Why you should flip apartments instead of houses
by @thewillcrozier
Good money can be made flipping houses. I did it for years. Even better than the money was the fundamental skill set acquired while flipping houses: Real Estate, Money Management, Partnerships, and Networking.
There are inherent limitations in SFR (Single Family Residential). For Example: Let’s say I buy a house for $50k in a neighborhood where similar houses regularly sell for $100k. No matter what I do to the counter tops, flooring, or floor plan, I’m never going to be able to sell it for $200k. In fact, there are many scenarios where I could spend $150k in improvements to my little $50k flip house, and still not be able to sell it for more than $125k. This is because SFR is valued on “Comparable Sales” or “Comps”.
MF (Multifamily / Apartments) real estate is valued differently. It is valued based upon the income it produces. This makes MF valuation much more like a business than SF real estate. This creates two very powerful opportunities for MF investors. They can 1-Improve Cashflow, 2- Take advantage of the “Magic of the Cap Rate Multiplier”. BTW, that’s the working title of the upcoming ninth Harry Potter Film.
Improving cashflow is really as simple as it sounds: increase income and decrease expenses! To increase income one could change the paint color of the buildings from purple to grey, have more professional and physically fit leasing staff, offer more amenities to the residents, or upgrade the unit interiors. To reduce expenses an owner could run a water conservation program, install energy efficient lighting fixtures, or upgrade the apartments with long lasting finishes like granite, vinyl plank, and tile shower surrounds that do not need to be replaced on each move out.
Now, onto the “Magical Cap Rate Multiplier”. This is where things get really fun. Let say you install a $200 over-the-range microwave in all of the apartments in your 250 unit complex. Your onsite manager is excited and tells you that she can lease apartments for an extra $20/month with the microwave upgrade based on the demographics in your property. It costs you $50k ($200 x 250 units) to make this upgrade, but in the very first year you make an extra $60k ($20/month x 12 months x 250 units) in income. So in the very first year you net an additional $10k in profit, then in the second year, you are making the full $60k extra each year. I think I’m like most people and would really enjoy an extra $60k a year. (Aston Martin DBS Superleggera payment?? No Will! You’re selling your cars right now, not buying more….) But that’s peanuts compared to the next realization. Your broker and banker tell you that your property is valued on a 6.5% Cap Rate, so you just added $923,000 of value to your property with a tiny $50k microwave investment. ($60k of increased income divided by 6.5% Cap Rate is the $923k in increased value of your apartment complex)
Based on real world experience, I’m about to receive 200 private messages bitching about my assumptions above, undoubtedly all of them are correct. If you don’t like how I told the story, write your own. $200 microwaves and not-commercially-available Aston Martins are the heroes of this one.
When my team goes into battle, we always have a strategic plan to bump rents $150/unit/month. We get this done by upgrading apartments, improving physical condition of the existing structures, adding resident amenities, improving management, and reducing waste. Go ahead and figure out what that “Magical Cap Rate Multiplier” does with a $150 rent bump on a 500 unit complex at a 6% cap… Hint: It increases the valuation by $15,000,000. If you are the deal sponsor/syndicator/lead investor in this deal and had negotiated a 20% cut of of the profits with your passive investors, you just added $3MM to your personal net worth in one deal.
All of this cap rate mumbo jumbo, hocus pocus crap works just as well, or in many cases, better, when dealing with commercial real estate ventures. This is also true for nearly all businesses, like a random import company or web application business, so apply these principals liberally to any of those asset classes.
Now please go set yourself free so we can hang out in Jakarta, Ibiza, Taco Bell in Irving, or wherever.
