How can you buy an Apartment Building? Consider the children’s poem from Shel Silverstein, “How to eat a Whale”. One of my childhood favorites.

The answer for eating a Whale is taking one bite at a time. The poem actually puts it as small, slow, consistent bites, over a very long time. So it can be done!

However, when buying an Apartment building we don’t want to take 89 years. Let’s look at it a different way.

Economies of Scale

For most real estate investors, they start out with buying a single family home to rent, then maybe a duplex, then a triplex or fourplex. In my case I just bought fourplexes only. I skipped the small stuff. But even with buying fourplexes, at some point you want to graduate to the bigger stuff. Why?

Because Apartment Buildings provide greater returns in a shorter amount of time. They are much more scalable. 1-4 unit properties are considered residential property. As such their value is based on comparable sales, typically based on the square feet, number of beds and baths, and the overall condition. Not a whole lot you can do to increase the value other than making it as nice as possible. Sometimes you may be able to add an extra bedroom or bathroom. The good thing is you can usually get them on a 30 year fixed rate mortgage, and can househack to get a very low down payment and the lowest interest possible, not to mention save on living expenses. But if you increase the rent by $100, that is exactly what you get, an extra $100/mo since it is one single rental unit. But it doesn’t increase the value of the property just because you raised the rent.

5 units or more are classified as commercial property. Commercial property have their value based on the income they produce, or the Net Operating Income (NOI). I won’t get into all the details but the NOI is basically the income minus expenses. Then with that NOI the value then is calculated using the Cap Rate, or Capitalization Rate. This will vary with each market and specific location and the property itself.

For example, let’s say a property has an NOI of $100,000 and a Cap Rate of 5%. You divide the NOI by the cap rate to get the Value. So $100k/.05 = $2,000,000. The cap rate can change based on the safety level of the income. So if you have a building being rented by Walgreens, you will have a low cap rate because that is a pretty well guaranteed income. But a building being rented by a local daycare during a pandemic may have a higher cap rate because it is more risky.

Let’s say you have a commercial property that is currently at that $2M value and that income level as mentioned and we’ll keep the cap rate the same. You do some updates and lower expenses. It costs you another $100,000 to renovate the units which increases the rent, and you maybe change out the toilets to low-flow ones that use very little water and make some other changes to reduce your expenses. So yes, it cost you $100k (a full year’s worth of income at the beginning NOI) to make these updates. But by doing that you now have a higher NOI. Let’s say this is a 20 unit building that was renting for $600/mo for each unit which equates to $144k/yr income. And therefore the expenses were $44k which left us with the $100k NOI. After the updates, the rents can be pushed to $850/mo and the expenses were reduced from $44k to $25k.

Here’s where the Awesome happens

The yearly Gross income is now at $204k and expenses at $25k which gives a new NOI of $179,000. Maybe you are thinking spending $100k to update 20 units = $5k/unit may not be worth it to only increase the rents by $250/mo. I still think that is pretty good because you are at almost a 60% return on investment, taking the yearly increased income. But let’s look at the new valuation. $179k/.05 = $3,580,000. By spending $100k we have increased the value of this property by at least $1,580,000. I say “at least” because it is likely we have also made this property more stabilized and “better” so the cap rate may be lower, maybe a 4%. So a 4% cap rate would be $179k/.04 = $4,475,000, almost $1 Million more!

That is why Apartment investing is so awesome! You can spend very little to have a huge increase. (I say ‘little’ but $100k is still a lot, but little in relation to the value increase)

You may be asking, “Sure, sounds great. But I don’t have that kind of money to fix it up, let alone BUY it to begin with.” That’s where the eating the whale example comes in. YOU don’t have to be the one to eat it all. YOU don’t have to come up with all the money. If you do things right you may not have to put any money in it, or at least not a lot. Find a great property and bring it to a syndicator and they will probably let you be involved just for finding the deal even though they will do all the work, they will likely still give you some ownership in it because they want you to bring them more deals.

SYNDICATION Basics

Instead of eating the entire whale yourself and taking a lifetime to do it, what if you invited your friends and family to eat it with you? Each person gets a fair portion and you can all eat it within a few days. Buying a multi-million dollar apartment building is similar. You can use a syndication. The bank still takes the majority of the cost with a loan. You need to come up with the down payment, some reserves, and the rehab budget. To keep things simple let’s say it is a $4M purchase price and you need a 25% down payment, or $1M. And you have a rehab budget of $500k. So you need a total of $1.5M plus some cash reserves, maybe another $200k, so $1.7 Million total. Where do you get that kind of money?

With a Syndication, you are offering other people the opportunity to partially own this property with you and get a return on their investment. At its most simplest form, a syndication is basically a group of investors who pool their money together to buy an apartment building. 

Maybe you get 10 people to each put in $100k and another 10 people to put in $50k each, and then a few other people to put in $10-40k each. Boom! There you have the funds you need. You offer them a nice interest payment and some equity, paid using the rents that are collected, and then when you refinance or sell the property in 3-5 years, you pay them a portion of the proceeds. In the end they get an average of 15-20% IRR, maybe even doubling their invested money by the end of it. And you made a great return and possibly still own the property if you were able to refinance it at the higher value and pay back all the original investors.

Of course, there is more to it than that, some SEC laws and regulations need to be followed so please do not do this on your own without first learning or working with someone experienced. A great basic resource is the book The Best Ever Apartment Syndication Book by Joe Fairless. Should be a Textbook, not just a book then the acronym could be the BEAST.

You can also learn a lot from several podcasts, such as Diary of an Apartment Investor with host Brian Briscoe, a personal friend of mine. There are a lot of resources out there. Many opt to pay for a mentorship program to learn and to form partnerships with other members with the sole purpose to do syndications. This may not be for everybody, they usually come at a high cost. But if you are someone who takes action, it may be worth it.

There are a lot of details to cover, much more than can be simply put in a blog post. But this is a general overview of what it is. How do you get involved in one? Start networking with people that do it. Right now there are virtual meetups literally every day of the week with different groups. You can find some of them at places like BiggerPockets.com and LinkedIn, or even reach out to some that you hear on a podcast. Don’t be afraid to contact them. I have made several great connections by simply doing that. They will then start sending you opportunities to review and invest in if you like it. You can invest passively as an LP or Limited Partner, meaning you invest money but are not involved with the operation or management of it. Or as a GP, or General Partner, meaning you are actively involved in the management of the project in some role. Some people do a LP deal first to help learn the process before taking on a GP role.

If you are interested in learning more, use the contact form to reach out and I would be happy to discuss this and other Real Estate investing techniques and opportunities with you. Or simply email me at CTRfinanceblog@gmail.com

This is generally not something most investors start with, but you can. Nobody says you have to start with single families or duplexes.

One FInal Thought

Another view of the eating the whale mindset is, how long do you want to take to reach your Financial Independence? You can get there, eating one small bite at a time (single family houses) and take 89 years to reach your goal. You can along the way use a 1031 exchange to convert smaller properties into larger properties. Or you can use syndications, or partnerships, or many other options to scale more quickly and eat the whale in a much faster timeframe. Therefore freeing up the rest of your life to do the things you enjoy. I look forward to hearing from you on your success.