Everything You Need to Know Before Purchasing Your First Apartment Complex
Andrew Carnegie once said that 90% of all millionaires gained their wealth by owning real estate. Over 100 years later, his words still ring true. While there are a variety of types of real estate to invest in, apartments are among the most lucrative.
For many investors, multifamily real estate also has significant advantages over investing in other types of commercial properties, single-family homes, stocks, bonds, and other types of investments, such as private equity or venture capital.
In this article, we’ll review almost everything you need to know to purchase your first apartment property. Over the next three sections of this guide, we’ll answer questions including the pros and cons of apartment ownership, how to get investors, how to find your first deal, how to get a multifamily loan, how to close, and what to do after closing.
A. Getting Started: Pros, Cons, Investors, Loans, and Deal Selection
1. Why Should I Purchase An Apartment Building Over Other Types of Investments?
That depends. Apartment buildings are a great investment, but they’re not for everyone. Primarily, however, buying an apartment building is a great way to use leverage (debt) to buy an income-producing business. Buying an apartment building also allows an apartment investor/syndicator to pool people’s money into an investment that is somewhat easily understood by the public. For instance, in most cases, it’s far easier to acquire equity investors for an apartment building than it is for an unproven startup or small business.
2. What are the Pros and Cons of Apartment Investing?
Pros of Apartment Investing:
Leverage: Almost no other kind of investment can be purchased with a loan of 75-80%+. This type of leverage can significantly increase your returns.
Taxes: Apartment investing has a variety of tax benefits, including taking accelerated depreciation deductions.
Easier to Attract Investors: Apartments are a known commodity, unlike startups or unique small businesses. Therefore, investors may be more comfortable placing their money in an apartment building rather than another type of private investment.
Cons of Apartment Investing:
Leverage: While leverage is a huge bonus, it’s also a drawback. If you’re late on your loan payments, the apartment building could go into foreclosure.
Liability: As the GP (general partner) of the apartment investing venture, you could be held personally liable for something that happens to the investment, especially if your loan is non-recourse or your ownership entities are not properly structured.
Liquidity: Unlike stocks or bonds, apartment buildings are real property, and can easily take 3-6 months or more to sell. Plus, you owe it to your investors to carry out your initial business plan-- and you don’t want to sell in a bad market. This means that you and your investors' money will generally be locked into the apartment community for several years, depending on your business plan and investment strategy.
3. What is Apartment Syndication (i.e. Purchasing an Apartment Building With Other People’s Money)?
While many individual investors purchase apartment buildings using their own money, most people gather a group of investors together utilizing a process known as real estate syndication. This means that the investors will be LPs (limited partners), while the operator(s) of the apartment business will be the general partner(s) or GPs.
Limited partners take only a passive role in the business, get paid first, and are generally not liable for the activities of the business. General partners are responsible for putting together a team, executing the business plan, running the business, communicating with investors, and financially managing the property (asset management). They are also responsible for selecting a successful property management firm and monitoring the firm’s progress.
Ultimately, the general partners are also legally liable for the apartment complex and the associated investment business they operate. For instance, if investment company X Capital buys a property, it will typically place the property inside an entity called a special purpose vehicle (SPE), often an LLC. They will also have their own entity, X Capital, generally another LLC, which owns the shares in the SPE that owns the apartment complex.
This arrangement protects the borrower (the investing company) by attempting to ensure that if the apartment entity declares bankruptcy, the GPs are not financially impacted.
Of course, before you think about any of this, you’ll need the funds to purchase an apartment building. That typically means investors. Unless you have the capital to buy the property yourself or you already have a business partner, you’ll need to get others to buy into your business plan and commit their own money.
4. What Type of Loan Do I Choose?
Even if you and your investors have lots of cash on hand, using a multifamily or apartment loan to finance your property is generally a good idea. This is because increasing the leverage will increase your overall profits as represented by the investments IRR, or internal rate of return.
