Many investors enter the real estate game by buying a multifamily residential or mixed-use property. Beginning with just two to four units is a great way to start. That’s what I did, and many of the buildings I bought after that first one stuck to that model as well. If you want to go bigger right off the bat, you might look at a building with eight to twenty units, but make sure you have good help in your corner before you take on a challenge of that size. Here are some tips to keep in mind when you’re looking for your first apartment building.
As with just about any other type of property, the three secrets to buying the right apartment building are location, location, and location. The neighborhood in which your property’s located will make all the difference in terms of what you pay for it and how you manage the asset.
Your property doesn’t necessarily have to be located in a terrific neighborhood. Many investors recommend a strategy of buying not-so-great buildings in the best neighborhoods, and improving the buildings to drive up the rent. That’s a very good idea, but it’s not the only way to turn a profit.
Terrific neighborhoods—those with the best schools, the best infrastructure, the best access to retail, and the highest per-family incomes—aren’t always the best locations for a rental property, because they tend to attract buyers, not renters. A neighborhood that’s not the fanciest—a neighborhood that’s good, not great—is usually a more suitable location for rental properties.
A neighborhood where the schools, infrastructure, houses, and family incomes are a little above average is a great place to own property because a neighborhood like that will be what marketers call “aspirational.” People who live there will be striving to improve themselves and their surroundings. They’ll welcome a responsible landlord who is also interested in improving the community and who will bring respectable tenants into his building.
Even a neighborhood with a bad reputation—one with low incomes, higher crime rates, and a transient population—can be an advantageous place to own an apartment building. You won’t have to worry about demand, because someone is always looking for lower-cost housing. But if you own in a bad neighborhood, you’ll have to give your building a lot of attention, maybe even more than you’d give a building in the best neighborhood. You can do very well by owning a good building in a bad neighborhood. People will want to live in it, and will pay a premium rent—and by owning a safe, well-run building, you’ll have a ripple effect on the surrounding area, so that in a few years, that bad neighborhood will have become a good one.
You need to pay attention not just to the property, and not just to the quality of the neighborhood. You also have to know how the neighborhood has been zoned by the local government. If you have a notion to turn the lower floors into retail and office space, for example, you had better know, before you buy, whether the zoning laws will permit it.
Get as much of your financing in place as you can before you start looking at properties and making offers. You won’t be able to borrow money until you have a specific property in mind to buy, but you can visit several lenders beforehand, tell them what you’re planning to do, show them all your financial information, and get an idea of how much you’ll be able to borrow, on what terms.
Work with a broker. If you try to make the deal yourself, unless you are a trained real estate professional yourself, you’ll be at a tremendous disadvantage: a street brawler against a guy who’s got black belts in karate and aikido.
Interview several brokers, and avoid working with close friends or family. If you’re working with a real estate agent to find a suitable property, avoid working with seller’s agents. They’ll have a fiduciary duty to the seller. However, it pays to talk to seller’s agents, because they can point you to likely properties. It’s often a good idea to work with a broker who is a Realtor—a member of the National Association of Realtors. Realtors have a pretty strong code of ethics that’s meant to ensure that they’ll look after the best interests of all parties to a deal. It’s not a must to work with a Realtor—there are plenty of good brokers out there that may not be part of NAR, but it’s an option.
Do your own research when you’re looking at a building. Walk the neighborhood; question the locals. Look on the web to get an idea of what buildings are selling for in the area, on a per-square-foot basis, so that you’ll know what to offer. Find out whether the building you’re looking at has been on the market long, or whether it’s been offered for sale by owner, or listed with some other brokerage. (If the answer to any of those questions is yes, you might be able to buy it for less than the asking price.)
Don’t simply consider the price of the building. When you’re negotiating with the seller, look for concessions. Would the seller be willing to make certain improvements prior to the sale? Would he assume the closing costs? Always look for these “value adds.”
It’s usually best to have more than one property in mind. If you get too emotionally attached to the idea of buying a particular property—well, it’s like being obsessed with one particular girl. If you don’t keep your options open…well, you know the rest.
