S.E.C. Real Estate Observer

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The traditional sources of profits in apartments, as in most other types of real estate investment, include cash flow, loan amortization, tax shelter through depreciation, and appreciation.

But in apartments there are some potential additional sources of profit we should not forget.

Miscellaneous income –

Laundry – The most common miscellaneous item included in apartments is income from a coin-operated washer-dryer operation. Typically, the owner provides a space for these items, along with utilities, and an operator provides and maintains the machines, and collects the cash, and keeps a percentage of the take. However, there are some owners who choose to own and maintain the machines themselves. Today there are also sophisticated systems that use tokens instead of coins, thus allowing owners to control cash better.

Another option would be to actually rent an in-unit washer and dryer to a tenant. The machines could pay for themselves within a very short period of time. In this morning’s newspaper I saw an ad by a large store selling washer-dryer pairs from $238 to $589, depending on the brand, size and bells and whistles. At, say, $20 or $25 a month, how long does it take to make a profit on this, even if you are paying for the cost of the water and an occasional repair?

Coke and snack machines – These can be quite lucrative, especially if someone already on the payroll is keeping them up. You can sometimes buy soft drinks for as little as 17 cents each, and you can sell them for $1 to $1.25. Not a bad mark-up. It may be worth the management hassle to enter this business and reap the rewards.

Garages – In some markets, especially those in inner-city areas or colder climates, individual garages are a great profit center. Alternatively, some apartment owners provide free parking outside, but charge a monthly fee to park in the parking garage.

Creating additional rooms or apartments – I have seen situations in which 1-bedroom units were converted to 2-bedroom units, or 2-bedroom units were converted to 3-bedroom units, within the existing footprint for that unit. Alternatively, some larger units may be able to be converted to 2 units.

Buying wholesale and selling retail – This is what condo and co-op converters do every day. If your market is receptive to this, it can be a great way to provide considerable profits, as one alternative exit strategy.

Providing affordable housing – the government wants to make sure that working people can afford a place to live, and therefore it provides incentives to help make this happen. Through the Low Income Housing Tax Credit Program, for example, I have sold existing run-down properties for more than their value as income property. The buyer/developer of one 240-unit property scheduled $2.4 million in development fees for rehabilitating and repositioning this asset, using 100% of other people’s money and equity, and non-recourse long-term debt. The Federal Home Loan Bank System’s Affordable Housing Program also provides low- or no-cost funds that can assist in these types of transactions.

Special tax benefits – There are other programs through the IRS and the U.S. Department of Housing and Urban Development that can provide considerable tax benefits, such as 2 to 10 year depreciation schedules, and no capital gains taxes for certain developments in specific areas.

Alternate future land uses – At this time existing apartments in the close-in Atlanta market, which might have an economic value as apartments of, say $40,000 to $50,000 per unit, are being sold for at least twice that, due to a rapid change of land-uses and the potential for much higher density mixed-use redevelopment of the sites. If you can buy before that time comes, and anticipate the new uses, you can make a lot of money.

Upgrade your tenant profile by improving the unit – If you think your market might support it, the next time you turn a unit, do an experiment. Put in stainless steel appliances, upgraded cabinets and upgraded light fixtures. Maybe there is a brick wall that could be exposed, or some hardwood floors. The cost might be an extra $1,000 or $2,000, but you may be able to get an extra $100 a month. Not a bad return on your investment.

Do your market research – As an owner you may not know what your residents want until you’ve done market research. First you should define a current resident profile and a target profile, to determine what kind of tenants you wish to attract. You need to conduct surveys and focus groups with both existing residents and targeted groups to ask what they would like in their apartments and in the community.

Upgrade the entire property by making some simple improvements and/or adding services that tenants want. After you’ve done this market research, perhaps you can take a unit and convert it into an exercise studio or a business center. What will it cost to provide free wireless high-speed internet service for your tenants? Maybe you could offer a concierge service, or if a larger family-oriented community, provide a supervised after-school care program at no charge (only if you want to see your occupancy rate move from 90% to 97% in a very short time!). What is the cost of doing this, versus the cost of that 7% vacancy loss you are gaining? If you have 100 units and they rent for $650 a month, the difference would be $54,600 a year for the increased 7% occupancy. You can probably operate an after-school program for somewhat less. Will tenants stay longer, thus reducing the costs of having to paint and repair every time a tenant decides to move on? How much more will you save due to lower turnover of tenants and associated turnover costs? (The U.S. national average cost to paint a one-bedroom unit at turnover is $480. Wouldn’t you rather use this $480 as additional profit?) Will word of mouth spread among the residents’ friends and acquaintances that this is a great, family-oriented place to live? You bet.

Consider cable TV/satellite and/or high-speed Internet and/or telephone service as a profit center, in which the apartment complex owns the infrastructure, and joint ventures with an operator to provide service to individual tenants, or some variation on this theme.

What else can you do to reduce expenses, vacancy, and turnover? Have your common area lights been converted to something other than incandescent bulbs yet? Have you considered installing separate utility meters or sub-meters for all tenants, if not already done? One landlord found that the investment in sub-metering water had a payback period of 14.4 months. Have you added attic insulation, so as to keep utility costs down for tenants, thus helping them decide that they will stay longer? Have you considered tweaking/upgrading heating systems, thus lowering operating costs? How about replacing older toilets, which use 7 gallons per flush, compared to 1 to 1.6 gallons for the newer fixtures?

Plant some flowers, and keep them coming. Change them out several times a year, so that there is something blooming much of the time (this is easier to do in some climates than others). It costs very little, and you’ll be amazed at how much value is perceived through the eyes of the tenant. Along with this, of course, is keeping the grounds and common areas in pristine condition.

Increase rents every year – No matter what else happens, it is really hard to increase it twice as much next year if you did not do it this year. Everyone expects some inflation, and apartment owners should be like everyone else if at all possible. Even if you have to add a service to justify the increase, strongly consider it.

Additional cash flow through leverage – Apartment loans are available at the highest loan-to-value ratio and at the lowest interest rates, compared to other real estate investments. With apartments financed through FHA, for example, it is possible to obtain up to 85 to 90% financing, amortized over a 35 or 40-year period. With interest rates for these deals as low as 5.85% as of Sept. 29, and with many apartments providing cap rates of 8.5 % to 9%, there is considerable cash flow available through using this positive leverage.

These are just a few ideas that may help you find additional profits in apartments as you go about investing in real estate.

Ernie M. Eden, S.E.C., has sold more than 100 apartment complexes since 1985.