In August of 2012, I invested $100,000 in a commercial multifamily apartment building in Texas. I wanted to discuss this property as it recently completed a refinance and I think it makes an excellent case study for why I love investing in commercial multifamily real estate.
While the numbers are real, every property is different.What is more important are the concepts that this property illustrates.
The apartment building is 170 units built in 1971. Since it is a C grade property, it enjoys better cash flow than A and B grades properties, but has the downside of less appreciation. Nevertheless, it was purchased in a high quality Texas market that is fueled by outstanding population growth with a soaring economy.
Both the asset manager and the property manager are top notch.
I have received quarterly distributions since my initial investment with the exception of one quarter when distributions were held in favor of paying a higher property tax assessment that was later beaten down by a formal property tax protest.
In total, my quarterly cash-flow from this property over the 28 months prior to the refinance equaled $20,550.93. This represented a healthy 8.8% cash-on-cash annual return. This yield is far better than what I would have received from CD’s, bonds, and most dividend stocks.
However, for commercial multifamily real estate, this is pretty typical. In my experience a high quality asset manager can typically produce 5% – 10% annual yields for B and C grade properties. In general, the longer the hold, the higher the yield.
Long-term readers of this website know that there is more to the story. You see, cash-flow is just one of FOUR ways an investor makes money with commercial multifamily real estate.
- Cash-Flow
- Appreciation
- Principal Pay Down
- Tax Benefits
Equity in the property is produced by merely servicing the debt or making the mortgage payment each month. Additionally, raising rent, increasing retention, and wisely managing the expenses creates forced appreciation. This appreciation also creates equity and ultimately decreases the loan-to-value. For example, the equity gain on this apartment over 28 months saw the loan-to-value drift downward to approximately 50%. This allowed the asset manager to re-leverage the property back up to 75% and harvest some of that equity for the investors.
Of note, that harvested equity was all TAX FREE!
That’s just how it works in commercial multifamily real estate. Refinances are always tax-free.
In early January of this year, a check for my share of the harvested equity from the refinance arrived in the amount of $34,450.56. Combined with the quarterly distributions, I’ve had a total of $55,001.49 of my original investment returned to me in just over two years.
Obviously, I would not have been able to obtain these annual double digit returns without using leverage. Additionally, I’ve been able to utilize the concept of velocity of money so that I can redeploy my money and keep it working for me instead of just sitting there lazily as accumulated equity.
There are a couple of other things I should point out. I’ve already told you that when you harvest equity in the form of a refinance, the proceeds are always tax-free. What I haven’t told you is that I also received my quarterly cash-flow distributions tax-free thanks to the magic of depreciation.
The other notable thing is that I was able to do all of this without losing my ownership position in the property. In other words, I didn’t have to sell to get my money like I would have had to if it was stock or mutual funds. Of course, that sale would have triggered a 20% capital gains tax that I would have had to pay. Given those disadvantages, how much better would a stock or mutual fund portfolio have to perform to give me the same economic benefit?
P.S. More doctors, dentists and other health care professionals should really look into the wealth building power of commercial multifamily real estate. Diversifying a portion of your portfolio has never been easier to do. Contact me to see if you qualify. And as always, there is no cost, no obligations, and no hassles to learn more.
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