Find out everything that’s wrong with the building, and I mean everything. It’s usually okay to buy a property that needs a little fixing—just so long as you know, going in, what needs to be done and how much it’ll cost to do it. Many, many investors have bought a building that they thought was a bargain—and then they found out the hard way why it was priced so low.
Before you buy, determine whether you’ll manage the property yourself or hire a management company. Unless you’re a talented handyman and want to spend a lot of your time on the property, I’d recommend hiring a manager. They usually are not expensive—and the good ones are worth every penny.
When you’re choosing a management company, of course you should ask other landlords for recommendations. But be careful not to put too much faith in what tenants say about a management company. Tenants just don’t like building managers! After all, those are the people who collect the rent, and who hold back some of the deposit if the tenant has damaged the unit.
Are you going to live in the building? If you are, you might be able to get better terms on your mortgage—if you figure in the amount you’ll be saving on rent. Tenants usually prefer a building that has the landlord on-premises. (The downside is that you’ll get the first call when something goes wrong in the middle of the night.)
Whether or not you’ll be managing the building yourself, get to know the tenants. Find out from the current owner if any of them are likely to give you problems in terms of paying rent on time, making noise, making unreasonable demands, not taking care of their unit, or abusing the common areas. The eviction process is long and costly, so do your best to prevent it ever happening. (And for heaven’s sake, don’t buy an empty building unless you’re experienced at bringing in tenants. Even if it’s a good deal, the building will do you no good if it doesn’t produce a positive cash flow.)
Owning and managing a building is a science, not an art. It’s a fairly simple science. If you’re responsible and hardworking, and if you have normal intelligence, you can do it very well. Here are some pointers:
Don’t overextend yourself. If you own a building of fewer than ten units, you can probably take care of all the maintenance and management yourself, if you want to. Much more than that, though, and you’ll have to hire people, such as a building superintendent and maybe a cleaning company.
Don’t scrimp on the hired help. Don’t hire just anybody as maintenance or management personnel and pay them minimum wage. Hire experienced, knowledgeable people and pay them a market wage or salary. You get what you pay for, and if you’re paying someone to manage your fortune—which you’re doing, in this case—pay them well.
House rules should of course be included in the lease agreement—but post them in a prominent place in a public area of the building, too. These rules should include:
You’ll deal with contractors quite often in your career as a property owner. Whether it’s a plumber, electrician, landscaper, carpenter, or generalist, you’ll find that several basic rules apply.
First, do your homework. Before you hire a contractor, check its reputation with your local chamber of commerce, and get recent references. Look up the company on the web. (But don’t automatically eliminate any candidate that has a few complaints against it on the web. Disgruntled customers are much more likely to comment than happy ones, and their complaints aren’t always reasonable.)
Don’t let a contractor pressure you with an offer that’s “good for today only.” Any reasonable contractor will give you at least a day to make up your mind. A contractor might ask for money up front, especially if it’s a big project, and that’s a fair request, but it shouldn’t be the whole price of the project. Typically, you’ll pay one-fourth to one-third of the estimated cost before any work is done, with more payments as the project progresses. Keep a paper trail of all agreements and payments.
Think about how you plan on collecting the rent from your tenants. If you’re going to be living in the building (or if you have a property manager living in the building), you could always go with the time-tested “slip it under my door on the first of the month” method. This is as simple, low-cost, and low-tech as it gets. But it also means that when someone is late with the rent, they may go out of their way to avoid you and your apartment, creating an adversarial relationship between you. Not only does this create an unpleasant living situation, a tenant who’s avoiding you because they owe you money is also not about to call you up if there’s something wrong with their apartment, meaning that things could be breaking in their unit and you don’t know about it. This could lead to a costly or even hazardous surprise down the road.
Another option is to have your tenants mail you the rent each month. Again, this is simple and cost-efficient—all it takes is an envelope and a stamp. But this method also gives delinquent tenants access to the oldest excuse in the book for late or missing rent payments: “It got lost in the mail.”
