I just purchased another apartment complex and I want to share you the step-by-step
process you can use to purchase your first apartment complex. When I first got into real estate investing, I started out with single family rental properties, duplexes and fourplexes but now I've moved up to bigger apartments. I currently own properties ranging in size from 11 units to 32 units.
Over the years I've had the opportunity to go through this process many times when purchasing smaller units but even more when it comes to purchasing apartment complexes. The process is similar in some ways but also very different. In this article, I'm going to give you the step-by-step process of everything, or at least almost everything, that you need to know to be able to purchase one for yourself.
Step one is to figure out the financing. You’re probably wondering how you're going to come up with the money to buy a commercial building or apartment complex. There are multiple ways to do it, but we’ll just be going over those that I’ve done. For my properties, I’ve come up with 20 to 30 percent down to be able to get the loan to purchase a complex. You can set up a syndication or a partnership if you want to borrow or pool money with other people. Most of us just want to use savings, so we’ll focus on that process. You will either need 20-30% down payment, unless you can get the seller to work with you so you may only need 5-15% down.
Could you pay for the property in full with cash? Yes, but it doesn't make sense to. Your percent return will be higher with a loan. If you have a million dollars and want to purchase a $1 million dollar property, you could obviously pay cash. However if you are like me and want to maximize your return, you would be better off buying four properties with $250k down on each, and get a substantially larger return.
Types of loans
For a 4-unit or smaller rental, you may have gotten a residential or personal loan under your name in the past. These types of loans are easier to get access to with better rates and better terms. Unless you've built a solid relationship with your bank, often on your first deal on a commercial loan you're not going to get the best rates or terms. The bank sees you as a liability, you have got to prove that you are a good investment for them. Before you meet with a lender you need to understand the whole process. Banks will be less enthusiastic about doing business with you if you do not have at least a basic understanding of the process. Reading articles like this and watching my videos will give you a solid foundation to know what’s going on during the loan process. The banks do want your business so they're still going to be a little bit forgiving but it helps to know what you're talking about. Try to understand and learn as much as you can about real estate and investing first, before you ever set foot in the bank.
What matters to the bank?
On smaller loans, your personal credit and debt to income ratio will be crucial to getting a deal. On bigger loans, your personal credit and debt to income ratio are a little less of a concern to them. What matters more in a commercial loan application, is the details of the deal. You need to make sure you have a great deal on the apartment complex so the bank feels confident that it’s a good investment. They also want to know where the money is coming from. You’ll need to have the money in the bank or in reserves to show them you can afford this. If you do a partnership, all the bank will want to know is that you have the money, regardless of where it’s coming from. You will want it to be in an LLC or whatever type of business you have set up for the partnership.
Working with the bank
This first deal with the bank has a little bit of a catch-22 because you are expected to know everything upfront and have an idea of your structure, but then you will also have some unknowns as far as what the bank will expect of you. The key to getting your first loan is to learn as much as you can beforehand, go into it as knowledgeable as you can be, but also be flexible and ready to work with the bank’s expectations to get it set up. You will be working between your lawyer on how you’ll structure the deal, and then negotiating with the lender to make sure it’s funded properly. When you call the bank to get pre-approved, you want to be able to tell them:
- The type of property you’re looking for
- How much money you have in reserves for the down payment
- That you’re ready for this investment, and you need the ballpark idea of rates/terms from them
- You’re going to look at multiple banks but you prefer to work with them
You want to call the bank in advance to be pre-approved so you are ready for when you do find your perfect deal.
Before you start putting in offers, get a deal under contract, or any of those steps toward a deal, you need to know your criteria. It is usually tied to two different things:
- The actual deal
- The financing
The actual deal
My criteria for a deal is pretty simple. I want great appreciation upside and great cash flow. This can be tricky because you’re going to have to figure out what that means for you and your situation. I have been in a market that for the last three years has been in the top five markets for appreciation. It has gone up in value 10-15% for years when it comes to property values. I love knowing that I’m getting a good amount of equity every year with every rental property I purchase. On top of that, I want to have strong cash flow. My bottom criteria for cash flow on a 25 year am with 25% down, is at least a 12% cash on cash return. What you need to consider is that you may not be able to get a 25 year am or 25% down. If you’ve got to put 30% down on your first deal, that may change your criteria. If you have to do it over a 20 year am instead of 25 year, again that may change your criteria. Figure out what your cash on cash return criteria is, and stick to it. I don’t worry about the cap rate as much because it all depends on what financing I can lock in. The cap rate could be good, but if you’re paying 10% in interest, it’s a terrible return because you’ve got a terrible interest rate. I look at the cash on cash return because it combines both. My minimum is 12% on a 25 year am with 25% down.
If you are going to finance through a bank, there are terms that can vary depending on the market or situation you are in. Let me explain. When I first started, my first loan was on a 20 year am with the rates changing every five years at about a 4.5 - 5% interest. These aren’t great terms, but I didn’t know any better. Also, I needed to build that relationship. The bank wasn’t willing to give me the best deal because I was unknown to them. They weren’t sure whether I would be a good borrower, so I got bad terms. I’ve now built up a good relationship and reputation with the bank so I get a 25 year am instead of 20. I have a balloon payment at 10 years and have my rate locked for the first 10 years. I’ve gotten down to a 3.6% interest rate. My origination is substantially less than it was when I started. As you can see, there are many facets to your rates and terms. You have to have a general idea of where these will be so you can analyze a deal. This is why the pre-approval is important, you will get an idea of the worst case scenario as far as the rates and terms. Then when you find that home run deal for your first property, you’ll still make it work and make money even though the terms aren’t the greatest.
