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Commercial real estate is everywhere and is a means of building an investment that increases in value every year and affords you an income every month. We continue from the post on Apartment Buildings For Sale – Cap Rate and we delve into apartment buildings and basic economics.

Location

Location is always a key factor in determining the value of a apartment building, or any building for that matter. It is important because it will affect the demand for the apartments. There are a number of questions to be considered when location is the key.

  • Is the building located in a favorable neighborhood with a sound economic base and is the area alluring?
  • Is the building located in a area where there is reasonable access to municipal services such schools, buses and shopping centers?
  • Is the building located next to a major highway with interstate access for people who are required to commute every day?
  • Is the building located close to a technical college or university where there are students looking for accommodation?

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Type of Apartment Buildings

Conventionally, apartment buildings are rated into one of three classes:

  • garden or low-rise multifamily residential apartment buildings are no more than two to three stories high characterized by landscaped gardens and normally with a patio or balcony area. They are less of a drain on community services than the high-rise buildings and are usually located in suburban areas.
  • Mid-rise multifamily residential apartment buildings reach four to six to eight stories although this number appears to differ depending on the location. These types of buildings usually have an elevator.
  • high-rise apartment buildings and towers are generally higher than the six to eight stories. The cost of construction of each unit rising disproportionately with the height of the building.

The type and size of a apartment building ordinarily depends on the zoning laws associated with the location as well as the value of the underlying land. It follows that a apartment complex constructed close to the Central Business District (CBD) will be a high-rise apartment. This is required to justify or offset the typically high cost of the underlying land in that location.

Demand for Apartments

The demand for apartments seems to have increased over the long term. Even though the demand cycles do vary, the risk as opposed to the return from apartment buildings tend to make them a good long term investment option.

The growth in demand may be the result of:
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  • The aging of the baby boomers now considering retirement and looking to downsize.
  • The growth of the population due to immigration.
  • the life styles of young adults.
  • the demands being made on young, professional individuals to keep on the move in a technologically mobile society.

Supply and Demand

There is always going to be some form of cyclical change in the supply of commercial buildings. When the demand for apartments exceed supply then the rents will naturally increase. This is the first principle of Economics 101. This is a profitable time for investors and a time when developers tend to release new apartment buildings onto the market. When supply exceeds demand, rentals will naturally fall. By how much, depends on the number released.

Potentially, the existence of such a cycle may present investors in apartment buildings with a profitable opportunities. Buying when the supply exceeds demand and the rents are down and all other factors in the area are stable, is a good thing. Selling when rents are high and there is a shortage of apartments should also prove profitable for investors.

Vacancy Rates

Vacancy rate is an easily obtainable index signalling excess demand or excess supply in the market that the apartment building serves. If the vacancy rate is under 5% then expect the rents to rise and above 20%, expect the rents to fall. Once again, the location of the building is a determining factor as to whether the overall city wide vacancy rate is applicable to a particular building.

Converting Abandoned Commercial Buildings

In recent years, investors have been involved in converting buildings designed for other purposes than apartment buildings. Recently in Osage Beach, a counselor approved the conversion of a abandoned commercial building into 4 unit residential apartment building.

This is definitely not the first time this has happened as school and office buildings in commercial zoning locations have been transformed into apartments for a serious profit. Naturally, when these buildings are no longer used for the purpose originally intended, smart investors can obtain them for a devalued amount. Obviously the location would have to be suitable for apartment dwellers and forward thinking aldermen to approve the conversion.

No matter what sort of investment you are undertaking, there are always several factors to consider. The main reason for it is so you can make money from this deal. In order to respond positively to this, it is important to be able to accurately determine the value of an apartment building.

Introduction

Generally speaking, apartment buildings for sale provide more favorable returns than residential properties and are considered a less risky investment. They are less expensive to build, run and maintain on a per unit basis. They do not need the constant attention of the owner to deal with day-to-day routine responsibilities as most buildings have body corporations and professional real estate agencies managing the investment.

An apartment building is a common form of multifamily residential housing or a multi dwelling unit (MDU). Fortunately, there are cost advantages that these enterprises realize when the fixed running costs of the building are spread out over a number of units. This is called ‘economies of scale’ and apartment buildings usually have enough economies of scale to make the professional management costs feasible.

