Rehabbing an apartment building is not an art-form as some make it out to be. It’s about nuts and bolts of the business really. The success of your apartment rehab comes down to four basic things. One, the finished product must be pretty. Nothing fills up faster than a beautifully renovated building. Two, you must be in an area where you have “paying” tenants to market to. And your marketing strategy must be sharp and pointed. I’ve never seen a fully occupied apartment building that markets to the general public.
Thirdly, the actual building has to be in good physical shape, meaning a good roof, sound foundation, no structural issues, etc. Physical problems will wipe out cash flow in a heartbeat. The last thing and probably the most important are the nuts and bolts of what makes an apartment building worth what it is. Below, I discuss what creates true value that translates to huge profits. These are all things you need to keep your eye and checkbook on the whole time of rehab and ownership. You may think your rehab is worth “X” thousands, but in reality, it’s only worth what the next investor is willing to pay and secondly what an appraiser appraises it for. See below for what these two guys value most.
Net operating income (NOI) – net operating income is defined as the amount of income you collect after vacancies and operating expenses are paid. It does not include mortgage or interest payments.
Let’s demonstrate the power of the NOI:
• This 24-unit garden-style apartment complex is in an 8 cap area of town. By increasing the rent and lowering expenses over time, you have increased the NOI by $20,000. To see how much value you added, do the following math:
$20,000/8 cap = $250,000 in increased value alone. That’s $250,000!!
Leases – some say when you buy a commercial property, you are buying the leases and the property comes for free! That’s how important the leases are to a commercial property. What do you think is more valuable to a bank or appraiser given that both tenants are paying the same rents each month: a) a 50-unit apartment community with everyone on a 12-month lease Or b) a 50-unit apartment community with everyone on week-to-week leases?
Comparable sales – look at what sold for the last 6 months, not 12. Going back 12 is what real estate agents will give you, but this market is far too volatile for 12 month to mean anything to you. Evaluate what each comparable property sold for per unit. Compare it to what you are buying yours for. If your price is higher, you may be paying too much, do more research, or lower your price. Be smart and don’t get caught up in the emotions of the deal. If the deal is meant for you, it’ll come to you.
Location – unfortunately, location is an unchangeable factor. You can fix up a property, but you cannot fix up its location. An ideal situation to be in for rehabbing any apartment building would be to have an ugly property in a great location. That way, once you fix up the property, the value of the property will match the value of the location. Got it?