How much cash do you need to buy your first apartment building?

Not much, especially if you don’t already own real estate.

The federal government has a program called the FHA which provides banks with insurance in case a borrower defaults on his mortgage. Because of this insurance, banks are willing to loan up to 96.5% of the cost of a 2-4 unit building, as long as the borrower will actually live at the property.

In Los Angeles in 2012, FHA borrowers can borrow up to $934,000 for a duplex, $1,129,250 for a triplex and $1,403,400 for a fourplex. That means a borrower could put down as little as $51,000 and buy a $1.4MM fouplex.

Now, these loans come with strings attached. You need to have reasonable credit, a stable work history, and verifiable income. You also need to pay what’s called “private mortgage insurance”, which is an additional monthly fee that helps the government insure against borrowers with less than 20% equity in their properties defaulting.

Also, because of the way the numbers work, you need to make sure that you’re actually making a good deal. It’s no good to buy what you think is a cashflowing asset and then find out that it sucks money out of your pocket. This is where having an experienced agent helps.

But all that aside, I can tell you without a doubt that being able to buy an apartment building in this depressed market using 3.5% or 5% down with a fixed, 30 year mortgage is an amazing, amazing opportunity. I have a buyer I’m working with now who is in the process of buying an incredible duplex in Echo Park by putting down around $35,000.

What does that $35,000 get the buyer? A great place to live for the present with out of pocket expenses substantially less than what he would pay to rent the same unit, then, when he moves out, a cashflowing asset that will ensure that he retires with a sizeable nest egg, whatever else happens.

Do you have a stable job? Do you have reasonable credit? Do you have, or can you get access to $25,000-35,000? That, plus the willingness to take the leap is all you need to buy your first Los Angeles apartment building.

[Edit: Are you interested in getting started? Read this next post about how to proceed.]

Why I write this blog

You might be wondering: Why does this guy spend so much time writing about apartment buildings?

I think the financial crisis of the past few years has changed something fundamental about the relationship between young people and real estate, and I want to try to both explain that change, and help shape it and move it forward.

Before the crash, here’s how most people felt about real estate:

  • I want a big house on a big piece of property
  • I will work very hard at my job in order to afford to take out a big mortgage to afford this big house
  • While I own it, this big house will increase in value every year
  • Some day, I will sell my big house, take my profits and buy an even bigger one

Here’s what happened as a result: A lot of people ended up buried under huge mortgages, unable to sell, unable to re-finance, and facing years (maybe decades) of hard work in order to pay off loans on properties that will never be worth what they bought them for (at least, in real terms).

Sensible young people looking at this situation could come to two conclusions, both reasonable:

  1. I will never own property. It’s not worth the risk. There is value in the flexibility that renting provides. I will therefore rent. Or…
  2. I will own property, but it will be income property. I will slowly build an asset base, taking advantage of the low price of real estate, the availability of cheap debt, and the major subsidies that both the national and state tax codes provide to owners. Over time, as I save more money, I will buy more income property. And, eventually, one day, maybe 10-20 years from now, I will wake up to the fact that I have secured my family’s financial future.

I write this blog for the people who have reached conclusion two. If you are one of these people, or think you might be, get in touch.

I will help you learn for yourself how this whole thing works. And then, when you’re ready, I will help you buy your first income property. (Bonus: The whole thing is free, because, as a broker, I get paid by the sellers of property, not the buyers.)

Silver Lake Income Properties In High Demand

We’ve just completed a review of the data for sales of 2-4 unit income properties in Silver Lake over the past six months. For more on the methodology, please see below. Meanwhile, here are the headline numbers:

  • Median estimated gross rent multiple: 12.7x annual rents
  • Median estimated CAP rate: 5.5%
  • Median sale price as % of list price: 98%
  • Median days on market: 51
  • Median price per sq ft: $318
  • Median price per unit: $226,500

More color on the data:

What does it mean that properties are selling at 98% of list?
Buyers need to know that the days of low-balling sellers in Silver Lake are pretty much over. To get a property, they need to come in with a strong offer at around the list price.

What does a 12.7x gross rent multiple mean?
This means that properties are selling at around 12.7x the total annual rent that they generate. Here’s some more info on gross rent multiples.

What does a 5.5% cap mean?
An estimated median cap rate of 5.5% means that, if you bought these properties using all cash (instead of a mortgage), you would be earning 5.5% on your money in year one. Here’s some more info on cap rates.

What does it mean that the days on market number is 51?
Days on market includes the time from when the property was first listed until the date of closing. It generally takes 30-45 days to go through the escrow process. This means that properties are getting accepted offers within roughly one to two weeks of being on the market. So buyers need to be confident enough about what they’re doing to move aggressively on properties they like.

Why are buyers paying prices that equate to 5.5% cap rates?

  1. Interest rates are around 4%, so borrowing money to buy these properties actually boosts your annual return into the 8-10% range.
  2. With money market rates around 0.5%, even a 5.5% return looks pretty good.
  3. Buyers are betting that rents will continue to increase over time, thereby increasing the returns.

Fine print: 

We looked at properties listed as sold by the MLS between 9/1/11 and 2/28/12 in the area defined as Silver Lake by the LA Times Neighborhood Mapping Project. There were 20 properties in the initial sample. We removed four properties which, for various reasons, would not have qualified for a mortgage, meaning that only a professional flipper could buy them. For the remaining properties, we estimated the rents for units which were delivered vacant at time of sale. We also estimated the cap rates based on an expense margin of 30% of rents.

Based on information from the Association of REALTORS®/Multiple Listing as of 2/28/12 and /or other sources.  Display of MLS data is deemed reliable but is not guaranteed accurate by the MLS.   The Broker/Agent providing the information contained herein may or may not have been the Listing and/or Selling Agent.

Oh, and yes, we know we left out leap day. Sue us!

The data: Silver Lake Income Property Survey February 2012 – final