When it comes to apartment flips, you might think buying low and selling high remains the golden rule. Well, not exactly. Before taking out Arizona commercial real estate loans on apartment buildings, you need to learn to look beyond the initial sales price, and above all, look for ways to boost income.
It’s important to note that commercial properties are valued as follows:
• Annual income/market cap rate
Unlike residential flips, buying low and selling high, doesn’t always apply in the case of commercial properties. Because if you can raise annual income, by even a smidgen you can achieve a drastic return from your investment upon resale.
To illustrate this point, let’s consider two investors who follow two very different strategies.
• Buy Low, Sell High: Our first investor might see a complex going for $100,000 in a middle-class suburb. Dollar signs flash through his mind because the sales price is too good to be true. Well, it is too good to be true. It is going to take 12 months of work to get all ten units up to a livable standard. The work will require $560,000 in hard money financing, taken at a 14% interest rate.
• Boosting Income: In the same neighborhood, another investor sees a different 10-unit building listed for $800K. Hopefully no one calls the SEC, because our investor has a bit of inside information. She knows that leases are up on all ten units, which will allow her to raise rents by $250 a month on each unit. However, she doesn’t want a bunch of disgruntled tenants on her hands, so she decides to add a pool to the complex to help justify her rent increase. She takes out a loan for $640K, again at 14% interest. The loan is expensive, but she’s confident her work will be finished in four months.
Remember that commercial valuations are valued based on annual income/market cap rate. In our scenario, both properties are in the same neighborhood. Let’s say the prevailing cap rate is 7%.
• Buy Low, Sell High: Our first investor brought the property up to a livable standard in 12 months, but because the property is only livable, he can only charge his ten tenants $1,000 a month in rent:
• 100 K/.07= $1,428,871 resale value.
Factoring in the cost of his loan, he earned $515,711 in profit. Not bad, but what about the other investor?
• Boosting Income: Our other investor simply added a pool and raised rent by $250 per unit. This increase added $50,000 to the annual income earned from the property:
• 150 K/.07= $2,142,857 resale value
Accounting for the cost of her loan, she earned almost double the profit of the first investor. She bought high and sold for even higher. By focusing on boosting income instead of making drastic repairs, she made more money in less time.
These examples make it clear: before taking on a loan to invest in commercial property, look beyond the sales price and consider how you can boost cash flow above all else.
Level 4 Funding LLC
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Hard Money Loans
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Arizona Tel: (623) 582-4444
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Dennis Dahlberg Broker/RI/CEO
NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave | Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.