These days, I prefer to have my tenants pay electronically. There are plenty of services out there that handle online rent payment. There are a couple major advantages to using an online service. Tenants can set up automatic monthly payments so that they don’t have to remember to pay every month, which gives both you and your tenant peace of mind. Online rent payments are often tracked by credit agencies, which allows tenants to build their credit by paying their rent on time, something paying through more traditional methods doesn’t do. And best of all, many online rent payment services let roommates split up the payment among them, so everyone automatically pays their share, even if those shares aren’t equal (for instance, if the guy who gets stuck with the smallest bedroom gets to pay a smaller share of the rent). This avoids the classic roommate headache of one person forgetting to chip in each month.
The downside to electronic rent payment services is that they’re pricey, at least when compared to the cost of a stamp. These services make their money by taking a small percentage from each payment. It’s not a big amount, but landlords still need to compensate for it by either passing the expense along to the tenants by asking a higher rent, which could theoretically drive away some tenants, or by simply accepting that they’ll make a little less each month. To me, the convenience of online rent payment services makes them more than worth the cost. Ever since I switched to online payments for my properties, I haven’t looked back.
Consider whether you might require, or at least encourage, your tenants to obtain any specific forms of insurance. More and more landlords are requiring renter’s insurance, particularly in the wake of natural disasters like Hurricane Sandy, which devastated numerous apartment buildings when it tore through New York and New Jersey.
In Europe, it’s common for many tenants to seek out security deposit insurance as well, and now that’s starting to become more popular in the States. Personally, I’d love to see this trend continue, because the security deposit is one of the most common points of contention between landlords and tenants.
Every sitcom set in an apartment has made a joke about the security deposit at some point. (“Great, there goes my security deposit!” Cue laugh track.) But if you’ve ever rented an apartment, you know that security deposits are no laughing matter. They add a significant amount to the initial move-in costs, and an equally significant amount of stress when it’s time to move out, as the tenants worry about whether or not they’re going to get that money back.
A typical security deposit is equal to one month’s rent. With security deposit insurance, instead of the tenant paying that to you, they pay a fraction of it—maybe 20 percent—as a one-time payment to the insurance company. That’s major savings for the tenant off their move-in costs.
Now, unlike a normal security deposit, they’re not going to get that money back, even if they take perfect care of the apartment. That initial deposit is nonrefundable. So why would they want to do it? Well, in addition to lowering their move-in costs, security deposit insurance can cover them for as much or even more than a month’s rent. On a $1,600 apartment, an initial one-time payment of $320 might provide two thousand dollars’ worth of coverage.
As a landlord, this is a great deal for you. Not only do you get more coverage than a normal security deposit, if there’s any damage that needs fixing, you don’t have to fight with your tenant about it. You just file a claim with their insurance company. When landlords and tenants fight about security deposits, it can get ugly fast. It’s not uncommon for those disputes to end up in court, which takes time and can end up costing you more than the initial security deposit anyway. Security deposit insurance skips those headaches altogether. I highly recommend checking around to see if it’s available in your area.
Always ask yourself, “What could I be doing to give my tenants a better experience?” Could the common areas be improved? Could the building be cleaner? Do you have spare space that could be put to use—maybe as a laundry room or play area? Is it time to touch up the paint to give the building that extra boost? When you run into a tenant in the hallway or outside the building, ask them, “How’s the apartment working out for you? Anything we could be doing better?”
When you put energy and thought into your building, it encourages tenants to put energy and thought into how they maintain their apartments. But it can’t just be all talk. You have to lead through action. For instance, you could offer your tenants a list of ways they can save energy and go green in their apartments, and a few tenants might pick up a pointer or two. But if you start swapping out the light fixtures in the common areas for ones with energy-saving bulbs, or replace your building’s black tar roof with an environmentally friendly roof garden, it will send a strong and clear message to your tenants that you’re serious about making the building greener, and they’ll be more likely to pitch in.
