Here are the four main reasons I love apartments:
They’re real assets, not paper, and can’t be easily replaced.
They produce positive cash flow.
Apartments appreciate when rents rise – the Multiplier.
Leverage of debt to increase your position.
Let me explain by using an example: I am buying an apartment building in Orlando, Florida; let’s see if it stands the test of the four main reasons I like apartments.
This property is 240 units, in a great location across from the Ritz-Carlton Hotel, with great street frontage, is 95% occupied, and produces a positive cash flow in the first month of ownership of 8% annualized.
First Rule - Cannot be easily replaced – Don’t lose money. Short of some worldwide devastation, this property will not suddenly disappear and is built to last hundreds of years. No technology can suddenly replace it. The property is in a great location where there are lots of good jobs and where people want to live.
Second Rule - Produce positive cash flow – The property produces 5% to 8% positive cash flow per year, based on current operations. I will put $15 million down to buy the $50 million property, which should pay investors at Cardone Capital from $900,000 to $1,200,000 per year.
Third Rule - Appreciation: The Multiplier – Now, this is very important. Our target for all our investments is to sell the property, at some time in the future, where we make a minimum of 100% on our investment, in addition to the cash flow.
Fourth Rule - Leverage: The Ultimate Multiplier – The ultimate multiplier is the fact that we can use one dollar and buy four. What investment allows you to invest $1 million and own $4 million in assets? Add to that: these are real assets that can’t be easily replaced or lost (1), plus cash flow (2), meaning we are paid to wait for appreciation (3).So, we receive cash flow on the down payment, and waited for the entire $4 million to appreciate; this is the ultimate multiplier combining leverage and appreciation with cash flow.So, at what price would I need to sell this $50 million property for us make 100% on our money? At first glance, you would think I need to sell for $100 million to make 100%, but in reality, because we used leverage (debt) I only have to sell it for $65 million to accomplish our 100% target. Investors paid $15 million to buy the property, not $50 million, as I was able to leverage my relationships with lenders and get a great loan.
So, lets say it takes me 10 years to accomplish this to see if it is
Will the property still be there in 10 years? 99.99% chance it will and insurance covers the .01%. Can it be easily replaced? It can’t be destroyed and it will cost more to build in 2028.
Positive cash flow of just 6% a year (very conservative) will produce $900,000 ($15 million x 6%) in free cash flow to investors and this assumes current cash flow percentages without rent growth. Remember, this is for 10 years, which represents 60% of our down payment.
Appreciation – The future value of apartments, unlike homes, is determined based on the future value of the rent. The current rents on the property are $1,500, is it possible that the rents in 2028 would be conservatively closer to $2,000 or more? This increase in the rents of only $500 ($50 a year) will increase the value of the property because the income of the property has increased.
Leverage – Remember, this is the ultimate multiplier. We paid $15 million for an asset worth $50 million. If it only goes up in value by $15 million, and sells for $65 million (easy to imagine) we’ve made 100% on our money. Our capital invested doubled without the asset doubling.
And this brings me to the calculation of your exit formula. If you
don’t know how to calculate this you will be stuck in the deal
forever. When I buy a deal I know what I am going to sell it for.
Seems impossible to predict the future but in reality, if you can’t calculate future value you shouldn’t buy the deal. Rents will determine future value; another reason why I love this asset class so much.
The EXIT Formula (future value calculation)
x $500 (rent increase)
x 12 (months)
x 95% (occupied)
= NOI increase of $1,368,000
Increase in Value = $22,800,000 (NOI/Cap Rate (6%)).
Remember, we bought this deal with $15,000,000 and financed $35,000,000. When we bought it, the property was doing 5% to 8% cash flow after all expenses and debt.
In 2028, if the rents increase by only $50 per year, this means I could sell the property for $72,800,000 based on the same cap rate or even a little higher cap rate in 2028.
So, what did we make on the deal?
Return of Capital $15,000,000
Cash Flow $9,000,000 ($900,000/year x 10 year)
It would appear that our $15 million investment is now worth
$46,800,000, an increase of 312%. BOOM!