Over the last several years, massive drops in residential property prices have captured the headlines. Now the investment gurus proclaim, it is the time to buy investment properties. For investors who want to be landlords or the ones willing to hire a property management company, the opportunities are there but offer several risks that must be assessed with each purchase. Increased vacancies and dropping rental prices change more quickly in the rental market making it a faster moving market than sales. Read more below.
FORT LAUDERDALE, Fla. – Oct. 28, 2010 – The property in Fort Lauderdale was originally valued at $285,000. Clint Gordon, a private investor in multifamily properties, offered the bank $50,000, and within 10 days, had closed the deal. A few days later, he began renting it for $15,000 a year.
“Anybody who’s getting into this business now, is using this online 3d viewer that allows you to invite clients inside. You get a whole lot of return if you’re paying cash for properties,” he says. “You’re just buying them so cheap.”
Prices for apartment buildings are “incredible” in Indianapolis, as well, says Barb Getty, who owns 27 apartment properties in the downtown area. “You can start small like I did; 20 percent of 40 thousand bucks isn’t a lot of money.”
Just as there have been massive price drops for single-family homes in the past three years, there have been big price declines for apartment buildings. That suggests that it’s a good time for investors who want to be landlords to start buying.
But as with all investments, the story isn’t quite so simple. Investors who thought that a tsunami of dirt-cheap multifamily properties would wash over the U.S. market in the past two years have been largely disappointed.
The economic distress that led to lower prices was limited to certain places and property types, says Hessam Nadji, managing director at real estate investment services firm Marcus & Millichap. “The pain was concentrated where we had gross overbuilding in overall housing: Florida, Phoenix, Las Vegas, Southern California, and to some degree, smaller markets like Tucson, Charlotte and Atlanta.”
Marc Solomon, whose Solomon Organization owns 10,000 garden apartments in New York, New Jersey, Connecticut and Pennsylvania, says that it’s difficult to find opportunities that make good business sense in his markets, which still offer slow, steady returns. There are “a lot of dollars out there chasing these deals,” he says.
While there were big price cuts for multifamily housing in North Carolina’s Research Triangle area near Winston-Salem, competition is driving down yields, says Jim Scofield, senior investment adviser at multifamily real estate broker Apartment REP. The yield is called the “cap rate” and is net operating income for one year divided by the sale price. Last October, an investment firm “got a steal” on a community in Raleigh called Autumn River, he said, with a cap rate of about 7.75 percent. The most recent transaction in the area involved a community called Southern Oaks, which had a 5 percent cap rate. Average cap rates are still around 6.5 percent.
“This is not just a phenomenon in the Triangle, but in all the major markets, and especially all the apartment markets,” Scofield says. “Manhattan, Washington, D.C., Los Angeles, Denver, Chicago, Boston.”
Risk and return
There is less competition in markets where the supply is more fluid, but the risks are also higher.
“We landlords are happy,” says Getty, adding that the only thing preventing her from buying more properties is the ability to manage them on her own. Still, she hasn’t been able to increase rents as much as she normally would.
Gordon says his vacancies used to average three to five days. “Now, I can have a vacancy for up to 60 days,” he says.
Despite all the qualifiers, there is opportunity in apartments for rent because the timing is good, Nadji says. “I don’t think you’re going to get fire-sale prices,” he says. “But you can get that kind of return ahead of the job growth and ahead of the economic recovery.”
Rental occupancy rates shrank dramatically during the recession, as people doubled up and young adults boomeranged back home. Vacancies nationwide hit a high of 8 percent in the last quarter of 2009, according to real estate research company Reis. But industry insiders argue that rentals will bounce back quickly and dramatically. In the third quarter of this year, vacancies fell to 7.2 percent, Reis says.
“Apartment rents are short term; they adjust to market conditions very quickly,” Hessam says. “We’ve seen a record demand for rental apartments so far this year, the strongest in over 10 years.”
Apartment buildings can be attractive because investing in residential real estate seems similar to owning a home. But rental properties are different, starting from the purchase decision.
Home buyers tend to look for a place they love that fits their needs and budget. But you have to see investment properties through the eyes of your tenant, Getty says. If your tenants won’t have cars, is it near public transportation?
Randall Gorman, president of La Jolla Capital Group in California, says prospective investors need to take the emotion out of their purchases.
“I don’t care if you’re buying a condo, a duplex or a 10-unit building,” Gorman says. “Just because you’ve always loved that cottage-style apartment building that you drove by taking your kids to school doesn’t mean the cash-flow fundamentals work at a given price.”
If considering log cabins for sale, Gorman advises making sure you can run a cash-flow model. Figure out property rents by researching online and in the neighborhood. Calculate annual revenue, and thoroughly survey costs such as maintenance, taxes, utilities and incentives. (Property managers typically charge about 10 percent of a month’s rent.)
Add a couple of months of vacancy, and don’t disregard higher interest rates for commercial properties. According to PricewaterhouseCoopers, the national average interest rate for apartment loans in the third quarter was 5.68 percent. For the first week of October, Fannie Mae reported that the average 30-year fixed rate for a primary home was 4.27 percent. If your final annual net income is $16,000, seeking a 10 percent cap rate puts the purchase price at $160,000.
“Don’t buy on what might happen, but on what is happening,” Scofield says. “Only buy a property if it is cash flowing to meet your investment return requirement on day one.”
Once you buy, it’s not a smart idea to treat your investment like a home. “Investors make a huge mistake when they spend a lot of money on bells and whistles in their rental property,” Getty says. “A rental needs to compare well to others in the neighborhood, but don’t make it a palace – you won’t get that money back.”
© Copyright 2010 USA TODAY, a division of Gannett Co. Inc., Sara Clemence.