How do people make substantial amounts of money buying with loans?

The numbers don’t currently make sense to me…

Let’s take an example of an apartment complex listed for $1,000,000 that has a NOI of $100,000. (10% cap rate)…

If you put 20% down, and borrow the other 80% ($800,000) at 4.5% over 20 years, this gives you about $60,700/year of loan payments.

Subtract that from the $100,000 NOI and that leaves you just under $40,000 of profit.

Is that all a person should expect from a $1,000,000 apartment complex?

I do know that very large firms buy sometimes 70% with loans, sometimes using private investors that would want a higher rate than a bank.

So how do they make so much?

Your example pushes off an initial cash-on-cash return of 19.63% Add in depreciation, mortgage pay-down, natural market appreciation, and perhaps forced appreciation, raising rents, and you could probably achieve a 30% plus return the first year…

Working backwards:

$1,000,000 Price 20 Units? $50,000/unit? Built in 1984.
$ 200,000 GSI $833/mo per unit? 1.66% Rent/Price Ratio
$ 100,000 NOI (After management/maintenance/vacancy) 10% CAP RATE
<$ 60,734> Debt Service
$ 39,266 Pre-Tax Cash-Flow (19.64% Cash-on-Cash Return)

Without any more information, this would be an better than average multifamily deal.

Issue: *Large firms don’t buy $1M apartment buildings.
Issue: *Large firms don’t borrow private money to buy $1M buildings.

Interesting. Thank you.

What do large firms buy? More expensive buildings? Do these give them better deals because there is less competition?

How do large firms borrow money then?

Also, what you’re calling a 19.63% return… Wouldn’t it be more like a -80.37% return? Breaking even at about 5.09 years until you see your $200,000 down payment back.

If you put $200,000 in a stock and it returns 19.63% on the year, that means you will have $239,260 at the end of the first year.

No, you divide your cash flow of $39K, by the amount invested of $200K, and you come up with a first year 19.63% return on the $200K invested. Depending on the cash flow for the second, third, and following years, the annual returns will vary.

I don’t know what kind of calculator you’re using, to come up with 200%, but you need a refund on that sucker.

Large firms buy large properties that are generally pride-of-ownership, with relatively stable and predictable performance. They don’t buy fixer uppers, or even buy for cash-flow necessarily. They’re happy with relatively average returns, and I would say way less than a smaller operator would insist on. I’ve never seen a REIT that did offered more than I could do for myself. Whatever that means.

In fact, once you get over a certain size, like 150 to 250 units, the management overhead can run 20% of the gross, and the returns become barely more than parking cash, and simply an effort to capture appreciation. That doesn’t mean they don’t buy right, or ignore the overhead numbers when buying.

Large operators typically buy/build 100/unit plus complexes, and borrow from high-finance sources, which can include just about any group of that handles investment money for pensions, stocks, insurance companies, and of course private equity firms. That’s the extent of my interest, or knowledge on that subject. Perhaps someone else can chime in with more specifics.

Otherwise, at that level of investing, it would seem that predictability trumps any other objective.

Let me just say that between 5 units and 30 units, you have a lot of competition from the tinkerers that typically self-manage their real estate, and drive the CAP rates down.

Between 30 and 120 units, you lose both the tinkerers, and the high-finance operators, and find better CAP rates (grossly generalizing here).

Meantime, this range represents a sweet spot, with the fewest buyers in my experience and opinion, which you didn’t ask for, but…

FWIW

I definitely did ask for your opinion and thanks for it.

Why do tinkerers drive cap rates down? Just because they don’t know what they’re doing?

Wouldn’t this be an opportunity for some good deals if I did know what I was doing and could improve their operation?

Their cap rate and my cap rate might be two different things.

  1. Anytime there are more potential buyers for deals, there’s gonna be more competition for deals; higher prices; and lower cap rates. And it’s worse when the buyers are newby amateurs willing to pay asking price, because they’re too ignorant to know better.

Never mind just paying too much, because the buyers don’t negotiate prices and/or terms that allow for 3rd party management, like you’d see buyer do in a 50/unit project negotiation. And never mind the self-managing sellers are marketing to other self-managers in the first place, on the assumption that the units will continue to be self-managed. And the agents are just itching for a closing, and telling the buyers what great deals they’ve got, and never mind nobody else has paid this much for similar units to date, but “you know they’re never gonna see ‘these’ prices again,” there’s all sorts of room to immediate raise the rents… blah, blah, blah.

All reasons contributing to paying more than one would pay on an identical unit in a larger project with professional who knows what he’s actually buying and why.


  1. Theoretically, this would be an opportunity. It really comes directly down to finding and pitching motivated sellers, which also brings me back to answering your question about ‘when is it a good time to buy cash flowing rentals.’ Anytime’s a good time, but again, it all comes down to finding, pitching, and closing on motivated sellers. Assuming you know how to analyze deals, that is. Then it comes down to finding, pitching, and closing on motivated sellers.

  1. The CAP rates a seller quotes is ALWAYS different from what you know is gonna happen. Sellers always lie, underestimate, and otherwise forget about maintenance and management costs, and otherwise try to sell you on the ‘fact’ that their units are so ‘EZ’ to operate, they practically manage themselves, at no cost. And they hardly ever need maintenance, because, you know they did all the ‘major’ stuff back in 19-something.

Sure, and where’s that bridge you wanted to sell me?

Are you saying that the Empire State Building is a bad buy and all those people trying to buy it are more interested in their own egos than in making money? (This is in reference to a different post about pride of ownership purchases). I find this interesting and significant.

There’s a whole bunch of bad reasons people bought the Empire State Building; ego trips and bragging rights are right there at the top. However, this doesn’t mean every investor was buying for the wrong reasons. There have been buyers that were looking for value added situations, where they could force the appreciation and increase their equity, by re-positioning the project. After all, nearly every building becomes obsolete at some point, without periodic interior upgrades and improvements. At one time the ESB didn’t have elevators, plumbing, or phone lines.

So I should be buying apartment complexes between 30 - 120 units and what do you think about hotels?

Apparently, they follow the 5% rule instead of the 50% rule?

Do you have any experience or opinions about hotels?

Hi,

 There is NO hotel rule!!!!!!!!!!!!!!!


       GR

And I was just kidding about the empire state building not having elevators, phones, and plumbing at one point. Of course, it has had all those things since it was built. I’m betting not the same as what’s installed today, but I digress.

I want to do whatever is profitable. My personality can adapt to the situation.

The 5% rule was in reference to another post analyzing the profitability of a hotel.

Why are hotels and apartment complexes so different and why, even given the opportunity, would you shy away from hotel investing?

For starters and for giggles, hotels don’t screen tenants, there is daily turnover, higher wear and tear, high maintenance, constant upkeep, management intensive, and again I am not curious, or whatever interested discussing these operations. This is not investing in real estate. This is just operating a business.

This is a good question. I think some people use their own money to invest in the first few transactions and then after making money after these transactions, you can use this money towards your next transaction.