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Buying an apartment unit or a complex to fix up and flip is a whole different ball game than flipping a house. That's because you need to cater your flip to two different types of interested parties: tenants and real estate investors. The end game is to make improvements that will increase the rental rate, which will boost the price that a financial investor would be willing to pay for the apartment.
This guide will show beginners what to keep in mind as they consider buying an apartment unit or building to fix up and flip so they maximize the return on their investment.
What is apartment flipping?
Apartment flipping involves purchasing a condo unit in an apartment building or the entire apartment complex and renovating it so you can sell it for a profit. The main objective is to make improvements so that prospective tenants are willing to pay a higher rental rate, which in turn boosts the property's income. That would then make it more valuable to a real estate investor, enabling the apartment flipper to sell the unit or building for a higher price.
What makes flipping condos different?
The primary difference between flipping a single-family home and an apartment is how investors value the property. The purchaser of a single-family home -- which can include a condo sold to a buyer who plans to occupy the unit -- values that property against comparable sales. If three-bed, two-bath homes or condos in a neighborhood have been selling for $250,000 to $300,000 apiece, a house flipper with a similar property won't sell theirs for too much above the top end of the comp range, no matter how much money they spend fixing it up.
Tenant-occupied apartment units or buildings, on the other hand, don't sell based on comparable values. Instead, investors value these investment properties based on their capitalization rates (cap rate), which is the property's net operating income (NOI) divided by the purchase price. Thus, if it generates $25,000 of NOI and real estate investors usually pay a 5% cap rate for high-quality multifamily property investments in the area, then the rental property value would be $500,000.
Given this difference, an apartment flipper needs to focus on making renovations that will bolster a property's NOI, since that's what will drive value creation. Thus, a flipper needs to concentrate on updates to the property that make it aesthetically pleasing to would-be tenants so they're willing to pay more rent each month, since that will help boost the property's cash flow.
How to calculate the profit potential of an apartment flip
It's relatively easy to figure out the profit potential of a house flip. The return calculation involves some simple math: The target sales price (based on comparable sales) minus the purchase price and all renovation, holding, and closing costs.
Here's an example return calculation of a hypothetical house flip:
|Targeted sales price||$300,000.00|
|Holding and closing costs||($25,000.00)|
Calculating the return on an apartment flip, on the other hand, takes a bit more effort since you can't look up comparable sales to provide a rough estimate of the profit potential. Instead, you need to know the cap rate investors typically pay for similar investment properties as well as how much NOI the multifamily unit will produce post-repair.
To demonstrate how to make this calculation, we'll walk through another hypothetical example. A prospective apartment flipper finds a dated condo that's for sale with a list price of $200,000 that currently leases for $$950 per month. With expenses consuming about 30% of the gross rent, the property generates $7,980 in annual NOI, which implies a 4% cap rate. Nicer apartment units in the area, however, rent for as much as $1,100 per month.
If the flipper can renovate the condo so that prospective renters are willing to pay that higher rate, it would increase the NOI to $9,240, if we assume expenses remain around 30% of gross rent. They could then sell the unit to another real estate investor for a $231,000 valuation using a 4% cap rate. That leaves them with a potential value increase of $31,000, before accounting for renovation, holding, and closing costs. As long as the flipper keeps those expenses below that number, they'll make a profit on their flip.
The calculations would be similar for flipping apartment buildings. In this case, the value of the real estate would be the combined NOI of the entire apartment complex divided by its cap rate. Again, as long as the flipper's total expenses come in below the difference between the purchase price and the post-renovated value that real estate investors would be willing to pay for the apartment building, they'd make money on the flip.
How to maximize your apartment-flipping profits
Like flipping a house, one of the keys to a successful apartment flip is buying it for the right price. In this case, however, the aim is to buy the property at a higher cap rate than what typical units in the region fetch. If stabilized apartments that are in reasonably good shape and a nice neighborhood sell at a 4% cap rate, then the apartment flipper should seek out those selling above that level because that will provide them with some cushion on their project.
Using the hypothetical from above, if the flipper bought that unit at a 5% cap rate and then flipped it to an investor upon completing renovations at a 4% cap rate, the total value increase of the property would be nearly $72,000. That boosts their profit potential, as long as they don't go overboard on the reno.
That leads to the other crucial factor when flipping apartments, which is to focus on making value-add renovations. Carefully consider the features in units that fetch higher rents. If nearby apartment units that rent for $1,100 per month have solid-surface countertops and laminate flooring, then there's no need to spend the extra money to put in marble counters and hardwoods in your apartment flip. Prospective tenants likely won't be willing to pay the additional rental rate needed to justify that investment, which would only eat into your return potential.
Apartment flippers need to know their numbers
Apartment flippers must appeal to two sets of potential clients to make their flip a success. The remodeled unit has to meet the desires of prospective tenants so that they're willing to pay a higher monthly rental rate. Meanwhile, the numbers need to work for the investors who buy the unit, since they're focused on the cap rate, not the purchase price. Because of that, an apartment flipper needs to concentrate on completing renovations that will boost the rental rate because that's the primary way to increase the sales price and make money on the flip.
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