Buy and Sell Multifamilies?

[GrayGhost]

I recently read through The Complete Guide to Buying and Selling Apartment Buildings by Steve Berges and was intrigued by the strategy he recommends: buy and sell, instead of buy and hold.

It's true that buy and hold can give you 10% to possibly 15% cash on cash return if you know what you're doing. In fact, we're probably going to get such returns on our real estate investments this year.

But what about buying and selling? We're looking at the numbers now, but it seems like we may be able to get 40% cash on cash return by investing a few thousand bucks into capital improvements. We just rehabbed a unit that went vacant on a shoestring budget (because we personally did the work) and if we contract out some bigger jobs, like redoing siding, getting an asphalt parking lot over the original concrete, and other stuff, we can really increase the resell value of the property.

Since most of our tenants are longer term, we're not going to be able to rehab their units and increase rent, especially after we already increased rent back in the spring.

Still, I am pretty sure with the work we've already done, and the work we're going to get done, we could easily net a 40% return on our investment, even after all closing costs and things like that. This is, clearly, better than the 15% ROI we'd get from holding.

The one big negative to a buy and sell strategy for multifamilies is that if you want to do it year in and year out, you have to keep going through the annoying and lengthy process of closings, getting tenants to sign new leases, getting them to realize that you can't be pushed around, et cetera. Even then, however, a buy and sell strategy is a part time job--and if it gets you $50k+ a year, and a 40+% ROI, it seems to me that it's worth it.

I know MMM prefers smaller scale real estate investment, particularly with single families, and that's a legitimate strategy as well. However, we have the money and are increasingly getting the experience and connections to make buy-and-sell a viable strategy.

So what do you think? Do any of you buy and sell multifamily properties? What are your thoughts on the general strategy? Are there any pitfalls I should look out for, or difficulties that I might not be aware of?

Thanks in advance!

[Daleth]

Personally I think of flipping houses as gambling, and buying houses to rent out as investing. But that's just me--you may have a higher risk tolerance than I do.

[Another Reader]

It's a better one-time return.  IF you could duplicate that consistently on multi-family properties, you would quickly be very wealthy.  And so would everyone else that bought the book and followed the blueprint.

The trouble with that idea is that in most markets, multi-family properties are priced on rent multipliers or capitalization rates.  Are you going to be able to increase your rents 40 percent by doing the rehab?  Will you be able to go in, evict all the tenants quickly and do the work?  Can you tolerate zero income on a much pricier property that will likely have a mortgage while you spend 6 months or a year doing this and then leasing up the property?

Large companies try to buy obsolete or poorly maintained apartment complexes and "reposition" them.  Sometimes they are successful, sometimes not so much.  They don't usually generate 40 percent returns doing that.

[GrayGhost]

We can't increase rent by 40%, but we brought our long term tenants from $650 to $700, and the unit that we're renting out is going for $775 now. Furthermore, we bought the property at such a discount (seller dropped the price by nearly $100,000 before we went for it) that capital improvements very likely may increase resell value back up to his original sale point.

It was a rare position, we had several long term tenants, we had two tenants move out, one unit was refilled immediately, we rehabbed a unit, and now that we understand the rent vs. price point patterns in the area for multifamilies, we have a better handle on what a deal we got.

Here's what I mean. Let's say that in our area, price point is generally 100x monthly rent. But you would expect a well-maintained property to sell for more than a poorly maintained one, even if monthly rent is equal, wouldn't you? And in our case, we increased monthly rent--by a fair amount--and we're making capital improvements that add a ton of value to the place. It's a very good area for landlords with low vacancy rates, a good local economy, and I think the improvements we've made, and the increased rent, do justify a much higher price point than we bought it at.

[Another Reader]

If you bought the property at a discount, then some of the increase in the expected sale price over purchase price is due to that and not to the improvements.  Buying less of a fixer at a slightly lower GRM isn't going to produce the same return.  As long as the flow of these deals continues, what you suggest is viable.  However, at some point the market will change, and then what?  In your shoes, having a stable of those 15 percent cash on cash rentals to fall back on would be an important part of my long term plan.

