We’ve all heard the saying “A Penny Saved, A Penny Earned.” This is very sound advice. However, in investment real estate, I like to say “A penny saved in commercial real estate is a dime or more earned.”
Some of you might be thinking “that doesn’t make much sense. How can one penny earn 10-15 pennies?” It doesn’t sound logical until you understand the multiplier effect of multi-family real estate investments and when you understand how multi-family real estate is valued, then you will realize how true and rewarding this statement is.
Investing a penny in multi-family real estate earns you a lot more than just that penny because of how multi-family properties are valued. In multi-family real estate such as apartments, the value of the property is determined by how much money the property earns after subtracting out the expenses. The amount that is left over is the profit which is also called net operating income or cash flow.
As an investor you want to understand what you’re investing in and the “end game.”
“Begin with the end in mind”. – Stephen Covey
For you, a potential investor in multi-family real estate, the end game has two stages: a) maximizing profit from operations, which provides the maximum annualized return for you, the investor, and b) appreciation upon sale, which provides you a lump sum of cash when the property is sold.
How does a multi-family real estate company maximize this?
- Conduct due diligence in buying a property at the right price in the right market.
- Bundle the financing to get a great rate with maximum flexibility and minimal risk (non-recourse).
- Turn-key management team to provide proven operational efficiencies.
Regarding the right property in the right market, these are the key components to look for:
- occupancy rates are not at market levels;
- rents are not at market levels;
- minor improvements and renovations will make the property more desirable to potential renters, e.g. special accent wall colors or new appliances that will allow you to increase rent; and
- recognize efficiencies to decrease expenses, e.g. put in new windows which decrease utilities.
A consequence of finding the right property is that you can increase rents, which increase cash flow, which in return increases value. So by increasing the gap between income and expenses, you increase annual profitability as well as the value of the property, which means you can eventually sell it for significantly more than you paid for it. It’s a pretty simple formula that can have huge dividends.
Additionally, the multiplier effect is only in commercial real estate investments and does not exist in residential real estate investments. So, what really makes multi-family real estate so enticing as an investment is that you can take small increases in rents for a single apartment and apply them to all the apartment units literally multiplying its effectiveness.
A penny saved is a penny earned is good advice. However, investing in positive cash-flow, multi-family real estate takes that same penny and allows you to earn multiple pennies, potentially even a dime or more.