I have been investigating buying an apartment complex as part of my real estate investing portfolio. I currently have a roster of single-family homes, but I’m pretty excited about the prospects with apartment complexes. And that’s for 7 big reasons. The main one being SIMPLICITY.
What kicked it all off was looking to rent out my 3-bedroom personal home for $2200/month. That’s a decent chunk of change for sure, but then I asked my friend living in a highrise what he was paying for his 2-bedroom apartment. It was $1800/month! A number that blew me away! Plus there are dozens of apartments in that building each going for as much as my entire house. What?!
Sure, there are issues to work out, but here’s the take.
Apartment complexes are great investments overall, but they’re not magical. Ideally, you won’t jump straight into the big building life, but buy one after having first lived in a duplex or quadplex, and house hacked your way to wealth.
Then owned another expensive rental home for a few years. You will end up with a lot of money to invest. You could keep buying more houses OR get an apartment complex.
The steady cashflow of middle-income homes and live-in quadplexes, and the staggering returns of high-value homes are certainly attractive. But apartment buildings offer all of that on a much larger scale and with a lot more efficiency.
So today I will go through:
- Why apartment complexes are so attractive for investors
- How to use it best to your advantage
- When you should get in.
Apartment Complex Recent History
According to the New York Times, the last recession triggered by the real estate crisis kicked off a trend towards renting and away from homeownership.
The same article cited that since 2004, there is demand for 770,000 new rental households each year. Rental housing is not keeping pace with such demand and that is rents are increasing much faster than the general rate of inflation in the country. Great news for landlords!
Why buy an apartment complex?
Okay, so there’s demand-galore and it’s obviously lucrative. But there are actually 7 other reasons apartment complexes are so attractive.
1 – Automatic Inflation Adjustment
By owning an apartment complex, you are all-in on rising rents. And as you can see, rents have been rising above inflation for nearly 2-decades.
You own an asset that provides an increasing rate of return. Since supply isn’t keeping up with demand, the prices won’t be going down anytime soon.
No, this isn’t special to apartment complexes but the returns are 100% rental income-based with an apartment and therefore is stable and predictable. Single family homes have a big appreciation factor in the mix, that moves on its own terms and has cycles associated with it. Those are hard to plan for.
Apartments, 100% rent-based, meaning simple planned increases. Which leads to the next reason.
2 – Simple Appreciation
I said we didn’t need to worry about appreciation with apartment complexes but that’s a bit of a trick.
This is actually a fun twist. Where home appreciation is usually based on the “trendy neighborhood” effect, commercial and apartment complex properties’ value is based on rent roll. And since your rent is always increasing, so is the value of your property.
It’s neat and simple and plannable.
This simple “rent equals value” equation also applies for bank loans. Unlike a typical house where the bank bases the loan on your job income, banks value apartment complexes and conversely set loan limits based on the property’s rental income. Also, commercial real estate loan rates are set very competitively compared to home mortgage rates. (Another fact I learned after working with banks in financing my properties.)
Which leads us to…
3 – Super loans
Look at some major banks’ websites; you’ll see that they all list their rates for credit card loans, car loans, home mortgages, etc. But you won’t see them quote rates for commercial loans. Those are private conversations, and they give heavy concessions for commercial real estate investors. Now you aren’t going to walk away with less than 1% interest rates, but they will fund renos and be quite nice otherwise.
It makes sense to them to be more lenient with such clients; they would have to originate 10 mortgage loans or 60 new car loans for the equivalent of ONE commercial real estate loan for a $3 million apartment complex. See, bankers appreciate simplicity too.
Also, for you as an investor, having one $3M loan is simpler than ten $300K loans.
Yes, this simplicity is a trend that’s worth hopping on board! Just wait and see.
4 – Recession Resilient
A great benefit of commercial property in your portfolio is that it is more resilient during a recession than a normal house.
Not only does commercial real estate perform better than residential real estate prior to a recession, but it tends to bottom faster, recovers faster, and performs better post-recession. Morgan Stanley, a major investment and research firm, evaluated the two asset classes found exactly that in 2016, well after the Great Financial recession had ended.
Based on this chart, commercial real estate bottomed in 2010, two years ahead of residential real estate. Not only that, the recovery in commercial was more than twice as much in residential real estate.
It makes sense to me, recessions cause fears of bankruptcy but people need places to stay, and if anything people tend to move towards more affordable housing in a recession. It’s no farm level of resiliency but it beats the stock market and short term housing pricing.
5 – Super Depreciation
Unlike your car’s depreciation, depreciation in real estate investing is actually a GOOD THING. It allows you to claim a certain loss which helps you at tax time. This is nothing new for real estate investors, this works for small homes and mega-properties alike, however there is one ultra-important detail when it comes to apartment complexes.
