Monday, November 20, 2006

Multi-Housing Investment Factors

Today I had a prospective investor ask me about the financial benefits of multi-family housing as an investment vehicle. I gave him the run-down -- positive and negative -- and realized it makes sense to share this information here. So, here are the factors affecting multi-housing investments.

- Apartment buildings can be leveraged to a higher degree than other commercial properties.

- The tax shelter benefits have been favored, although investors usually do not purchase apartments solely for the inherent tax benefits. Benefits include cash flow, leverage and appreciation.

- Real estate has never been considered a liquid asset, and prior to the mid-1980s, apartments were usually more liquid than other real estate vehicles. In the late 1980s, the apartment market slowed as a result of the loss of favored tax treatment. After a period of adjustment, they are regaining popularity. The resale market is generally good.

- Less sophistication is required to own and operate apartment buildings.

- A utilitarian demand exists because people need a place to live.

- Variety of apartment sizes and prices allows various types of investors to enter the apartment ownership market. From "Ma's and Pa's" to major corporations and pension funds—all own apartment buildings.

- Responsiveness to entrepreneurial efforts. Unlike other real estate vehicles, apartment building value determinants (occupancy, income, expenses, financing, etc.) can be affected by the owner, and it is easier to do (as opposed to an office building, where major tenants have long-term leases that cannot be renegotiated until the end of the lease period).

- Professional management is usually available, but at a cost.

- Unit mix must be matched to the demographics of the area (e.g., studio apartments are less likely to succeed in a family area).

- Not having key or anchor tenants may be an advantage.

- Exposure to government regulations (primarily rent control).

- Institutional and seller financing availability.

- Apartment visibility and close proximity to major highways, labor, transportation, shopping, and residential housing tracts are good elements.

- Pricing apartment buildings involves the use of the gross-rent multiplier, price per square foot, price per unit (CPU), and capitalization rate as "rules of thumb," or value measurers.

- Deferred maintenance can be extremely costly and detrimental to achieving investment objectives.

- Ratio of land to improvements affects the amount available for depreciation, and this affects the tax benefits associated with the property.

- If the owner is required to pay utilities, it will substantially affect the expenses connected with the property.

- Vacancies affect the appeal of the property, as do the number of units on the market, and whether or not rents are in line with competition.

- Investors can move up to larger properties through IRS 1031 tax deferred exchanges, thereby delaying payment of capital gains taxes.

- Parking conditions and the number of spaces available, as well as the type (covered, carports, open).
Furnished vs. unfurnished affects the rental schedule and amount of depreciation available.

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