The Complete Guide to Buying and Selling Apartment Buildings Chapter 5-6

Establishing Your Niche and
Locating Properties
Success is not measured by what a man accomplishes, but by the opposition
he has encountered and the courage with which he has maintained
the struggle against overwhelming odds.
—CHARLES LINDBERGH
T
he preceding chapter discusses the
merits of the value play. This chapter examines some important concepts to
consider prior to the deployment of your acquisition campaign. You must
first determine your niche in the marketplace by analyzing key factors
regarding the type of property you are seeking. Once you have defined
exactly what type of property you are looking for, you will be ready to
embark on locating the property best suited to your needs.
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CHAPTER 5
Establishing Your Niche
Before you begin your search for an apartment complex, you must first
define your niche in the marketplace. There are four crucial factors to con-
sider:
1. The resources available to work with.
2. The size of the property.
3. The age of the property.
4. Your holding period.
It goes without saying that there is some crossover among these factors. For
instance, the more capital you have to work with, the larger and more
expensive a property you can acquire. One is not necessarily a function of
the other, though. Just because you have a large pool of capital to draw from
does not mean that you have to buy a larger property. Let us examine each
factor in more detail.
Availability of Resources

Obviously, the amount of capital you have available for real estate invest-
ments is a key factor in establishing your niche. The more you have to work
with, the greater your choices are. In general, loan-to-value (LTV) financ-
ing of 80 percent is readily obtainable. If you had $100,000 to invest and
procured an 80 percent loan, you could buy a $500,000 apartment building.
With that same $100,000, you could acquire a $750,000 complex with an
85 percent loan or a $1 million building with a 90 percent loan. In my expe-
rience, “nothing-down deals” do not exist when it comes to buying larger
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properties. You may be able to find them for single-family homes, but for
multifamily properties, be prepared to come to the closing table with your
checkbook. I am not suggesting that it is impossible to find a nothing-down
deal for apartments; I am just saying that I have never seen one. I suppose
you could structure a deal on an 80/10/10 basis, meaning 80 percent bank
financing, 10 percent seller carry-back, and 10 percent from a partner,
friend, or relative. The bottom line is that the capital you have to work with
will be a constraint and a determining factor in establishing where you will
fit into the multifamily marketplace. Define your limits before conducting
your search.
Property Size
While the number of units you can acquire is in part a function of the capi-
tal you have to invest, there is a wide range of prices per unit available. Some
older apartment complexes may sell for as little as $5,000 per unit, while
newer properties may sell for as much as $75,000 to $100,000 per unit or
more, depending on the region you choose to invest in. I recommend that
newer investors get their feet wet with a smaller property of 50 units or less.
A smaller apartment building will provide you with the opportunity to be
directly involved in the operations of the property. In short, it will give you
some hands-on experience. As your expertise and knowledge grows, so will

your confidence. This self-assurance will manifest itself through your ability
to graduate to larger and larger multifamily properties.
Midsized apartments typically range in size from 50 to 150 units. As you
move up the scale in size and magnitude of the properties in your portfolio,
you will most assuredly want to employ full-time managers and mainte-
nance personnel. Furthermore, unless you plan to keep up with all of the
accounting functions, such as the accounts receivables, payables, and col-
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Establishing Your Niche and Locating Properties
lections, you should seriously consider engaging a reputable property man-
agement firm. An effective management company will handle all of the day-
to-day operations such as managing the staff, collecting the rents, and
paying all of the bills. It will also generate month-end financial reports from
its accounting programs, which will provide you with all of the details of rev-
enue and expenses. Depending on the size of the company, management
firms generally use field supervisors, adding a level of supervision that
would not otherwise exist. These supervisors will usually oversee and be
responsible for 5 to 10 different apartment complexes. If your on-site man-
ager runs into a problem outside of the normal day-to-day operations, he or
she can call the field supervisor for help. A competent supervisor should be
able to resolve most issues.
Larger multifamily complexes are typically those with 150 units or more.
Larger properties allow the owner to achieve a higher degree of efficiency
through economies of scale. Depending on the size, instead of having one
all-purpose maintenance person, you would be able to hire one maintenance
person who is also qualified in air-conditioning and another who has
plumbing skills, in addition to a groundskeeper and perhaps a porter.
Employing individuals with these types of skill sets can be a very effective
cost-savings measure because you do not have to call in an outside contrac-
tor every time an air-conditioning unit goes out, for example. With mainte-

nance personnel on-site and readily available, your tenants will benefit, too.
They will appreciate the better service. Satisfied tenants mean lower
turnover, resulting in additional cost savings to you. Larger complexes gen-
erally mean larger budgets, which can give you greater flexibility in the way
you operate your property. You can afford to have a professionally trained
sales staff that will ensure that things run as smoothly as possible. A skilled
manager will know how to address issues as they arise and how to deal with
them effectively. This, too, will result in lower turnover. Trust me: a quali-
fied manager can make all the difference in the world in how profitable your
apartments are. Don’t be afraid to spend a little more on the individual over-
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72
seeing the day-to-day operations. An increase in salary expense of $5,000
for a competent manager will be more than offset by an increase in revenues.
Regardless of the size of apartment building you purchase, the use of a pro-
fessional property management company can be extremely important to you
as an owner. You and you alone must determine what the best use of your
time is. Where do you add the most value to the process? In the early stages
of building wealth through real estate, the day-to-day, hands-on involve-
ment will give you invaluable experience not available from any other
source. As your level of expertise increases, however, it will be time to shift
some of those responsibilities to others. Why burden yourself with trying to
personally manage and oversee every detail of a 100-unit complex, for
example, when you can pay someone $20,000 to $30,000 a year to assume
those duties for you? This frees up your time to focus on more important
things, such as preparing to implement your exit strategy for your existing
building and beginning to identify potential acquisition targets for your next
value-play opportunity.
If you allow yourself to get bogged down in the day-to-day management,
you will soon discover there is little time left for anything else. I am not, of

