Why Invest in Real Estate, Specifically Apartment Buildings?

Benefits

  1. Cash Flow
  2. Principal Reduction/Equity Gain
  3. Tax Advantages
  4. Appreciation Potential
  5. Low Risk
  6. Market Timing

Cons

  1. Longer-term Investment
  2. Vacancy Rates
  3. Capital Injections
  4. Not Liquid

Introduction

The theory with investing in apartment buildings is to rent out real estate to tenants and have their rent cover the costs of the entire building (mortgage payment, real estate taxes, insurance, utilities, maintenance, management, lawn and snow, etc).

Investing in a single family home is NOT an investment – it is a liability! An asset should put money into your pocket and buying a home takes money OUT of your bank account. Don’t compare the two because they are not the same!

Buying apartment buildings is one of the best investment strategies available. I heard a statistic that 50% of the wealth in America is from real estate, so wouldn’t it make sense to have your investment portfolio contain 50% real estate assets for TRUE diversification?

The stock market only invests one way, and that’s bullish (up). When the market goes down, you lose money. When real estate goes down, you still make money because your tenants are paying everything for you!

Benefit #1 – Cash Flow

You make your money when you buy, not when you sell. You have to buy at the right price in order to set yourself up to succeed in the future. This is why no property should be bought unless it has a positive cash flow. This is the money left over in addition to paying all the expenses and mortgage payment! Over time, as the bank account increases in value, there can be a partner payout from the cash build up that is not needed to pay for reserves or other repairs.

Benefit #2 – Equity Gain

This is why most people invest in their single family homes. Because over time, as you pay off your mortgage, you will own the property free and clear and not have a mortgage payment. Well the same is true with apartment buildings, but the tenants are paying the mortgage for you! So in essence, you are building net worth (equity/principal reduction), and over time that number increases every month as the proportion of interest decreases on your mortgage payment. This means that your initial rate of return has an automatic inflation mechanism built into it!

Benefit #3 – Tax Advantages

High income individuals buy apartment buildings purely for the tax deduction that they get from owning rental property. This helps offset their yearly income and lower their income taxes, which by the way, are the #1 single largest expense you will incur over your lifetime. You see, even though your investment makes money, you can still report a loss to the IRS! Why? This is because you can depreciate the cost of buying appliances, making renovations, and the value of the improvements. This tax break is available to the wealthy to fuel investments in rental property because 50% of America doesn’t own a home – they rent! So even though the building has the potential to appreciate in value, the government allows you to depreciate the asset in order to offset your income taxes. This is a win-win! And I haven’t even mentioned all that mortgage interest that you can deduct…and you didn’t even pay the interest – your renters did, but you get credit for it because you OWN an apartment building!

Benefit #4 – Appreciation Potential

Speaking of appreciation, historically real estate increases in value, which is why everyone thinks their home is their #1 investment. So this benefit doesn’t take any explaining. I know you understand if you buy low and sell high, you can make money simply from capital gains. What I like to mention on this benefit is that this is all GRAVY. I do not include any appreciation calculation whatsoever in my analysis, as you can never predict the future and depending on appreciation to make money is one sure way to lose it.

Benefit #5 – Low Risk

I cannot stress this enough that investing in apartment buildings is one of the lowest risk, highest reward strategies available for your money. Real estate can never go down to a zero value, whereas a stock can easily drop to $1 in no time. There will always be a need for people to have a place to live, and particularly in Madison, WI the real estate market is so resilient that a drop in the nationwide real estate market does not significantly impact the local market in Madison. There is constant growth with the government, health, and education industries in Madison and there is limited space with the lakes and isthmus land shape. I strongly urge you to consider transferring some of your stock market portfolio into real estate.

Benefit #6 – Market Timing

We have an unbelievable opportunity at our fingertips because NOW is the time to buy! This is the perfect storm of low market values, high inventory, few buyers, and LOW interest rates. All of the ingredients are there to set the base of a solid investment.

This wouldn’t be an unbiased fact sheet if we don’t discuss the negatives with investing in real estate:

Con #1 – Longer Term Investment

Traditionally, real estate is viewed as a long term investment due to obtaining a mortgage that amortizes over 30 years. The longer you hold onto it, the more money you will make, which is why I always tell people to only invest money that you had planned for retirement and do not plan on needing for awhile. It is money that you want to grow and have available at least 5 years down the road. There is still the potential for cash payouts as dividends, or the ability to refinance and cash out money then, but it would always be up to the entire partnership and have to be the best financial decision for the building.

Con #2 – Vacancy Rates

This is the biggest risk when renting out property. What if tenants stop paying rent? What if you can’t find a suitable renter and it stays vacant? This will always be a risk, just like there is risk in everything we do. This is the job of the property manager to make sure quality, screened tenants are living there and to collect their rent on time. If there is no income, the property manager doesn’t get paid, so there is plenty of incentive. Generating income is the single most dependent factor to investing in real estate, because if you don’t have any income, then you can’t pay your bills. The good news is that there are market statistics that show the vacancy rate by zip code, so you know what to expect when you get into the building. Plus, I always factor this into the cash flow analysis, so it is already included in the budget that there will be vacancies! So if a property needs to take a month to move out tenants and renovate the unit, it’s OK because this was already incorporated into the calculation.

Con #3 – Capital Injections

This is the other risk that I need to tell people about. If the roof caves in, our water pipes burst or some other catastrophic event happens where there isn’t enough money in the bank account to pay for it, then it’s the responsibility of the investors to come up with the money. Now, first of all, insurance will always be in place, so we are talking about some type of loss that isn’t covered by insurance. If there is, we will have a reserve account on hand to pay for anything that comes up. This is also factored into the monthly budget so that this continues to grow over time. Also, at the time of purchasing the building, we set up an initial reserve fund that is excessive of what is actually needed to begin with. This is so that the LLC only has to make one contribution at the start and shouldn’t have to worry about any future capital injections.

Con #4 – Not Liquid

Unlike the stock market, where you can exit your mutual fund in one day, if you needed to extract capital from your real estate investment it would take a much longer time. In fact, that time is unknown, as you would have to put the property on the market and wait for a new buyer to take over. Or, you could check with your fellow investors and see if anyone else in the partnership would want to buy you out for your share of the business.

Conclusion

The purpose of this document is to hopefully open your eyes to a terrific way to build wealth. The benefits heavily outweigh the negatives and can usually yield at least a 10% return just from cash flow and equity gain. Tax advantages would add another 5% and appreciation isn’t even factored in. Use your mind to think of the possibilities. If you have money in a stock market retirement fund, there is a way for you to use that money to buy real estate. It’s called a self-directed IRA and I can help you get everything set up. Not having money is not a reason that this isn’t possible. It’s simply your rationale and overcoming your fears of making money in a real estate investment that you probably didn’t realize how many benefits come with it. Buy apartment buildings – not single family homes!

Put your money to work for you, rather than you working for money!!

*** For a FREE cash flow analysis on ANY apartment complex, contact Matthew Pantzlaff ***

Total Real Estate Solutions

608.239.0367