Why We Love Apartments and Why You Should Too
When we began our investment career, we started with smaller properties. We bought a duplex, and flipped/rented houses from there. Why this path? It’s straightforward, cheaper per purchase, and systematic. The deal comes across our desk, we buy it, fix it up, and sell it or rent it. This business model is proven and it works.
Economy of Scale
The issue with this strategy, however, is each property must be maintained separately. Each property needed the landscaping done, snow plowed, lawn mowed, mechanicals repaired, the roof and driveway kept in good condition, etc. We came to realize that it would be difficult for our company to achieve any kind of economy of scale by owning properties all over, especially as out-of-town investors.
What became apparent to us when we bought our 48-unit property was that there was a new level of efficiency involved. Since all the units were in one location, the per-unit expenses were much less. For example, there was only one lawn to mow, one roof to fix, one garbage bill to pay, and collecting rent was much easier. Yes the lawn is larger, but it is cheaper and quicker for a company to mow a large lawn than go to 48 different properties. This economy of scale made it much easier (and more affordable!) for us to manage our investment.
If you own a single-family house, and it goes vacant, the mortgage attached to it still has to be paid. However, if you own an 8-unit apartment complex and 2 of the 8 tenants vacate, you still have 6 other income streams that cover the mortgage. Apartments allow for the owners to mitigate their downside risk by having multiple tenants paying for the expenses. In this way, apartments can become an income producing asset when the revenues from tenants exceed the expenses associated with debt service and operations.
The U.S. tax code benefits real estate investors in several ways. The ways that are most impactful on the bottom line are no limit mortgage interest deductions and depreciation accelerations. These shield part of the cash flow generated by the property and protect the profits of the investor. There are other activities that qualify for deductions as well, such as repairs, travel, and insurance. However, a good rule of thumb is that the most impactful deductions are usually associated with the debt and expenses the property incurs. When it comes time to sell, investors have the opportunity to catch another break if they so choose. At the time of sale, the IRS allows investors a 1031 provision, which gives them a pathway for their capital to flow tax free from one property to another, so long as certain conditions are met. The taxable gains on the sale of the first property are deferred to the future, and all the capital from the sale of the first must be rolled into the purchase of the second property. Of course these principles apply on smaller real estate investments as well, but are just larger benefits on commercial properties as they are larger in size and value.
Extra Income Stream
There will always be some form of risk when dealing with real estate investment, but much of that risk can be mitigated. Analyzing the deal in depth, doing genuine due diligence, and learning about the surrounding market are all great ways to mitigate this risk. When you do find a great apartment investment, you have an extra income stream that helps you move forward towards your financial goals. There also seems to be a level of solidity and stability associated with owning a physical building because there is a physical asset. So why apartments verses a single family rental? With apartments your risk is lessened because one vacancy or bad tenant doesn’t knock out your whole cashflow--similar to economy of scale. More units means more diversity and buffer for risks and surprise issues!
Rental property investments can provide a regular and dependable income stream that produces positive cash flow and yields higher than typical stock dividend yields. Where investing in a promising stock is volatile and uncertain, a property investment has a much greater overall ROI over time, even if there is a temporary market downturn. And for a rental, you can ride out those low markets and wait to sell when it rebounds--after all, people always need a place to live, even when the economy is bad. In fact, when the economy is bad, that means more people will be renting instead of owning homes!
We always take into account the lifetime of our investments, and we highly recommend apartments to anyone looking to build wealth and equity over the long-term. Looking to learn how to get into apartment investing? Reach out to us anytime!