course, suggesting that you remove yourself completely from the process.
Your role is to manage the managers by defining your objectives for the
property. You provide the leadership, and then get out of the way and let
them do their jobs. Do not micromanage. You will continue to maintain
close contact and make yourself available for questions. In addition, you will
scrutinize every detail of the financial reports every month to ensure that
you are on track to meet your stated objectives.
In summary, whether you own a small, midsized, or large apartment com-
plex, you must decide as the owner what the best use of your time will be
and how you personally can add the most value to maximize the return on
your investment.
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Establishing Your Niche and Locating Properties
Property Age
Depending on their age and physical condition, apartment complexes are
commonly classified as A, B, C, or D properties. As a general rule, the newer
a property is, the more expensive it will be on a per-unit basis. You might
pay, for example, as much as $75,000 to $100,000 per unit for a newly con-
structed building, or you might pay as little as $5,000 per unit for a much
older building.
Class A apartments will typically be newer properties, less than 10 years old
and in excellent condition. They may even be newly constructed buildings
that are still being leased up. This type of apartment will command the high-
est price per unit for several reasons, one of which is the cost of new con-
struction, building materials, and labor. Due to an inflation-driven economy
(even at 3 to 4 percent per annum), it is a simple fact of life that it costs
more to build today than it did a year ago, 5 years ago, or 10 years ago.
Before developers and builders begin a project, they will perform a feasibil-
ity study to determine whether the project makes sense. They will estimate
all of the costs that go into the project, examine the potential market rents,

calculate the pro forma net operating income, and extrapolate the value of
the completed project based on a range of capitalization rates. If the rate of
return on the developer’s invested capital meets the threshold, the project is
deemed viable and they move forward with it. All of these factors drive the
value of the property and result in a higher per-unit cost compared to older
buildings. Class A apartments are often held by a group of investors that
owns a portfolio of properties, possibly in a real estate investment trust
(REIT).
Advantages of Class A buildings include higher rents, lower maintenance
costs, and numerous amenities such as swimming pools and weight rooms
to attract tenants. Disadvantages include a much higher per-unit cost to you
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as the investor and, usually, a lower initial rate of return. Another disadvan-
tage you must be aware of is that in the event of a downturn in the economy,
this will be the first group to get hit, especially if the downturn is followed by
a strong upward cycle. This is due to the fact that as interest rates decline,
more and more product comes on line, and as rates start to go back up,
there are still a number of projects in the pipeline yet to be completed. In a
very strong upward cycle, the housing market may become oversaturated
with supply. If the economy softens, Class A properties may be affected
because of (1) the oversupply of new product and (2) tenants’ tendency to
migrate toward less expensive housing in an effort to save money and con-
serve their own resources. Instead of paying $1,500 a month to live in a nice
Class A complex with all of the amenities, they will likely look to move down
to a Class B property for only $900 per month. I remember that the Texas
economy, and Houston in particular, got hit hard with a situation very sim-
ilar to this in the mid-1980s. There was an oversupply of Class A buildings
available; oil prices turned downward, and layoffs followed. Almost
overnight, vacancy rates increased significantly, and prices came down hard

and fast. Many, many bank loans went bad as investors walked away from
their properties.
In summary, for the value-play investor, Class A apartments offer the least
upside potential because there is no additional value to create. The proper-
ties are newer, the utilities are already submetered, and they offer many
amenities to their tenants. Furthermore, not only is there no additional value
to create, but investors will often pay a premium for these higher-quality
assets.
Class B apartments are slightly older than Class A buildings, usually between
10 and 20 years old, and are still in relatively good condition. Class B prop-
erties will generally range from $25,000 to $75,000 per unit, depending on
the market. These properties are often located in solid middle-income areas
and are likely to be the most stable among the various property classes. This
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Establishing Your Niche and Locating Properties
is due to the fact that the surrounding neighborhoods are well established
and are in relatively good condition, with little or no deterioration. The
apartments are still new enough to offer many attractive amenities, and old
enough to be affordable for many families. As air-conditioning units and
other equipment begins to fail, Class B properties will experience higher
maintenance costs than the newer Class A apartments.
Opportunities to create value acquiring Class B apartments are available to
the patient investor who takes the necessary time to conduct a diligent
search. They are not as readily available as Class C apartments, however.
The example cited in Chapter 4, the 22-unit building, was a solid B property
that had not been kept up. As previously mentioned, most of the deteriora-
tion was aesthetic and was therefore not that costly to bring back into good
condition.
Class C apartments are those that range in age from 20 to 30 years and in
price from $10,000 to $30,000 per unit, depending on the relative market

values, rents, and property condition. Value-play opportunities are abundant
in the Class C category for a variety of reasons. Many of these older units
are still in fairly good condition, but may not offer some of the amenities that
newer ones do. Cosmetic improvements can do wonders for Class C build-
ings, as can the addition of a few of the amenities that newer apartments
offer. Modernizing the individual units with updated appliances and cabi-
nets is an affordable way to add value. In addition, many of the Class C
buildings were built before the notion of submetering became popular. As
energy costs rose, investors in newly constructed units began more and
more often to pass these costs on to the tenants. Also, many investors in
existing buildings have retrofitted their apartments with individual meters to
provide the tenants with direct control of the comfort in their respective
units, as well as the responsibility for the bills. The all-bills-paid properties
are quickly becoming a dying breed as investors move to shift these costs to
tenants, especially in the face of ever-higher energy costs.
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