To the average person, it’s not very obvious how someone makes money by investing in apartment buildings. After all, these rental properties are not like corner stores or restaurants where the business activity of selling goods generates revenue. In fact, many people are not even aware that apartment buildings are businesses at all.
I grew up in apartment complexes. I didn’t live in a house until I was 23 years old. I’ve lived in high rises, walk-ups, student housing, townhouses, and more. Never in all those years did I think about the business side or potential rental income of an apartment building. All I knew was that we paid our monthly rent, sometimes to a landlord, sometimes to a property manager, but that was about as much thought as I put toward the inner workings of multifamily properties.
And even though I’ve had residential real estate investments for over 10 years, it wasn’t until recently that I understood how the apartment building business operates. However, once I learned how an apartment complex creates cash flow, I instantly recognized how superior apartment investing is over single-family rental properties. The most obvious reason? – the number of units under a single roof.
After reading this article, you’ll have quite the commercial real estate education. So, the next time you drive by an apartment complex, you’ll see much more than a multifamily building. You’ll see a profitable piece of commercial real estate.
A business is simply a way to make other people’s lives better. – Richard Branson
Perhaps the best-known or most obvious aspect of how the apartment business makes money is rental income. After all, most of us have lived in an apartment before, so we understand the basics: if you want to avoid getting thrown out, you pay your monthly rent on the first of the month. Or else!
Rental income is the primary way that an apartment building makes money. The rents collected become the biggest chunk of the gross income for that month. Then, the mortgage and expenses are paid, leaving the net operating income, or NOI.
In other words, the NOI (net operating income) is the apartment building’s monthly profit. When you jump into apartment investing alongside other commercial real estate investors, you split the NOI amongst those partners and investors as passive income.
For example, let’s say you’re an investor in a 250-unit apartment building. Rents average $1,000 per door, for a total gross monthly income of $250,000. Let’s say that the mortgage is $75,000 and that expenses (maintenance, repairs, utilities, management fees, and more) come out to $125,000.
$250,000 (gross income) – $75,000 (mortgage) – $125,000 (expenses) = $50,000 (NOI)
In this case, your NOI is $50,000. If you owned this entire apartment building investment property yourself, you’d be taking home a rental yield of $50,000 per month. Most likely, though, you are probably investing in apartment buildings alongside a group of many real estate investors, so that $50,000 is split amongst all the partners and investors, either on a monthly or quarterly basis.
But imagine if you had several multifamily properties in your investment portfolio. The potential rental income is exciting, even if you’re splitting it with other investors, especially since you aren’t responsible for any on-site work as a passive investor.
Ancillary Income Is A Good Investment Strategy
While the tenants pay their monthly rental requirement for physically occupying the apartments, many apartment buildings also have other ways to generate income, through ancillary income sources like lock boxes, laundry services, covered parking fees, and more.
These are all the little extras and amenities, like a coin-operated laundromat, vending machines, clubhouse rentals, reserved parking spaces, covered parking spaces, trash valet, shared wifi or cable, pet fees, and more. This is where apartment owners can get really creative, learn about the needs of their residents, and provide services and amenities of to make life easier and better for their tenants.
For example, many people who live in single-family homes take for granted the fact that their Amazon packages can get dropped off right at their door. For apartment residents, however, having packages delivered and held can be a predicament, especially if there’s not a dedicated space in the building for them.
This need presents an opportunity for the apartment owner to provide an amenity that would be very useful to tenants. The apartment owner might install and rent out package lockers, which provide a needed service for the residents, as well as additional income.
When you purchase a single-family home, you know that the resale value of your home is connected to comparables in the area. If the neighbor’s three-bedroom home just sold for $475,000, your similar home’s market value is probably around the same amount. Even if you put in a crazy amount of upgrades, you’d probably be hard-pressed to get more than $525,000, depending on the asset class.
Apartments are different.
Apartment buildings are not valued on comparables, but rather, on the amount of income the apartment complex generates.
Let’s imagine you just purchased your first apartment building that generates $20,000 per month in NOI. You work together with a property management company to increase occupancy, bring rents up to market rates, and decrease expenses. Over the course of a year, you’re able to increase the monthly NOI from $20,000 to $30,000.
This might not sound like much, but that extra $10,000 in monthly NOI means your apartment building is now worth $1.2 million more. Yeah, you heard me, $1.2 million.
