How to invest in apartment buildings

How to invest in apartment buildings

Investing in apartment buildings can seem very complicated at first glance. Thankfully, there are numerous beginner-friendly strategies to get started as well as arrangements that suit accredited investors.

1. Buy an apartment yourself

One option to invest in an apartment is to simply work with a real estate agent who specializes in this type of real estate and to invest by yourself. However, this approach requires an immense amount of capital, especially if you're searching for larger buildings with many levels and dozens of units.

Additionally, if you invest alone, managing the apartment building is your responsibility as well. Landlords often work with property management companies to help find tenants, stay on top of payments, and to keep up with maintenance. But again, the barrier to entry for this solo investment is likely too high for most investors.

How much down payment is needed to buy an apartment? To buy a multi-unit building, you should aim to save up between 25% and 30% for a down payment. As with a regular home loan, the lender will examine your finances. A loan officer will look at your credit report, check your credit score and examine your debts.

If you don’t have great credit or you’re carrying some debt, consider saving a little more to offset your risk to potential lenders.

2. REITs

Real estate investment trusts, or REITs, provide a much more beginner-friendly way to invest in apartments or other forms of commercial and residential real estate. And if you're interested in fixed-income, REITs certainly deserve a spot on your investment radar.

A REIT is a company that owns or operates income-generating real estate. By law, they're required to pay out at least 90% of annual taxable income back to shareholders as a dividend. And since many REITs are publicly traded, you can purchase shares through your online stock broker very easily. This includes residential REITs that invest in multi family homes and apartment complexes.

The main advantage of REITs is that you can generate income with them. And if you stick to publicly traded REITs, liquidity isn't as high of a concern as private REITs.

However, growth potential is lower for REITs than something like growth stocks. This is because REITs must distribute 90% of taxable income back to shareholders, which limits how much capital can be put back into growth. But if real estate income is your goal, REITs are an excellent investment.

3. Real estate crowdfunding

Like REITs, real estate crowdfunding platforms present another low-barrier-to-entry option for investing in apartment buildings and other residential or commercial real estate deals. Crowdfunding companies pool money together from investors to purchase and operate income-generating real estate. Many platforms have their own eREITs which invest in numerous properties, while some platforms also offer individual deals you can buy-in to.

Fundrise is one of our favorite platforms since its $10 minimum lets you

invest in real estate without much money. It also has very low annual fees and has historically returned around 8-9% annually. Streitwise and CrowdStreet have a mixture of individual deals and are also branching into eREITs, although both focus on commercial real estate like office buildings slightly more.

In any case, crowdfunding is a viable way to add real estate to your portfolio without much capital. And you can still reliably earn dividends in a similar fashion to REITs.

4. Work with a partner

If you like the idea of owning an apartment building yourself but don't have enough capital or want to mitigate some risk, you can consider investing with a partner. This route makes it easier to acquire the capital to invest in the first place. And, you and your partner can divide sourcing and management responsibilities between one another how you see fit.

The main downside of this strategy is that you give up some control. This might not matter for day-to-day management once tenants are moved in and things are operational. But when it comes to upkeep, potential renovations, and deciding when to sell, it could be more challenging to always be on the same page.

5. Syndication

Similarly to investing with a single partner, you can also explore real estate syndication agreements to invest in apartment buildings or other types of real estate.

In this arrangement, a sponsor generally invests a large percentage of the required capital for an apartment building and then handles the active management. Other members of the syndication are limited partners, meaning they're passive investors but provide the additional funds to complete the deal.

Everyone in the syndication can benefit from rental income distributions and potential property appreciation. But it's the sponsor who's in control of the property and management. This can work out perfectly for all parties, assuming everyone agrees with the sponsor.

Also note that like many forms of real estate investing that require a lot of capital, you need to be an accredited investor to take part in a syndication agreement. This means having an annual income of at least $200,000 ($300,000 with a spouse) or having a net worth of $1 million or more.