When choosing a loan, the question should be: what is the best type of loan that I can qualify for? In general, U.S multifamily and apartment loan options can be broken down into a few different categories, including:
Bank Loans:
LTV: 70-75% max
Terms: 5-10 years
Amortization: 20-25 years
Recourse: Full recourse
Rates: Fixed or variable
Fannie Mae Multifamily Loans:
LTV: 80-85% max
Terms: 5-30 years
Amortization: 20-30 years
Recourse: Mostly non-recourse
Rates: Fixed or variable
Freddie Mac Multifamily Loans:
LTV: 80-85% max
Terms: 5-20 years
Amortization: 25-30 years
Recourse: Mostly non-recourse
Rates: Fixed or variable
HUD Multifamily Loans:
LTV: 85-90% max
Terms: 35 years (40 for construction loans)
Amortization: 35-40 years fully-amortizing
Recourse: Non-recourse
Rates: Fixed
CMBS Loans
LTV: 75% max
Terms: 5, 7, or 10 years
Amortization: 25-30 years
Recourse: Non-recourse
Rates: Generally fixed
Benefits: Cash-out refinances possible
Hard Money Loans:
Terms: Varies, often 6-18 months
Amortization: Varies
Recourse: Full recourse
Rates: Fixed or variable
Benefits: Little to no credit or background checking
In addition to traditional apartment buildings, all of these types of loans are available for student living, nursing home, and assisted living property types.
For those who may not know, recourse loans allow a bank to repossess your personal property in order to make themselves whole. If a loan is non-recourse, it means that the bankruptcy of the property holding company won’t personally impact the borrower, unless they have done something illegal or against their contract.
This is why most non-recourse loans have what’s called bad-boy carve-outs. This means that if the borrower engages in “bad boy” activities, such as fraud or intentional bankruptcy, the loan can become a full-recourse financial instrument.
Note: Some loans, including Fannie, Freddie, HUD, and CMBS loans are assumable, which means they can be taken on, or “assumed” by the new buyer, typically for a 1% fee. This can be a great way to save money at closing and make your property more profitable, especially if the loan is fixed at a low interest rate and market interest rates have risen.
5. What are the Three Major Types of Apartment Investing Strategies?
Before you think about finding a deal or pitching to investors, you need to know about the major types of apartment investing strategies. The three most common types of apartment investing strategies are distressed, value-add, and turnkey investing.
Distressed Investing:
Distressed investing involves finding older properties that are in severe disrepair and may even have financial or tax issues associated with them. Distressed properties can be bought at a steep discount, but are a much riskier type of investment.
This is due to the fact that units may not be filled during the renovation process. As a result, investors will generally have to take out higher-interest hard money loans in order to finance the property.
While distressed property investing is high-risk, it also potentially offers higher returns, as rents can be raised significantly. Plus, once the property is stabilized, the owner can refinance their loan in order to get a better rate and a longer loan term.
Value-Add Investing:
Value-add investing generally involves finding apartment buildings that are between 15-30 years old, making moderate improvements to them, and raising rents by a reasonable amount to increase the property’s overall income.
These properties are typically already stabilized but have “value-add” opportunities, such as re-painting, re-landscaping, and minor unit renovations, such as new appliances.
Value-add investing is popular because it strikes a balance between the high-return, high-risk aspects of distressed investing, and the low-risk, low-return aspects of turnkey investing.
Turnkey Investing:
Turkey investing involves locating and purchasing properties that are in great condition and typically no more than 5-10 years old. Turnkey properties are typically fully stabilized (95%+ occupancy). They also often have top-of-line amenities, such as modern rec centers, pools, lush landscaping, and new appliances.
6. How Do I Meet Investors?
Investing in an apartment building is investing in an actively run business, even if the investors only have a passive role. Therefore, you’ll need to gain a high level of trust with investors before they put their hard-earned money into your deal.
In general, to invest in a real estate syndication, an investor needs to be accredited, which means they have an income of at least $200,000 (or $300,000 as a married couple) or a net worth (excluding their primary residence) of at least $1 million.
There are a wide variety of sources of investment capital for apartment buildings, including:
Friends, family, and co-workers
Real estate investing groups
Online forums like BiggerPockets
Other thought leadership/social media platforms, including:
LinkedIn
Instagram
Facebook
TikTok
SEO-optimized websites
Podcasts (both as a creator and guest)
Email newsletters
Texting
Paid ads (check with your lawyer first)
The benefit of platforms like blogs and LinkedIn accounts or newsletters is tremendous. Just as if you were speaking at a real estate conference, you can get in front of hundreds or potentially thousands of people to share your knowledge, ask questions, and develop your reputation as a trustworthy and competent real estate professional.
