Disclaimer: Bryan Church’s Real Estate Corner is not presented or intended to be used as investment, legal, tax, or as any other advice and should not be used as a basis for any type of decision.  Consult a professional before making any decisions.  

Why are Investors Buying or Building Apartment Buildings?

August 4, 2016

Historically, real estate investors have tended to start their real estate investment careers with single-family homes.  Then, as they acquire more experience and become more affluent, their equity is moved into multi-unit residential properties, then into leased investments—such as retail, office, or industrial properties—and, finally into single-tenant retail properties.  

 

The main reason real estate investors have followed this investment continuum is because of management intensity and tolerance for risk.  Single-family homes and multi-unit residential properties tend to require the most management intensity due to an inherently large number of small tenants involved; however, they tend to be the least risky type of property because people always need a place to live. 

 

As the real estate investor moves out of apartment buildings and into leased investments, management intensity tends to decrease with large, financially powerful tenants on long-term lease agreements.  As the real estate investor starts to reach retirement age, single-tenant retail properties have been popular because they reduce management intensity to one extremely strong tenant on a very long-term lease.

 

Seasoned investors, who have owned apartment buildings, leased investments, and single-tenant retail properties in the past, are now moving back into apartment buildings because of the greater risk and lower returns now inherent in leased investments and single-tenant retail properties. 

 

Real estate investors are aware of the dismal U.S. economy and tend to shy away from retail, and especially office buildings.  Both property types can be dangerous investments when the economy tanks.  Real estate investors realize that even if customers do not have much discretionary income to purchase products and services offered by retail tenants, they will make sure they have enough disposable income to pay rent and housing expenses. Office space is considered an expense item to most businesses and can be reduced when sales and profits head downward.

 

Consequently, residential tenants are perceived as being lower risk than retail, office, and industrial tenants; however, they may produce greater returns.  Lower risk and greater returns turns the risk-return theory upside down. 

 

Many investors have been buying existing apartment buildings—causing prices to shoot upward due to supply and demand.  To save money, some investors have elected to build a new apartment building, rather than overpay for an existing one. 

 

The savvy investor may be able to acquire a vacant parcel of apartment-zoned land at a good price per square foot. In addition, building material costs have decreased over the past few years as less and less worldwide demand for building materials have driven prices downward.

 

Additionally, general contractors and subcontractors have been starving since the end of the single-family housing boom in 2008, so an investor may be able to negotiate a very good deal on a new apartment building.  As soon as apartment development resumes on a full-time basis sometime in the future, these same contractors will charge significantly more money for the same services. 

 

Taking into account inexpensive apartment land, lower material costs, and less expensive general and subcontractors; investors who elect to build new apartment buildings may be in a solid position for current and future cash flows and price appreciation.  Newer apartment buildings, located in higher socio-economic areas, tend to command top-of-the-market rents and will typically need less on-going maintenance than older properties.

 

Another bonus: if the apartment building is built to "condo specs," and is individually metered, the owner may be able to subdivide the property in the future and sell each condominium unit individually to owner-occupied buyers during a hot upward-trending sellers' market. 

 

Investors have been trying to place some of their wealth into tangible assets that will hopefully provide reasonable cash flows in the future.  This trend may slow down after there is a correction in the stock markets because the incentive to place wealth into safe, tangible assets will be gone. 

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