6. Real estate funds

Like the name suggests, a real estate fund is a fund that invests in real estate. Typically, real estate funds are either ETFs or mutual funds, and some are actively managed while others are passive. There are also private real estate funds that invest in individual properties, although these often require much higher initial investments.

Like publicly-traded REITs, you can buy many real estate funds using your broker. And plenty of brokers offer their own funds as well, such as the MSCI Real Estate ETF (FREL) from Fidelity or Vanguard's Real Estate ETF (VNQ).

The main difference between REITs and real estate funds is that REITs pay out 90% of taxable income to shareholders whereas real estate funds mostly earn through appreciation. If fixed-income is your goal, most other apartment building investing strategies are a better choice.

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Pros and cons of investing in apartment buildings

Pros

• Monthly rental income can be quite lucrative
• Expenses like maintenance and property management are eligible for tax deductions
• In markets with limited supply and high demand, monthly rental prices can continue to increase
• You can exit by selling the apartment building or potentially sell individual units

Cons

• Some methods of investing in apartment buildings require immense capital or being an accredited investor
• It's not a passive investment unless you pay to outsource everything to a property management company
• Vacancies and late payments pose risks to cash flow
• Ongoing expenses, insurance, and renovations can be very costly

Who should buy an apartment complex?

Investing in real estate is a popular way to diversify your portfolio. And it can also serve as a good inflation hedge in many cases. Both of these advantages hold true for investing in apartment buildings. You can also generate some serious cash flow if the building has long-term tenants.

If you're mostly interested in portfolio growth, some options like REITs or crowdfunding might not be as enticing. And direct ownership, even with a partner or syndicate arrangement, requires a lot of capital.

For new investors, you can explore various crowdfunding platforms or stick with REITs and real estate funds to dabble in apartment building investing. And more experienced investors with serious cash can consider direct ownership, provided they do due diligence and understand the work that's involved.

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Tips to successfully buy an apartment building

If you’ve decided that the pros outweigh the cons and you’re ready to move ahead, follow these steps to a successful purchase of an apartment. Soon you’ll be calling yourself a landlord.

Consider expenses beyond the mortgage. Even if the property was inspected before you signed the dotted line, you may encounter unexpected repairs or hazardous materials or contaminants that need to be dealt with before the units can be rented out. And once tenants have moved in, you will have to manage the utilities (water, heat, electricity). If residents are not footing the bill, sometimes they can abuse and overuse utilities.

Among other costs you’ll likely face are regular maintenance and repairs such as pest control, plumbing issues, grounds maintenance and damage caused by tenants.

Finally, you’ll need insurance, and it will be more expensive than your typical homeowners insurance, especially if the building is older or in a rundown part of town.

Talk to commercial real estate experst. Start by finding a commercial real estate broker; they will have industry and local knowledge and may also be able to help negotiate the price of the apartment complex. You’ll also likely want to loop in a multifamily loan brokerage or advisory firm if you’re purchasing the building with a loan. These experienced intermediaries can offer investors experience and the benefit of their relationships to find your ideal financing option.

You’ll pay for these services, but especially if this is your first commercial property, you’ll likely register some savings that will benefit you for the life of the mortgage loan.

Get to know the neighborhood. Try to find a building in a neighborhood that you know or live close to. If you can’t do that, spend some time getting to know the area. Consider its employment and economic data, the health of local employers, the population and its growth trends and crime data for the area. An ideal apartment building is one located in an affordable part of town that is projected to grow over the years.

Calculate your potential annual return. One way to evaluate whether buying an apartment complex is a good investment is to employ a capitalization rate, or cap rate. This metric is commonly used in commercial and multifamily real estate investing to help calculate your potential annual return. The formula looks like thsi:

Net Operating Income (NOI) / Market Value (or Purchase Price)

NOI is the anticipated revenue from your property minus the necessary operating expenses. So if you’re looking at a property worth $1 million and your NOI is $75,000, your cap rate will be 7.5%. The higher your cap rate, the better.