7. How do I Underwrite An Apartment Deal?
Before you start developing your apartment investing criteria (or assembling a team of professionals in your target market), you will want to know how to underwrite an apartment deal. To underwrite, you will need to use or create a financial model, which attempts to predict how an apartment investment will perform over a certain amount of time under certain conditions.
There are a wide variety of models available (typically in excel, but also in other programs), but to fully understand underwriting, you may wish to construct your first model yourself.
As we’ve mentioned elsewhere in this article, you will likely want to underwrite at least 200 deals before choosing your first apartment building. The more deals you underwrite, the more familiar you will become with the process and the faster it will take.
When underwriting, you’ll need to conduct significant research, particularly if you are attempting a distressed or value-add strategy. For instance, you may have to call local contractors or roofing companies to determine going prices for property repairs, as well as researching state, local, and federal tax regulations to see how they may impact your overall returns.
A few general terms you may see in the financial model that you should be aware of include:
IRR: IRR, or internal rate of return, represents the percentage rate earned on each dollar invested for each period it is invested. When comparing two investments, the one with the highest IRR (over the life of the investment) is more profitable.
Cash-on-cash return: This metric calculates the cash put into a property vs. the cash taken out of the property. Cash-on-cash return is generally only calculated for one year at a time.
Cap rate: Cap rate, or capitalization rate, divides a property’s NOI (net operating income) with the market value. Higher cap rates generally mean a property is more profitable, but not necessarily, due to various risk factors inherent to the property and the market.
8. How do I Sell Investors On My Deal?
Before telling investors anything specific about your deal, ask them what they want out of an investment. Some may say high returns, some may say cash flow, and yet others will like the tax benefits of real estate.
In addition, due to these needs, an investor may only be interested in one type of investing strategy. For instance, the high-return investor may focus on distressed and riskier value-add deals, while a low-risk investor may only want turnkey deals. Not every investor will like your deal, and that’s okay.
When you pitch your property to an investor, you can then emphasize that particular aspect of the property. A few potential investor profiles include:
High-Return Investors: For investors looking for a high return, you may want to discuss the levered IRR or the potential for additional market appreciation (however, make sure to be realistic).
Low-Risk Investors: Lower-risk investors are mainly focused on avoiding financial losses, so you may want to emphasize the strong market demand for apartment housing in the area and other factors which reduce the potential risk of their investment.
Cash-Flow investors: For cash-flow-oriented investors, emphasize the monthly investor coupon, if your deal has one.
Tax-Conscious Investors: For tax-conscious investors, consider discussing benefits such as depreciation deductions (if these are passed on to LPs), or, if they are older, the benefits for heirs.
Just like a commercial real estate broker, you will typically have an offering memorandum (OM) that you’ve created based upon your underwriting of the property.
Your investor will often want to sit down and go over the details of the OM with you. Some potential investor concerns can include the project’s levered internal rate of return, or levered IRR, the property’s current occupancy, or the cost of the property management company.
Additional Notes:
As an LP, apartments may appear to be a lower-risk investment than stocks and bonds. Since so much information is available about apartment performance, it often seems easier to manage the risk of an apartment property compared to the average small business.
Plus, it’s common sense that, if nothing else, people always need places to live. This knowledge makes it easier to raise money from investors who may not understand technology or consumer goods, but can easily understand the concept of owning an apartment building.
As a passive investor, real estate returns are comparable to the stock market, with a generally lower risk profile. If an investor is accredited, they also have other options, including private equity, venture capital, hedge funds. However, most of these options do not offer any type of cash flow payments, and they are unlikely to be able to forge a personal relationship with the manager of the fund.
As an additional side note, if a friend or family member is interested in investing, but doesn’t know much about apartment investing, you may have to educate them on the topic.
9. How Do I Reassure Investors About My Lack of Apartment Experience?
Since this article is geared toward buying your first apartment building, you may have to reassure investors about your ability to conduct your first deal effectively and get them consistent returns. If questioned about your experience, you may want to point to:
General business experience: If you’ve worked in a business or managed employees, relate your apartment investing strategy to the lessons you learned from other work experiences.