Given that becoming a broker and starting my own brokerage firm was the key to my path to success, you probably think I’m going to say yes and just be done with it. I certainly think that brokers offer a tremendously valuable service to both the tenants and the landlords they work with. But the truth is, deciding whether or not you should use a broker is a little more complicated than that. It depends on your circumstances and the nature of your local real estate market.
Different areas have different standard practices when it comes to working with brokers. In New York City, pretty much everyone gives their listings to a broker. Even giant management companies that keep people on their payroll whose only job is to advertise and show their vacant apartments still give their listings to brokers, just to ensure that those vacancies get filled as quickly as humanly possible. The first person to bring in a qualified applicant, whether it’s an internal employee or an outside broker, gets to keep the broker fee.
Out in the Bay Area, on the other hand, working with a broker is virtually unheard of for rentals. The most high-end properties might use a broker, but all the other management companies and private landlords just dump their open listings on Craigslist and wait for people to come to them. Demand out there is so ferocious that property managers hold open houses and will review multiple applications at once, just like a seller considering multiple bids.
And there are plenty of cities, such as LA, where landlords and management companies depend on brokers to advertise and fill their vacant apartments, but the tenant never pays the broker fee—it’s always covered by the owner of the property. Any property manager who tried to pass the broker fee along to the tenant would be looked at as a crook.
Standards vary from market to market, and markets change over time. Even New York was not so reliant on brokers a few decades ago as it is now. And when I started Rapid Realty, no one was using brokers for rentals in the outer boroughs. That was just a Manhattan thing. Now it’s everywhere.
The fact of the matter is, when you’re first starting out as a property investor and you only have a few units to fill, you might be able to do it without the aid of a broker. In places where the property owner is the one who covers the broker fee, that’s obviously the tempting route to take, because it means you hold onto more money. But you’d better be confident in your ability to advertise those units and get people to come check them out, because every month that those units stay empty is a month you’re paying your building’s mortgage and expenses out of your own savings.
So it depends on what sort of time you have available to be working on getting your vacancies filled. If you’re dealing with few enough units that you can handle the responsibility of advertising and showing them every year, or however often they become available, then that’s great. I know plenty of people who actually started out as landlords—some inherited rental properties from their families, others got into the property investment game after making some money in an unrelated field—who then decided to become real estate agents themselves because they found they actually enjoyed crafting ads and showing vacant apartments.
You might also be able to get by without the help of a broker if your vacant units are somehow unique; for instance, if they’re priced well below market value, if they offer hotly sought-after features that most units in your area don’t have (like a private yard in an urban area), or if they’re located in an area where rental inventory is very scarce.
On the other hand, if you don’t have the time to be showing your units all day, or your properties aren’t located somewhere it would be easy for you to get to on a regular basis (many investors end up with properties scattered all over a city, or in multiple cities, or even multiple countries), or if your units don’t stand out from the pack on their own, or you simply don’t think you have the knack for advertising and showing prospective tenants, then working with a broker could be the smart bet right from the start.
In a place like New York where the tenant is often expected to pay the broker fee, what do you have to lose from working with a broker? It doesn’t take a penny out of your pocket, and you get all the benefits of working with a team of professionals who do nothing all day other than promote vacant listings and match people with homes that fit their needs.
Anywhere else, it’s a judgment call. Does the cost of a broker fee outweigh the cost of potentially having your units sit vacant? Most tenants are looking for a move-in date of the first or fifteenth of the month, which means that if those dates pass you by, and you don’t have tenants lined up, you may need to wait until the next month to find someone. Is that a gamble you can afford to take? It’s a call that every landlord has to make for themselves.
I’ve seen it a thousand times: a first-time, or aspiring first-time, property investor decides to buy a rental property and then immediately says, “I’ll rent it to my friends! It’ll be great!”
No. No, it won’t.
This is a prime example of a situation where your heart and your gut may come into conflict. But the single most important piece of advice I can give if you’re new to property investment is this: Don’t rent to your friends. At least, not at first.
