Updated: Jan 9
It appears that lately everyone wants to own an apartment building. Experienced investors, novice investors, “mom and pop” operators, foreign investors - they’re all bidding on apartment buildings. Not only are they bidding, they are overbidding as well, driving up prices well beyond the asking price. It’s no surprise, as apartment buildings are considered an excellent investment
There are many pros to owning an apartment building, as well as some cons that you should consider before putting down any money. I’m a huge believer in multifamily as an asset class, but it’s important that you are aware of the pros and cons of owning one.
Pro #1: Passive Income - Earning Money While You Sleep
Passive investors are those who put up funds in an apartment building but have no role whatsoever in managing the property. They are usually part of a syndication, and are investing because they want to earn passive income from their investment.
There are actually multiple income streams involved for investors. They earn their passive income from monthly rents, based on the property’s net operating income (NOI). This is income after expenses. If improvements are made to the property, and the reputation of the apartment building also improves, there is potential for higher rents over time, which can boost your passive income.
In addition, investors can earn money from appreciation when the property sells, usually after a pre-defined holding period of 5, 7 or 10 years. If the property is well managed and vacancy rates remain low, the property’s value will increase over time.
Passive income offers other benefits to investors. Your money is always working for you, with no effort on your end. You are able to continue working in your current profession, or focus on whatever passions you enjoy. That’s the meaning of “passive” - you don’t have to do any work at all on the apartment building. Others do it for you.
Pro #2: Economies of Scale
Whether you have a 2-unit apartment building or 200-unit property, you will enjoy economies of scale. If you have a property manager handling the day-to-day operations of your apartment building, it’s just as easy to manage multiple units, as it is to manage two. The property manger find new tenants, collects rents, manage repairs, etc.
Let’s look at how economies of scale affect expenses. Suppose you owned a 200-unit apartment building and were able to save $25 a month on each unit on water bills by installing some water-saving devices, like low water pressure shower heads and low-flow toilets. Your $25 savings in water utilities will generate an additional $5,000 per month, or $60,000 a year in positive cash flow. Plus, that cash flow will also raise the property’s value.
The biggest impact of economies of scale is on the value of the property, and the best way to demonstrate this is by example. If you have a 2-unit apartment building, or duplex, and you raise rents by $30 a month, you’ll end up with a $60 a month increase, or $720 per year. On the other hand, if you raise rents by $30 a month on a 200-unit apartment building, your increase would be $6,000 per month, or $72,000 per year. That’s a huge difference in income, but it gets better.