How does this happen?!
This is because in the apartment world, every additional dollar of NOI adds about $120 to the value of the property:
$1 (additional NOI/month) x 12 months x 10 (apply a 10% cap rate) = $120 added value
So that means your $10,000 of monthly income, multiplied by $120, comes out to $1.2 million dollars. Now, you don’t get this extra $1.2 million right away. It’s not like the monthly cash flow payouts you get from the rent. This $1.2 million is in equity, so you only receive that once you sell the property.
This is one of the reasons commercial real estate properties change hands fairly often. Each owner comes in, implements their business plan to improve the property, then sells for a profit and moves on to improve another apartment complex.
To accomplish these value increases, the apartment buildings’ owner and property manager must work together over time to optimize efficiencies. This drives up the NOI, thus maximizing the profit earned when the apartment complex is sold.
Another major way money is generated by investing in apartment buildings is through renovations, also called value-add opportunities. The simple act of improving a unit doesn’t make any money by itself. Rather, think about the goal of an apartment complex renovation. By providing property maintenance and improving a unit, you are providing a cleaner, safer, and better place to live.
As a result, you will be able to charge more rent, as people are willing to pay more for nicer places to live. Increased rent leads to higher gross income, which, in turn, increases the NOI. Increased NOI also leads to increased property appreciation. In this way, renovations can lead to both increased cash flow returns, as well as increased equity.
Further, if you also renovate the common spaces (e.g., improve the lighting, install new windows, improve the landscaping, get a fresh sign for the building, etc.), tenants start to take pride in their building and refer their friends. Passersby on the street start to take notice. And once that happens, you’ll be able to increase rents further and decrease vacancies, nudging up that all-important NOI.
Depreciation = Tax Advantages
Another great reason for investing in apartment buildings? You’ll receive tax benefits from the depreciation of each of your real estate investments. You receive a Schedule K-1 in the first quarter of every year for your taxes, which indicates the income and losses for that particular property.
Every year that goes by, the property depreciates a little more, which can be deducted from your annual taxes. These deductions offset your annual income from your investment property. Who doesn’t love tax breaks?
How To Invest In Apartment Buildings
So how do you invest in apartment buildings? It’s not as simple as buying groceries, but it’s not a difficult process either.
As an individual real estate investor, it’s likely only single-family rentals or very small multifamily properties have been within your reach. Apartment complexes cost multiple millions of dollars which is no pocket change!
Here are a few options for those with a net worth under the multiple million mark:
To invest in apartment buildings, invest as a partner through a real estate limited partnership. Choose an experienced partner operator to help raise money, find a reputable property management company, and perform due diligence to determine if specific properties are worth investing in.
Real estate syndications (sometimes also referred to as real estate crowdfunding) pool investors’ money to buy large commercial assets like apartment complexes and distribute the profits from the business plan to passive investors. This option allows high-net-worth investors to pool money together to invest in multifamily properties.
Real estate funds are similar to syndications but generally invest in multiple properties at once. When you invest in a real estate fund, you may or may not get to select the properties in your investment portfolio. Remember, it’s important to perform your due diligence on the company and the properties you’re investing in and ensure you’re satisfied with who you’d be investing with.
A Note On Making Money From Apartment Investing
Some people think that making money is a bad thing and that it shouldn’t be talked about. That somehow, because apartment investors are making money off people’s rent, they’re only in it for the money, or they’re greedy and are exploiting their tenants.
But think about it this way. What would happen if rental property owners didn’t improve the units? The units would fall into disrepair. Appliances would age, floors would become discolored, and tenants wouldn’t feel proud to live in those buildings.
For those real estate operating companies who allow their apartment complexes to fall into disrepair, I totally agree that those people should NOT be owners. But, the vast majority of apartment owners and investors are not like that. They’re in this business to provide an excellent place for people to live and to make a positive impact on the communities they invest in.
The fact that real estate owners can make money from apartment investing is a GOOD thing because it ensures that they are properly incentivized to provide good, safe, and clean housing for their tenants.
So, as you can see, apartment buildings are not just places for people to live. Apartments are a profitable business. And just like restaurants and corner stores, apartment buildings provide a place for people to gather, live life, and make memories.
Apartment buildings are good investment opportunities. As an apartment investor, you’ll make money, create a reliable passive income stream, and enjoy tax benefits, while providing a valuable service to people and communities.