Real estate experience: If you’ve invested in a single-family home, passively invested in other real estate deals, or have worked in the real estate industry in some capacity, even tangentially, you will want to emphasize this as well.
Your team: You may not be experienced in apartment syndication, but your property management team, broker, mentor, mortgage broker, and co-GP may have significant experience in apartment syndication. Emphasize their experience and how you will work together as a team if questions about your experience arise.
B. Planning and Executing: Selecting and Preparing A Deal
10. How Do I Develop My Apartment Investing Criteria?
Developing your criteria can take longer than you might expect, but is a key part of developing your business plan. First, you’ll need to:
Select A Strategy: Determine which apartment strategy you feel most comfortable with; distressed, value-add, or turnkey.
Select a Target Market: Next, you’ll choose a target market, based on factors we’ll discuss in the next section.
Determine Your Deal Size:
What size of a deal do you want to do?
How much can you realistically raise from investors and a lender? How many units will you buy? At what price per unit?
This will help you determine your maximum budget in order to exclude deals that don’t work. We will get more into this in the underwriting section of this guide.
Look Out For Red Flags: What other factors would make you say “no” to a deal? Section 8 units? Roof problems? A history of violence at the property? Make these clear, as these are also great ways to exclude deals that simply won’t work.
11. How Do I Find My Target Markets?
Finding your target market is one of the most important steps in selecting your first apartment investment. Instead of just one target market, you will likely want to choose 2-3 markets. You may wish to start with your local market since you likely know it best.
However, your local market may not be the best place to invest. In order to select other target markets, look for:
Personal Knowledge: Have you lived there in the past? Do family members and friends currently live there?
Economic Information: You can easily find information such as employment numbers, major employers, and economic growth numbers in the area through a quick Google search. Answer questions such as:
Is unemployment going up or down?
Are people moving in or out of the area?
Who are the largest employers? Are they growing or shrinking?
How much of the area’s employment is concentrated in the top 1-3 employers? (higher concentration = higher risk)
Deal Availability and Pricing: Are there a reasonable amount of buildings in the area (on-market and off) that might match your potential investing criteria?
12. How Do I Develop My Business Plan?
After deciding on your investment strategy, target market, and investment criteria, you will want to put together a general business plan for your company. This plan will change radically once you have put an apartment building under contract, as your plan will need to conform to the specifics of that property.
As we’ve said before, real estate investing is like any other business. That means you’ll need a strong business plan, with prospective financial statements and a logical exit strategy. Much of this involves properly deciding your investment criteria and investment strategy, which we’ve already reviewed, as well as underwriting, which we’ll discuss in later sections. Generally, a business plan should include:
A strong mission statement: this explains the how and why of the business: For instance “X Capital acquires and turns around distressed apartment communities to revitalize neighborhoods and provide a strong risk-adjusted return for investors. Like in the example, it’s ideal to mention whether you focus on distressed, value-add, or turnkey deals.
Strong underwriting: As we’ll discuss later, you will likely want to analyze 200 or more apartment buildings before deciding on your first choice. Don’t trust numbers provided by brokers or owners. Do you own comps and run the numbers yourself to see what your deal might look like in different market scenarios.
A strong financial model/OM: Creating your own operating memorandum, or OM, for investors, is essential. In general, this should include what may happen in a few different scenarios, including under both optimistic and not-so-optimistic market conditions.
A sales/disposition plan: How will you sell the investment? What are the associated sales costs?
Investor benefit/payment/repayment plan: How exactly will you repay investors? Are there cash coupons? An equity waterfall?What other benefits, including tax benefits, will investors enjoy?
A backup plan: What will you do if your numbers are off, the market crashes, or some other kind of disaster occurs. How much, if anything, will you be able to pay back investors?
Now that you’ve finished your plan, it’s time to start assembling the rest of your team (property management company, commercial real estate broker, and commercial mortgage broker) and start hunting for (and underwriting) an actual property.
13. How Do I Find An Apartment Building to Buy?
In general, there are 3 ways to find an apartment building to buy:
Search through an MLS, like Costar, Crexi, or 10-X.
