Whether you're buying a single apartment to rent out or a building full of them, you can reap many of the same benefits. You also get the same two key drawbacks -- dealing with tenants and owning an investment where your money is locked up and usually not able to be accessed quickly. Ultimately, though, most apartment investors feel that the benefits of owning multi-family property make it an excellent wealth-building vehicle.
Healthy Investment Returns
Even relatively conservative and low-yielding apartments offer healthy returns relative to other asset classes. Many investors are attracted to the cash flow, which, depending on how you buy your apartment, can be anywhere from a few percent to the mid-teens per year, calculated relative to your down payment. However, you're also paying your loan down, and this adds to the return you'll realize either when you sell the building and cash in your equity or when you pay the loan off and get an immediate increase in monthly income. While principal reduction may not seem like a major contributor to your return, bear in mind that your mortgage increases its impact, since the growth is relative to your down payment.
Compared with other types of investment real estate, apartments are relatively simple to operate. Your responsibilities are clearly defined, and your tenant relationships are straightforward. This is a significant difference from leased investments such as offices and retail centers where finding tenants can be time-consuming and expensive and the nature of each tenancy can be very different.
Like other forms of investment real estate, you can write off all of your expenses with essentially no limit to reduce your taxable income. If you use the proceeds from selling your apartment to buy more investment real estate, you can also defer your capital gains and recapture taxes. You can also depreciate your apartment and write off a portion of its value every year, further reducing your tax liability. Unlike commercial real estate that has a 39-year life, apartments get depreciated over 27.5 years, giving you a larger write-off every year than with other property types.
Owning apartments isn't like having money in the bank. You can't go to your apartment building and pull your money out whenever you want. Taking out equity through a cash-out refinance can take months and cost thousands of dollars in loan fees. Selling also takes months and could generate many thousands of dollars of commission costs. As such, if you aren't sure that you want your money to stay invested, apartments might not be a good choice.
For many owners, the biggest problem with owning apartments is dealing with tenants. While some tenants are easy to manage, others aren't. If you don't have a property manager, you will have to meet prospective tenants to show them units and take calls from existing tenants when something in their unit breaks. Hiring a management company can mitigate some of these problems, but their charges will cut into your profits. In addition, while a management company can cut down on the headache of dealing with tenants, it can't insulate you from the financial challenges of building repairs, unpaid rent and tenant turnovers.
- Nolo: When Should a Landlord Hire a Property Management Company?
- IRS: Instructions for Schedule E (Form 1040)
- Commercial Partners Exchange Company: 1031 Exchange - Defer the Tax - Retain the Gain
- Proapod: Understanding Depreciation: What the Tax Code Allows for Rental Property
- Annette Cooper: CAP Rates vs. Cash On Cash Returns
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