When I’m looking at properties, I want a C+ property or better in a C+ area or better. Look at some of my articles/videos to learn more about what a C+ property is. Bottom line, it needs to be a decent property. I’m not going to go into the slumlord realm. I like to buy older properties in markets with strong demand. That means I want to go into a market where there are no vacancies. I want to be in an area where every unit is full because everyone is looking for that kind of property. I like to be at the bottom of the market for that square footage or number of bedrooms. A lot of times people will go into an A+ property and they’re at the very top of the market. In an area where the bottom end is $900 and the top end is worth $1500 but the top end is brand new, nice finishes, etc. I like to be on the bottom end because it is protected if the market drops. There will always be a need for the lower end properties, whereas the top end will have to drop rent to stay full if the market plummets. If the bottom end property has to drop rent prices, it will be smaller percentage wise compared to the nicest places.
There are lots of opinions on property types, but I’ll tell you more about why I like the C+ lower end properties. I like this type of property for rentals because there are usually lots of value-add opportunities. There might be old owners that have it mismanaged or misrented. I can go in, buy the property, and increase rents pretty immediately. That is an instant value-add and I’m never overpaying for a property. I can usually find something with 15 - 20% cash on cash return by the time that I’ve owned it for a year. I can get there by bumping rents, adding value to the property in some way to get an even larger buffer. So I’ve got that minimum, but I try to get higher if I can. It’s important to me to have opportunity in this realm vs. going into a new construction or recently built apartment complexes.
Putting in offers
There is a saying that for every 100 properties you put an offer on or for every 100 deals you analyze, there will be one that you pull the trigger on. That may have been correct for me early on, but I have come to find by doing this a lot, it’s substantially less than that now. Today I have built up relationships with wholesalers, realtors, and other investors that know my criteria. They are looking through dozens of deals and sending me those they think would be a good fit. Because I have proven myself as a good buyer, they are eager to share with me. So now I have to personally look at fewer deals to get to the point where I’m buying. For you getting started, my advice would be to get a couple good wholesalers, realtors, and connect as much as you can with other real estate investors. Let the world know that you’re looking for apartment buildings with your criteria. Eventually they should start bringing the deals to you.
What I love
The kind of deal that I will jump on may not look great on paper. The property is older with lower rents and the owner is asking too much for it. However the owner is older and looking to get rid of the property as soon as possible. I know how to negotiate with this seller to make them feel great about the deal. I usually don’t find a great deal just scanning the MLS online. I look for opportunities in specific scenarios where I know how to make it a win for them and me. My realtors and wholesalers know my criteria and they help me do a lot of that sifting to find this type of a property with a seller like this.
Use my app, CDS Rental Calculator from the app store, and my spreadsheet found on this site, ChandleraDavidSmith.com to help you analyze deals. If you are still not comfortable enough to pull the trigger on a deal, you can pick up my real estate investing course to get even more helpful information on your journey to buying your first apartment complex.
There is a lot you could look at with due diligence, so we’ll just look at some high level points that you should be sure to hit on when conducting your due diligence on a rental.
- Know the rents in your area. If you see a two bedroom apartment that’s got 1000 square feet, you need to know what that should be renting for. If they’ve got it rented but it’s high for that market, you know that they got lucky but this isn’t worth it. Conversely if they’ve got it rented for $600 but you know that it could be renting for $1000, that’s an opportunity for you to have a home run deal. The best way to do this is to connect with a good property management company before you start looking at deals. With that relationship the property management company can tell you what they can rent the property for, and what your expenses will be. They can tell you how much money they’ll need to put into it, what the expenses will be, what vacancy will look like, and what you can get for rent.
- Financial due diligence. Go through taxes, insurance, profit and loss, income statements, etc. This is a large and important topic that we will discuss in another article, but just know that you will be combing through their finances to get a thorough understanding of where they stand.
- Inspection of the property. Hire a good inspector with a good reputation. Give yourself a good due diligence period so you have time to find out the shape this property is in and whether it needs major improvements that would ruin the deal. You want to be able to walk away if the inspector finds any deal breakers. The inspector can also help you to nitpick the property so you can get money back from the seller. This will get you more in reserves to spend on whatever value-add you’re planning on doing.
These are a brief skimming of the surface that are large topics on their own. I talk about these in depth in my course so if you want to delve into the due diligence topic with me, please sign up for the course. If not, go and research these points on your own before you finish the due diligence process and purchase your first apartment building.
Once you have completed your due diligence process, push the seller more to get more money back from them, push the lender to get better rates, better terms and shop them out. With a last minute push, often they will go to their higher-ups within the bank to finish the loan anyway. That’s another opportunity for them to ask for more on your behalf. Once you’ve gotten the best deal you can get with your seller and your lender, you’ll have a good title company that hopefully you have pushed for, and then you negotiate with them. Usually the title companies will have a lot of leeway, in the thousands of dollars on these bigger deals. So make sure you are getting the best they can offer you. Assure them that you are going to do a lot of business and you want to do it with them, but you want to see a big discount on this deal. If they are hesitant, look at multiple title companies to see what’s available to you. I have done this so much that I have great relationships with multiple title companies and they all work with me. The seller may be picky about which title company they want to use, so it’s good to have a working relationship with many of them. Even if you’re going to a title company that you don’t have a relationship with, try to get them to bend for you so you can save even more money and make this deal an even bigger home run.
I always want to knock it out of the park, beat my minimum by a lot, and I know that you can do the same on this first deal. Once you’ve gone through the process, they’ll get the paperwork and final disclosures ready for you, go through and make sure that everything you fought for is there. Get all of the deposits, the prorated rents, and anything else you’ve been promised. Now you’ve hopefully been rewarded for all your hard work with an incredible deal on an apartment complex.