Even though apartment complexes are big commercial buildings with commercial loans, they are still depreciated like other housing at 27.5 years (commercial buildings are depreciated over 39 years).
So, if you paid $27.5 million for an apartment building, you can take a depreciation deduction of $1,000,000 every year to offset your rental income. That is $1,000,000 of your rental income you don’t have to pay taxes on. For someone doing well with an entire state and federal income tax bracket of 45% ends up saving $450,000 in taxes. Wooooeeeee!
That is the real test to gauge if a property is a real estate investment or not. All those homeowners who bought their home saying it’s the best investment they’ve ever made – ask them to deduct a depreciation expense against their income. They can’t! It only applies to properties that are classified as investments that generate revenue.
Wait, so only apartment complexes get these perks?
Well no. Single family homes also get to have:
- IEver-increasing rent
- Appreciation of their property
- Big loans
- Better resilience to recessions than stocks (although apartments are better than normal houses and worse than farms).
- Depreciation at 27.5 years
So what gives, if a single family home has the same benefits why bother with a mega building with it’s mega loan?
Apartment complexes vs. Single-family, Duplex, Triplex or Quadplexes
I’m a big believer in single family rental homes. I’m not a believer in tenant diversification. I’ve said this before, I have never had a tenant leave my single-family homes.
If the single-family dwelling is in a good location and you’re fair with your tenants, tenant turnover in a single home is always lower than with a multiplex. Since tenants of single-family homes are the dwelling’s sole occupants, they tend to treat the home as their own, leading to lesser wear and tear and fewer turnovers mean fewer turnover expenses (it’s a big deal)!
Apartment complexes don’t have that but they have some other features. Tenants always are drawn to buildings with bonuses. Bonuses like 24/7 security and laundromats which both mean an increased income from that property and shorter turnaround time.
But the real advantage comes from economies of scale.
Managing properties is neither cheap nor easy. And yes, you’ll spend a lot more money maintaining an apartment building than a single family home or a duplex, but you’ll spend less per unit. You get to manage your expenses more efficiently.
Expenses, updates, staff… You get to spread those costs across multiple sources of income.
6 – The unparalleled benefit of apartment complexes
When you have a lot of houses you will be paying a lot of management fees. I spent $8,636 in management fees in 2018 for only 7 houses. Plus each expense is a tiny bit more work for me to approve. Boo.
Now take that pile of houses and simplify them into one. Once you have built a certain amount of wealth and can line up the right financing, you could bring all investments under one roof. This builds on the economies of scale – as you allocate a single, larger expense throughout all tenants, you also start building your own internal property management team.
A single person can handle rent collection, bookkeeping, and filling vacancies while another person manages security and maintenance. The cost of having experienced in-house staff can be considerably less than paying independent property managers that may charge a certain percentage of your rent roll.
This sounds trivial but it gets nuts. Here are the numbers. Standard rental managers charge 10% of the rent. You can get a lower 5% on an expensive home but 10% is normal.
A $30M apartment would make about 8% returns roughly, or $2.4M/yr in rental income. For a normal property manager that would equate to a $240K salary just to collect rent and organize repairs. But we all know you aren’t going to pay that.
You handyman can be onsite and give good deals, you can buy equipment like ACs in bulk. Everything is cheaper.
7 – Legal and tax stuff becomes worth it too
Investors of apartment complexes can also take advantage of tax arrangements that make sense for larger property transactions. One such tax law is Section 1031 of the Internal Revenue Code.
Section 1031 lets an investor defer having to pay capital gains taxes on the sale of a property, so long as the investor reinvests the sale proceeds within a specific time into another “like-kind” property or properties that are of equal or greater value. This process is called a “1031 exchange.”
What other investment has this kind of tax advantage built into the system for you? With larger commercial real estate, such as apartment complexes, you could buy the asset, depreciate the purchase cost over a certain number of years to offset any income the property generates for income tax purposes. And once you sell the investment, you can rollover the proceeds into another investment and defer paying capital gains taxes on the appreciation, technically, forever. Stocks, bonds, gold, crypto-assets, private equity, opening your own small business, you name it, those investors don’t get these types of tax benefits!
TL;DR Apartment Complexes are the end point of a MASSIVE real estate portfolio
Okay, so those were the 7 reasons I’m super into apartment complexes right now. They’re great investments that will be part of my portfolio and should eventually be part of yours if it gets BIG.
But NOT right away…eventually!
For now, move into a quadplex. Feel the benefits of having “pricey” rentals that are still manageable. And when you’re comfortable with the right experience and financing in place, do a 1031 exchange for your entire portfolio of different properties into an apartment complex.