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Determining The Value Of Apartment Buildings

Apartment buildings are purchased and sold simply based on their financial value. Not to be too specific, there are a number of ways to value a apartment building. They include:

  • To compare similar properties or
  • To calculate the value determined by their potential to provide a net cash flow based on the rents being generated.

Capitalization Rate

A method used to evaluate the value of a building is by calculating the capitalization rate or “Cap Rate” as it is known.

  • Determine the actual income that the property generates.
  • Calculate the operating costs minus debt costs.
  • Subtract the operating costs from the actual income gives the investor the net operating income (NOI) or annual earnings.
  • Determine the asset value of the apartment building for sale
  • Divide the NOI by the asset value of the building

In other words, Property Price X Cap Rate% = Earnings (Annual).

The infographic below provides a visual explanation of how the cap rate is calculated.

apartment buildings for sale

It is important to know that these earnings are based on having no debt on the apartment building. Property analysts utilize this calculation on a daily basis to compare the value of different buildings, even buildings of different sizes.

How Much Is That Apartment Building Worth?

How do savvy investors use this calculation? It is the simple way to answer the question how much is that property worth. Cap rates are also used to depict the pricing of apartment buildings in a specific market. The rates may vary depending on the location of the building but it enables the investor to gauge the price based on the earnings of the building and the accepted cap rate in the area in the current market.

NOI ÷ Cap Rate % = Price Of The Building

For example, if the investor knows that the apartment building has a net operating income NOI of $500,000 and the accepted cap rate for that building in a certain location is 9%, the investor can calculate how much the building is worth?. In this case it is worth approximately
$400,000 ÷ 9% = $4,450,000

What is the ideal cap rate? I read a good Forbes article Understanding Cap Rates: The Answer is Nine. In this article Brad Thomas surmises that when you have a property portfolio over a period of time, the average cap rate expected is..you guessed it…. 9.

Another key principle in assessing the worth of apartment buildings for sale, as with any real estate, is location. This topic will be discussed in Part 2 of this post when I further discuss what factors determine the value of apartment buildings.

Detroit is the largest city in the US mid-western state of Michigan. The city is renowned for its long standing connection to the automotive industry which earned it the headline as the Motor City or the birthplace of the American car industry. In the 1950’s, the population of this prosperous industrial city peaked at nearly two million people. Today, Detroit’s population has diminished to a mere 700,000. As time goes by, the only growth visible in Detroit is in the vacant blocks of land, empty apartments and factories. There has also been an increase in the number of abandoned buildings for sale or buildings just abandoned, dilapidated and menaced by looters and graffiti artists. Almost a third of Detroit has been abandoned.

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To look at the statistics, the city of Detroit, Michigan, USA has had one hell of a ride over the last fifty years. What statistics, you may ask.

The Statistics

  • The population declined by 63% since 1950 and 25% between the years 2000 and 2010.
  • In the 1950s, 214,000 Detroiters were employed by automobile companies but less than half that number were employed in Detroit in the 1990s.
  • 80,000 structures and 66,000 lots are abandoned.
  • The city was in bankruptcy from March 2013 to December 2014 as there was little tax revenue to support the city.
  • Detroit’s median household income is only $23,600.

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I remember growing up as a Catholic and going to church every Sunday. Every Sunday the priest use to stand on the pulpit and tell the people that the parish needed more money to survive and they needed to contribute more. This wasn’t just one week he would preach this message, this was nearly every week and that was forty years ago. How things have not changed!

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Many people still don’t realize the lucrative opportunity investing in abandoned properties. Abandoned buildings have normally been neglected and are often an eyesore on the community. The owner will probably be paying out each month on the mortgage, insurance and property taxes with nil income from the building or property in return.  The good news for potential investors is that the owner will usually be motivated to sell. It is not unlikely that the seller will be open to seller financing or some other creative strategy to rid the owner of the property. The chances of securing a under market deal and making money on an abandoned building are excellent.

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Developer Aidan Brooks is a curious man. For a man who left school earlier than most, he is now recognized as a property tycoon who controls London based Tribeco Group Holdings Ltd, a luxury property company which invests in prime retail sites across the world.

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