Use a commercial broker.
Hunt yourself for off-market deals.
Off-market deals are apartment buildings with a willing seller who have not officially listed with a broker or publicly advertised the property. These are typically the deals you will want to close on. In general, you will want to both work with a commercial real estate broker and hunt on your own for off-market deals by directly contacting apartment owners.
14. How Do I Find a Commercial Broker?
Finding a commercial broker isn’t hard, but finding a good one can be. Talk to friends, mentors, or others who have knowledge of the local market in order to find someone trustworthy and competent.
You may want to avoid the larger brokers, as they may not have the time and energy to focus on smaller investors. When you speak to a broker, ask them for their best off-market deals, as these are likely to be much better than the deals that are currently listed on the MLS.
Many brokers will attempt to put you under contract exclusively for their area or region. It’s generally a good idea to avoid this, unless you already have a longtime relationship with the broker and are very confident they can find you a good deal quickly.
Depending on your situation, it may be ideal to find a good property management company before looking for a broker, though these can be done simultaneously.
15. How Do I Select A Property Management Company?
The process of finding a competent property management company is similar to finding a commercial broker. Research online and ask within your network, or even contact the property management company for buildings in your target market that seem to be well kept.
When interviewing a property management company, you’ll want to ask questions including:
How many units do you currently manage? You may wish to find a company that manages 1,000 or more units, as these companies generally have more experience and charge less due to economies of scale. Conversely, if a company manages more than 10,000 units, they may not give you and your property the personal attention it needs.
Where does your company operate? You will generally want to find a company that is local and highly focused on your target market. If a firm manages apartment communities in multiple markets, it may be a sign that they are not as focused on your market.
How will your firm be compensated? Most management companies are compensated via a combination of fees and a percentage of gross rents (often 8-12%). This ensures that there is an alignment of interests between you and the company.
What responsibilities will you have? In general, property management companies market the property to tenants and take care of maintenance, including dealing with contractors and tradesmen for regular maintenance issues. Some companies may do more or less, so it’s essential to know what you’ll be paying for.
16. How Do I Find a Commercial Mortgage Broker?
Just like finding a property management company and commercial real estate broker, you can locate a commercial mortgage broker via a combination of referrals and cold calls. Before working with a commercial mortgage broker, sure they have a good reputation and have gotten financing for similar types of deals in the past.
In order to help you qualify for the loan and proceed with the deal, a good mortgage broker will collect your paperwork and “shop” your loan to various lenders while attempting to negotiate for the best rates and loan conditions.
Generally, your mortgage broker will need documents including:
Rent roll: A property’s rent roll contains all rents paid by tenants of the property, including discounted or written-off units for employees or a property manager (if the building has these).
T12: A T12, or trailing twelve months, shows the apartment building’s financial statements for the last year.
T3: A T3, or trailing three years, shows the apartment building’s financial statements for the last three years.
Property Inspection: A full property inspection by a licensed property inspector is generally required.
Appraisal: The appraisal is one of the most important documents you will need to show your loan broker, and thus, your lender. The appraisal will try to get as close as possible to the true market value of the apartment building. The appraiser must be certified and will typically use a combination of the three major valuation approaches in order to come up with a valuation. These include:
The sales comparison approach: Looks at the prices of 3 similar properties nearby that have recently sold to determine a prospective price.
The cost approach: Attempts to determine the cost to build a similar building plus purchasing the land, minus depreciation.
The income approach: Looks at the current income of the property in order to determine a value.
Physical Needs Assessment: A physical needs assessment, or PNA, looks at the current apartment conditions, lists needed repairs, and helps determine an appropriate amount for replacement reserves. Replacement reserves are funds set aside to maintain the property during its operations or pay for unexpected expenses. Lenders typically require a minimum amount of replacement reserves placed in an escrow account. For instance, Fannie Mae multifamily loans generally require $250 per unit/per year.
Zoning Report: Not always required, but usually needed if the property may be in conflict with zoning regulations.
Phase I Environmental: A Phase I Environmental (ESA) report checks for potential carcinogens in the area to ensure the property is safe for habitation. A Phase II ESA could be needed if contamination is found to determine the extent of the contamination and to develop a remediation plan.