Every landlord-to-be thinks that renting their units to their friends is the best possible situation. And why wouldn’t you? After all, it means you’d already know and have a great relationship with your tenants, which feels awesome, especially if you’ve never managed a rental property before. And you can trust your friends to pay their rent, because they would never want to make things awkward between you. Hell, if you gave them a little break on the rent, they’d probably even pitch in around the building!
It’s doubly tempting because you probably have some friends who could really use a cool landlord like you. If you live in a big city, even if you’ve never had a bad rental experience yourself, you almost certainly have a friend who has: the one who has to move every six months because they can’t find someone willing to give them a longer lease, the one who keeps finding great apartments and then getting kicked out because the owner decides to turn them into condos, the one who just got screwed by a giant rent increase that skirts the limit of legality. You could help them all. You’d be a hero!
Resist. As tempting as it is to give in to those noble impulses, resist. Because if you take a little time and really think about it, you’ll find that, as great as it all sounds, something about it doesn’t sit easy with you. That’s your gut talking, and it has a good point.
First of all, that discount on the rent you were thinking of offering—can you really afford it? I’m not asking if you think you can afford it, I’m asking if you’ve actually taken the time to crunch the numbers, because every dollar you lower the rent is increasing the time it will take you to make your full return on investment. Especially if this is your first building, you need to be very careful about being able to cover your mortgage, taxes, utilities, maintenance fees, and still leave yourself enough to cover any sudden, unforeseen repairs.
So, after all that, are you sure you can afford to offer that discount? You are? Terrific! Now, next question—can you afford to not get paid at all?
Right now, you might be thinking, Anthony, you don’t know what you’re talking about. My friend would never stiff me on the rent!
I’m 100 percent sure you’re right. Your friend would never mean to stiff you. They would have every intention of paying on time every month, of being a model tenant, and of gratefully enjoying the apartment you’re renting to them without ever being a pain in your side.
But then comes the month when they’re a little late on the rent—past the grace period you set in the lease (you did make them sign a lease, right?). You don’t say anything, or maybe you shoot them a quick, nonjudgmental reminder. Hey, everyone makes mistakes, right? Not a big deal. They pay up, and they’re embarrassed that it ever got so late in the month.
Then a few months later, they ask if they can get a little extension on the rent. Money’s a little tight this month. They’re stretched pretty thin. Can you give them a break? You know what it’s like to look at your bank account and be worried by what you see. And it’s your friend, for crying out loud. They wouldn’t be asking if they didn’t really need it. So you tell them it’s no problem. Maybe you even cut them a deal on that month’s rent.
Then a little while after that, they’re late again, and you don’t want to say anything, because it was awkward enough the first time, and hey, maybe they’re still having some financial trouble. So you let it go, and you let it go, and it slips off your radar when something else in your life pops up, and before you know it, you’ve just gone the full month without receiving your rent check.
No one in this scenario set out to screw over anyone else. No one was necessarily acting in bad faith. Maybe your friend really did just forget! But you still ended up getting the short end of the stick, and your friend still ended up taking advantage of you. And it happened because you, understandably, wanted to preserve your friendship. You didn’t want to be the kind of friend who lets money come between you. You wanted to be a good guy.
This is not a fantasy scenario. This is something that happens to new landlords every single day.
It may not always be in the form of skipping rent payments. It can happen in other ways. But one way or another, it’s all too common for friends to take advantage of their friends when they enter into a tenant-landlord situation. The landlord thinks their friend will take better care of their property than the average tenant, but actually the opposite is true—because of your personal relationship, your friend is actually less likely to take consistently good care of your property, because deep down they know you’ll cut them some slack.
What inevitably happens is that you end up losing money compared to a tenant with whom you have only a professional relationship, and even worse, you can often end up losing the friend. Once someone takes advantage of you like that, even if they weren’t doing it consciously or maliciously, once resentment over money enters the relationship, it’s hard to come back from that.
So, for the sake of your budget, your future, and your friendships, don’t rent to your friends. At least, not until you’ve spent a few years getting comfortable enough with maintaining landlord-tenant relationships and collecting rent in a timely fashion that you can separate your professional relationship with your personal relationship without risking them both.