One of the great strengths of the strategy of buying Class C apartment buildings with value plays and then executing the turnaround to stabilize the property and capture the upside is that it is market cycle neutral. It doesn’t matter where you are in the real estate market cycle, up, or down, there is always demand for Class C units. In fact, the demand for Class C housing increases in a downturn and Class C values remain unaffected while office, retail, and residential values are tumbling left and right.
But the fact remains, there is a lot of work involved in a Class C property turnaround. There is installing new management, overseeing the rehab, managing the managers during the lease up, and a good eighteen months worth of keeping everyone in your turnaround focused on rehabbing units and getting them leased until you have filled up the property. In the end though, after you have all the work completed and you pull six/seven figures out of the property with your refi, you know it was worth it.
If you have the taste for a strategy with slightly more risk though, you can buy a Class A or Class B apartment building during the upswing in the market cycle, in a Momentum Market like Los Angeles or San Diego.
A momentum market is a high dollar market that has rapid price appreciation in periods of expansion, and then steep falloffs in values after the peak has been reached and the market contracts. The chief feature of a momentum market is the volatility; the highs are ridiculously high, and the lows are painfully low.
For an apartment investor willing to track the market cycle and manage his/her risk, momentum markets can bestow huge fortunes on you without a whole lot of work.
The strategy is very simple. Instead of buying Class C properties, whose great advantage is the consistency of demand, you buy Class A properties, whose great advantage is being new and highly desirable properties, they are great containers of value. When the real estate market starts appreciating, Class A properties increase in value at a higher rate than Class C properties.
You start buying Class A apartment buildings when market appreciation breaks out of the downturn and starts solidifying itself into an upward trend. You buy the biggest apartment apartment buildings that you can manage, and you continue buying until you near the top of the market.
One of the most awesome strategies to use as an Apartment Entrepreneur is a Master Lease Option. Lease options are common place in the quick-turn “pretty house” arena, but lease options when used on single family homes don’t reflect anywhere near the profit potential that is really possible using this powerful piece of creative financing. When you move from single family to multi-family in your use of the lease option, the risk/reward tilts dramatically in your favor and your profit potential shoots straight up, in hockey stick style increase.
When applied to a multi-family property, the lease option becomes a “master” lease option. The distinction is you are leasing from an individual party, the Seller, but have the right to sub-lease to multiple parties, the Tenants. Hence you have the “master” right to sub-lease … Master Lease Option.
All of the benefits associated with a lease option you have heard about, apply to the Master Lease Option as well:
- less risk; you are not taking title, the deed, mortgage, and tax bill stay in the Seller’s name.
- less money required down; option consideration is at a maximum 5%, but often closer to zero.
- no qualifying; no 3rd party has to approve you, this financing is between you and the Seller.
- fast close; how long it takes to get a title search done and the agreement drawn is how long it takes to close, anywhere from a few days to a month at the outside.
- easy exit; if after running the property for 6 months or so you realize the deal is not as good as you thought it was and you want out, it is simply a matter of canceling the agreement with the Seller. In case of default, the Seller simply cancels the agreement for you and just keeps the option consideration as his/her sole remedy.
- control; you get all the benefits of managing and profiting from the property as though you own it, by merely controlling it.
- huge profit potential; you get an option to buy the property at a price based on what the property is worth today, that spans years into the future, allowing you to increase the value of the property over time and then sell it based on its new increased future value.
When the lease option becomes a Master Lease Option though, there appears another dimension that adds two or three more zeros to a deal’s profitability.
That is, unlike single family homes, apartment buildings are valued based on the income they produce. The value of a property with 30% vacancy and below market rents is dramatically lower than if it was 90% occupied with tenants paying market rent. For mid-sized apartment properties in the mid-west this difference can be in the hundreds of thousands of dollars. For larger apartment complexes in high dollar markets, the difference can be millions.