Title Report: A title report checks the title to the property to make sure the owner really owns it and that there are no other valid claims or liens on the building. If a title report comes back with issues involving boundaries or easements, a separate property survey might be needed. We’ll go more in-depth about title issues in the next section.
C. Closing, Management, and Sale: Buying and Selling 101
17. What Happens Before Closing?
Before closing on a property, you will need to enlist a local title company to provide a title search on the property. The property’s title, even more than the deed, is the key to legally owning the property. Unfortunately, some apartment properties have title issues, such as:
Unpaid property taxes or fees
Claims from family members or other owners
Mechanic’s liens from unpaid work on the property
If there are any title issues such as these, you may want to stay clear of the property. However, if the issue can be taken care of promptly by the seller, you may wish to go forward with the transaction.
You will also want to take out title insurance on the property in case any future title issues pop up.
18. What Happens at Closing?
At closing, you and the seller will typically each sign documents transferring the property from the seller’s company to yours. The property, which likely was held by an escrow company, will be transferred to your LLC or holding company, while the funds from you and your lender will be transferred to the previous owner after their mortgage has been paid off. The only exceptions to this are if the previous owner owned the apartment building in full or if you are going to assume, or take on, the loan.
19. What Should I Do After Purchasing My Apartment Building?
Unless you have assigned the duties to someone else, first-time syndicators are also generally asset managers. This means that they are responsible for the financial status of the apartment building as an investment vehicle. This includes:
Value-Add Opportunities: Asset managers must consistently identify ways to increase the value of the property, increase income via higher rents (within fair reason) and higher occupancy, and reduce expenses.
Managing Others: Asset management responsibilities also include supervising the property management company, general contractors, and other vendors. The asset manager or their designated payroll employee will be responsible for paying fees and taxes and paying investors.
Investor Relations: As a first-time syndicator, you will also likely be responsible for investor relations.
This means providing reasonable updates about the physical and financial condition of the property, as well as answering any questions or concerns your investors may have.
You will want to tell investors in advance how you plan to update them. A weekly email? A quarterly mailing? Whatever it is, make it simple and consistent.
In addition, you will also have to notify your investors if you cannot make their monthly cash coupon, or if additional expenses or low occupancy will reduce their overall IRR. These may be difficult discussions to have, but notifying investors upfront will allow you to gain their respect in the long term.
20. How Do I Sell My Apartment Building?
In essence, the same way you bought it. You will likely use a broker, unless you find an off-market buyer willing to take the property at a good price. Consider factors including:
Sales Timeline: Ideally, you are selling your apartment complex at a healthy profit at the end of your projected investment period. This is typically 1-3 years for distressed projects, 5+ years for value-add properties, and 7-10+ for turnkey properties, though this varies widely from investor to investor.
Tax Considerations: There are various tax considerations at property sale, as any gains will typically be counted as capital gains taxes. In the years before selling, it’s important to make sure you have taken all the applicable depreciation deductions, which count against an investor’s tax burden.
Cost Segregation/Depreciation Recapture: Cost segregation is one way to accelerate the speed of depreciation deductions, though it isn’t a good fit for every deal. However, when you sell, you’ll have to pay those deductions back in the form of depreciation recapture. Unless, of course, you do a 1031 exchange.
1031 Exchanges: A 1031 exchange is a legal vehicle that allows you and your investors to roll your money into the purchase of a new apartment building, along with your capital gains tax obligations. If some investors want to leave the deal, you can typically bring in new ones to buy them out. As of the writing of this article, legislators in the U.S. Congress are considering canceling the 1031 exchange, though this is far from a sure thing.
21. What Should I Do Next?
That’s up to you. If you’re serious about buying your first apartment building, this guide is just the beginning. Start networking and researching to learn more about all the aspects of apartment investing.
If you’ve followed the steps above (or similar steps) and have closed your first apartment deal, it’s time to think about the next steps. If you acquired a distressed or value-add deal, get working on your business plan to improve the property as quickly and economically as possible. However, if you acquired a fully-stabilized turkey property, it could be time to start this process all over again in order to add a new apartment complex to your quickly growing portfolio. Good luck!