[GrayGhost]

I agree with that to a point, which is why we're holding on to another multifamily. That one seems to have better tenants and somewhat less of an upside, plus the rent is higher, so we probably couldn't sell it for as much of a profit, if at all.

I guess buying and selling multifamilies is just another business with its own pitfalls and inadequacies. If you're saying not to rely on it 100%, I agree with you, but in this case I'd like to give it a try.

[Another Reader]

What is your plan for reinvesting the proceeds?  Have you identified some possible replacement properties?

The other issue is taxes.  Short term flipping means your capital gain is taxed as ordinary income. That's something else to consider.  A 1031 exchange defers the taxes, but serial flippers have higher taxes overall than buy and hold investors.

[Debt Free in Alabama]

Yes, I was going to reply about taxes being a big deal that provides guidance on deals liks this.
You'd probably pay 40-50% percent total tax (Fed, state, local) on a less than one year flip, or 15-20% if you held it longer than a year.  If you hold it a year, on purpose, while you improve it, you will benefit greatly.  1031 exchanges would be my strategy and I'd do my best to put off taxes forever that way.

[GrayGhost]

We're going to wait to sell until one year after we bought to take advantage of the lower capital gains rate. I've heard about 1031 Exchanges in the past, but to be honest I haven't looked into them until now. I guess my plan was to put excess money into indexes while retaining enough cash for the next buy-and-sell or buy-and-hold.

[Debt Free in Alabama]

You can find firms that help you with the 1031 Exchange.  I have friends that do it on all properties, deferring taxes indefinitely.....and allowing you to put that much more money to work into the next property.
I wouldn't put excess money into indexes unless your time frame on keeping it there is 7-10 years....as it very well may drop 25-50% while you are "storing" it there.
As you're seeing, some properties avail themselves to easily become flips, and some are perfect for buy and hold.  Some of both allow better sleep at night.

[GrayGhost]

We have a very good accountant who, I am sure, is more than familiar with 1031 exchanges. I'll get in touch with him about it a couple of months from now, when the bigger renovations are under way or getting done.

Money that goes into indexes is for long term investing. We're going to keep no more than $200k in cash to finance real estate ventures.

[Cheddar Stacker]

We have a very good accountant who, I am sure, is more than familiar with 1031 exchanges. I'll get in touch with him about it a couple of months from now, when the bigger renovations are under way or getting done.

Money that goes into indexes is for long term investing. We're going to keep no more than $200k in cash to finance real estate ventures.

Get in touch with your accountant now. I'm a cpa and it always sucks to not be consulted early on, then to deliver bad news about the tax consequences of the strategy your client just implemented. Make sure you ask up front. Its a slower time of year for your cpa. Call them up, take them to lunch, and pick their brain.

If you begin to do this 3 or 4 times a year its not cap gains even if you hold it for a year. It will be considered self employed income subject to ordinary rates.

I would suggest a flip, then rent strategy. Buy, do the work, rent it out for at least a year, then sell for capital gains. This is what I have advised clients and what I intend to do once I build the capital.

The only other downside I see was already mentioned: can you expect the deals to keep coming? If you can either profit on a deal once (flip) or every year (buy & hold) and the inventory starts to thin out you might be better with holding at least a few.

[Bobberth]

Why not rehab and flip houses instead of multis?  The pool for purchases is bigger and the pool of buyers is much bigger.  Also, people buy houses on emotion and any good investor buys a multi on the numbers and is more likely to try and beat you down on price more than a homeowner will.  It's also easier for a buyer to obtain financing on a house than a multi, especially right now.  It seems like a pretty small niche to put yourself into.  How many of these deals can there be in your area and how much more work is it going to be to find contractors in geographically different areas? 

Don't rule out rehabbing multis if a deal comes along but don't pigeonhole yourself in too narrow of a market.