his home equity line which was at a low promo rate.  He figured by increasing the NOI on his apartments he would make a significant profit after selling and could pay off his home equity line and still come out ahead instead of paying those expenses from the property's budget which would lower the property's value because of the low NOI.

rufflesinc said:   
dmlavigne1 said:    Plumbing and electrical are 50 years old and will need to be replaced in the next 10-20 years tops. 
  I'd be curious as to what this involves. All the houses around here are 50-60 years old. The plumbing is easily fixed as they are exposed in the basements and bathtubs have access panels. Electrical replacement is almost always just the panel and service.

  For insurance, I have to replace any electrical, water heaters and furnace components that are over 20 years old. My company won't insure them otherwise.

Some localities will require a building of a certain size (such as over 12 units) to have an on-site manager. That means you'll have 1 apartment out of the rental pool. If you self-manage, do you also want to live on site?

I'm not sure about when you initiate the mortgage, but I've seen some lenders require (if the property isn't doing well financially) that the owner hire a professional management company rather than self-manage. Not sure if that would be a potential requirement at the initiation of financing or only if things go South.

Also, think about things like asphalt/paving/striping, keeping up sidewalks, lighting, sufficient security, pool or other common elements.

Don't forget to check police reports for the area.

I'm also a newbie in this area and I've found that once you have that 'commercial' tag some items seem to become a lot more difficult. I have a property with 5 residential units and one commercial space and here's some examples:
- an appraisal becomes expensive because they have to include income approach etc and its no longer a standard form. Mine cost 2,000
- insurance was a pain because at least in my case I had to get a commercial policy instead of a regular landlord policy
- simple things like snow removal become your problem, I paid 1,200 in NJ for a contract to plow a small parking lot for the winter
-some residential contractors and service providers get deer in headlights look when you talk to them....

Sounds like a fun project for you though and it could certainly be worth it if circumstances are right, wish you best of luck!!

cajundavid said:   
rufflesinc said:   
dmlavigne1 said:    Plumbing and electrical are 50 years old and will need to be replaced in the next 10-20 years tops. 
  I'd be curious as to what this involves. All the houses around here are 50-60 years old. The plumbing is easily fixed as they are exposed in the basements and bathtubs have access panels. Electrical replacement is almost always just the panel and service.

  For insurance, I have to replace any electrical, water heaters and furnace components that are over 20 years old. My company won't insure them otherwise.

  For electrical , does that mean running new wiring? That's the only thing I don't bother with since it's behind the walls.

civ2k1 said:   Some localities will require a building of a certain size (such as over 12 units) to have an on-site manager. That means you'll have 1 apartment out of the rental pool. If you self-manage, do you also want to live on site?

 

  Is that necessarily true? Wouldn't you just factor the lost rent into the salary you pay the manager? I realize this probably gets into labor law, but it seems like they're getting a free apt out of it.

rufflesinc said:   
cajundavid said:   
rufflesinc said:   
dmlavigne1 said:    Plumbing and electrical are 50 years old and will need to be replaced in the next 10-20 years tops. 
  I'd be curious as to what this involves. All the houses around here are 50-60 years old. The plumbing is easily fixed as they are exposed in the basements and bathtubs have access panels. Electrical replacement is almost always just the panel and service.

  For insurance, I have to replace any electrical, water heaters and furnace components that are over 20 years old. My company won't insure them otherwise.

  For electrical , does that mean running new wiring? That's the only thing I don't bother with since it's behind the walls.

  Not the wiring unless it's aluminum just the panel.

rufflesinc said:   
civ2k1 said:   Some localities will require a building of a certain size (such as over 12 units) to have an on-site manager. That means you'll have 1 apartment out of the rental pool. If you self-manage, do you also want to live on site?

 

  Is that necessarily true? Wouldn't you just factor the lost rent into the salary you pay the manager? I realize this probably gets into labor law, but it seems like they're getting a free apt out of it.

  
If OP wasn't planning to hire a manager and was going to self manage, and an on-site manager was required, then OP would have to live on site.  My point was that OP can't just assume he can self manage and rent out 100% of the units.  And if he plans to hire a manager, then he needs to be aware of the law (if there is one) so that he requires the manager to live on site as a part of their employment.  That being said, it's possible a statute requiring an employee onsite could just mean any employee (such as a maintenance worker/handyman, so maybe OP wants to self manage and just provide free rent in exchange for up to 10 hrs per week of handyman/gardening/etc to one of the tenants.  It all depends, but something for OP to investigate so they are aware of potentially stunted revenue potential.

Spectacular thread

unless you got a ton of cash lying around, there seems to be too many disadvantages to buying a large apt complex

1. zoning. around here, anything other than SFHs get zoned to undesirable areas. Either they are all grouped together and you get a ton of competition, or it's on the corner with a major street.
2. exposure. If you drive by an apt building, you say ah-ha this is owned by some rich landlord. If you drive by a SFH (especially in a nicer area) you say it's a responsible owner occupant. Less chance of fair housing testers and lawyers and city inspectors nosing around
3. problems at a unit can affect others. if something happens at one unit, (fire, crime, etc) other units will know. For SFHs, this is not an issue and you can dispose of a troublesome unit at a loss without affecting others.
4. mortgages. for SFHs you can get 30 year conventional fixed rate mortgages for up to 10 houses (then another 10 homepath houses) and twice that if you have a spouse with a separate income. The rates may not be as low as they were a couple years ago but sub 5% on a rental is still awesome. For apt complexes, you're looking at commercial loans that are adjustable rate.

This has been a solid thread. Thank you. This has been something I have been curious about doing I am glad this thread is doing so well.

How would the return on equity from owning an individual apartment building compare to investing in a REIT that owns apartment complexes? Assuming you subtracted out a reasonable salary if you managed the apartment building yourself?

surprised nobody has mentioned that SFHs generally appreciate more than large apartment buildings.

bxd20 said:     ...
  Did you do this?

rufflesinc said:    For apt complexes, you're looking at commercial loans that are adjustable rate.
Lenders do offer fixed rates loans for apartments.   In fact, Fannie Mae offers very low fixed rate loans through approved FNMA DUS lenders for 5+ unit apartment buildings.  

This lender has rates and program guidelines posted on their website.  Other FNMA DUS lenders will have similar rates so just do a web search for FNMA DUS  rates.

http://www.commercialbanc.com/apartment-rates-main-fannie.html 

http://www.commercialbanc.com/fannie-mae-products.html 


A bit of background info about the FNMA DUS program:
"Initiated in 1988, the DUS program provides approved lenders the ability to originate and subsequently sell loans on multifamily properties, usually in the form of mortgage-backed security (MBS). MBS is purchased by investors at a low yield since the security is guaranteed by FNMA. The processes of loan origination and closing can be completed by the DUS lender without FNMA’s prior review as long as the collateral and borrowers meet the established underwriting guidelines." 

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