Apartment Buildings (5 Units or More)

The first type of investment property is the apartment building.  Most first time buying clients are surprised to learn that lenders break out investment property into two major categories; commercial purchases, and residential purchases.  It may sound deceiving, but a lender views any apartment with 5 or more units as a commercial property. This obviously means that a buyer will need to qualify for a much stricter commercial mortgage to obtain a building with 5 or more units.  These stricter requirements include larger down payments, cash reserves, higher interest rates, shorter term and more complex loans, lower debt-to-income ratios, and a possible business plan or history with property.  With such a stringent process, most first time buyers resort to the second category of investment property; the multiplex.  

However, for the sake of completeness, apartment buildings offer a few distinct advantages.  Primarily, with a large apartment building the revenue proceeds from rent are spread across multiple sources.  Meaning each unit will typically have 1 or more working adults providing the rent which means that the revenue stream is diversified across many industries and companies.  This benefits the owner in the event that if an industry or company suffers economically and that tenant loses his employment, it is probable that several other tenants are still in good shape with their employment.  And on that same line, the rent that has gone uncollected is only a fraction of the total revenue and therefore a smaller burden as a percentage of the properties total income.  

Another benefit of owning an apartment building is the higher propensity for cash flow than other property types.  What I mean is that apartment buildings are very much priced according to their cash flow or income position.  Unlike single family homes where the value is based on what the neighbor’s house sold for last month, apartment buildings are priced based on a multiple of how much money they will produce for the purchaser.  Because of this uniqueness with apartment buildings, along with a good adviser and broker, it is highly likely that the buyer will be making money from the beginning of the acquisition.

To Be Continued…

In part II of this article I will explain the difference between the apartment building and the multiplex (2, 3, and 4 units).  I will also conclude with some non-financial aspects of owning an investment property that first time buyers will want to consider.