GARY W. ELDRED, PHD, has invested successfully in real estate for more than twenty-five years and has served on the graduate business school faculty at Stanford University and the University of Virginia. One of America's top-selling real estate authors, Eldred's other books include Investing in Real Estate, Fifth Edition, Trump University Real Estate 101, and Make Money with Flippers, Fixers, and Renovations, Second Edition, all from Wiley.

Make Money with Affordable Apartment Buildings and Commercial Properties

By Gary W. Eldred

John Wiley & Sons

Copyright © 2008 Gary W. Eldred
All right reserved.
ISBN: 978-0-470-18343-4

Chapter One

Profit with Commercial and Multifamily Properties

Increasingly, small investors are beginning to explore the wealth-building opportunities offered by affordable commercial and multifamily properties. Because such properties provide many advantages, I encourage you to get into this lucrative field.

Advantages of Commercial and Multifamily Properties

Most would-be real estate investors already own a personal residence, so buying a single-family house to rent out merely repeats a familiar purchase process. In contrast, small investors usually steer clear of commercial and multifamily investments. Most likely, they fear that such properties cost too much or require extensive expertise. Neither of these perceived roadblocks is true.

In fact, at the age of 21, I began investing in multifamily properties with a 5-unit property, followed by a 7-unit property, and next added 10 units to my portfolio. If I could manage to buy and operate such properties, so can you. Neither beginning nor seasoned single-family residence (SFR) investors should fear investing in commercial properties or apartment buildings. A physician in Atlanta recently asked me for advice. I suggested that he look for a 4- to 12-unit apartment building or perhaps a small office building or shopping center rather than the single-family houses that he was considering. I set forth these reasons:

* Cost of acquisition

* Cash flows relative to price

* Search time

* Management

* Tax-free, trade-up potential

* Owner and/or partner financing

* Possibilities for creating value

Cost of Acquisition

The median price of a single-family house in the United States now stands at $225,000. In higher-priced areas such as San Diego, San Francisco, Boston, New York, and Washington, D.C., the median price of a single-family house exceeds $500,000. Unless you invest in less desirable neighborhoods-and even there, house prices can still seem out of reach, such as in East Palo Alto, California, or Chicago Southside-single-family investing becomes too costly for most investors of average means.

By "too costly," I do not refer only to price. Rather, I refer to price relative to rent collections. In San Diego, for example, a $500,000 house might generate no more than $2,000 a month in rents. Even in my (relatively) low-cost city in Florida, a $250,000 SFR typically rents for $1,000 to $1,300 a month. Put 30 or 40 percent down and these properties still throw off negative cash flows. (New investors feel like they are being eaten by alligators.)

Homebuyers, too, are realizing the advantages of owning income properties. Owner-occupied duplexes, triplexes, and fourplexes are attracting renewed interest. Individuals or families who cannot afford the monthly payments on a $350,000 house find that they can afford a $500,000 or $600,000 fourplex because their rent collections go a long way toward paying their principal, interest, property taxes, and property insurance (PITI).

When I talk with homebuyers who are priced out of their preferred neighborhoods, I tell them to look for a small apartment building. Buy it. Use rent collections to help meet monthly expenses. Create value through improvements and then sell or trade up in a few years. This is the same advice I give to real estate investors.

Given their lower per unit prices (relative to single-family houses), many income properties offer you a more affordable entry into real estate.

Cash Flows Relative to Price

If you think commercial and multifamily properties cost too much, go to http://www.loopnet.com. You'll find thousands of retail, office, and apartment buildings priced at less than $500,000. How about a retail (hard corner) building in Odessa, Texas, leased triple-net (tenant pays all expenses) to a prosperous local ice cream business? The price: $125,000. The net operating income (NOI): $11,245. Walgreens and other national brand retailers have located close by in this emerging growth area.

Or if you want a real bargain-basement price, how about a $39,000 duplex with long-term tenants who pay (in total) rents of $930 a month with a $7,000 a year NOI.

Yes, these two properties sit near the low end of the commercial and multifamily price range, but my point is that virtually anyone can invest in commercial or multifamily properties. Moving up the price scale, you can buy a building leased to Payless Shoes for a little over $300,000. That property yields an NOI of $32,000 a year. Or perhaps a well-kept 10-unit apartment building in a good area of Omaha for just $349,000. Its NOI exceeds $27,000 per year. In Athens, Georgia, near the University of Georgia campus, and just across the street from the newly proposed medical school, you can buy an 8-unit building (legally set up as condominiums for future sale to individuals) for $630,000. Current NOI totals $53,000 per year.

If you prefer offices, a seven-year-old Athens, Georgia, building net leased to a single tenant can be bought for around $325,000. Financed with an 80 percent loan to value (LTV) mortgage gives you a positive cash-on-cash yield of 10 percent.

We need not go further here because you can review tens of thousands of listings yourself at loopnet.com and other property-for-sale web sites. But the examples above illustrate my point. For prices lower than average California single-family houses, you can own commercial and multifamily properties that not only yield positive cash flows at 80 percent LTV (or higher) but they also offer potential for appreciation and value-add improvements and/or market repositioning.

Expect Yields to Fall in the Future Today, many affordable investment properties generate positive cash flows. Will this situation continue? I don't think so, at least not with 20 percent (or lower) down payments.

As boomers fret about the source and adequacy of their retirement incomes, increasing numbers will recognize the advantages of income properties. As more investors search for cash flow properties, they will bid prices up further. Although over time rent levels will continue to inflate, property prices will inflate at even greater rates. Relative to property prices, cash flows (rent collections) will not keep pace. We can see this trend in New York, London, Sydney, Dubai, and San Francisco. In these and other high-priced locations, speculators in appreciation potential have pushed most cash flow investors out of the market.

LoopNet has listed a six-unit property in San Francisco for $1.2 million. Rent collections for this property total just $7,200 a month. This price-rent relationship (the gross rent multiplier) came in at 166. With 20 percent down, the rents would barely cover the mortgage payments (debt service).

Either investors must come up with a higher down payment or go out-of-pocket each month to pay for property taxes, insurance, maintenance, and repairs. An all-cash purchase of this property would have netted an annual yield of just 4.7 percent (not counting appreciation, which, of course, is where the buyers would hope to make their money).

Fortunately, many commercial and multifamily properties still offer reasonable cash flows and potential for appreciation. But don't wait. Given that government and corporate bond interest rates offer low returns and yields...