Apartment Building Acquisition -- What You Need to Know

What does an investor consider during the process of acquiring a medium sized apartment building and just who is a typical investor of such buildings?

Types of investors vary greatly depending primarily on individual needs and requirements. It also became apparent that a wide variety of criteria for apartment building analysis were used to determine value for each investor. The different investors all seem to have their own formula for choosing just the right apartment building to suit their needs. There are, however, common themes among types of investors and standard ways of analyzing an apartment building for investment. These analysis standards are similar to all types of investment properties and are also used by appraisers, lenders and real estate professionals to determine value.

Medium sized apartment building owners and prospective purchasers seem to be as varied as the types and styles of apartment buildings. Most buyers of apartment buildings do have one thing in common. They already own or have owned an apartment building and are going to buy another one because apartment ownership has been a valuable investment for them. Many apartment owners manage the building themselves with the help of a resident manager and rarely use a professional management company as do owners of large apartment complexes. These medium sized building investors typically are handy and resourceful, able to fix many problems themselves, and have good communications skills to deal with a wide variety of tenants. The apartment building is usually not their only business. The owner or buyer will have another source of income such as a small business or salaried employment. Some investors hold the property for long term to help with retirement income, others hold for five to seven years to then tax-free exchange for a larger property, and still others hold for short periods of time to fix up and sell before moving on to another project.

Even though there are many different types of investors and many different buyer formulas for acquisition, the one overwhelming consideration is, of course, the bottom line. The investors, based on their calculations, must decide if the property is going to be profitable. The investor must weigh many factors, crunch numbers and finally decide what factors are most important. The age of the building and its condition must fit their requirements. Some investors want a new or newer building that won't require a lot of maintenance while others will want a building in need of repair to fix up for sale and profit,. The location of the building may have to be close to the investor's home or business so managing and maintaining the property will be more convenient. Other investors may want a building located in an improving neighborhood with a likely possibility of rents increasing more rapidly than normal for the general area.

Almost all investors look at the gross rent multiplier (GRM) and the cap (CAP) rate to determine value and rates of return on their investments. These two indicators are cornerstones of valuation for lenders and appraisers. The gross rent multiplier equals the price or value divided by the gross potential (scheduled) income. A typical or average GRM for all locations, all sized of buildings and in average condition is 8.0. Eight times the scheduled income will give the investor an average return if the expenses and the vacancies are also average. Generally, the lower the GRM the better the return. The CAP Rate (as a percentage) equals the net operating income (NOI) divided by the price or value. A typical or average CAP Rate is also 8.0% but the higher CAP Rate the better is the return. CAP Rate gives an indication of value by using the net operating income as a factor. The NOI is the bottom line after actual vacancy, credit loss, fixed and variable expenses, reserves and taxes are deducted. This bottom line number will give the investor a very good indication of how much money will then be left to pay debt service and to bank for profit. There is certainly no guarantee that the investment in question will continue to perform as before because CAP Rate is based on actual numbers from current and past years. CAP Rate is however the most accurate indicator of investment value and is also the appraiser's best indicator.

The apartment building investor does have some standard indicators such as the GRM and the CAP Rate to help choose an investment property but even so, the apartment building must conform to other intangible and personal requirements of the investor. A good and valuable apartment building investment therefore has a bottom line that must be both financially profitable and must meet many intangible personal requirements.

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