Monthly Archives: November 2011

A Creative Cash Flow Possibility

This post is probably going to raise an eyebrow or two about apartment investments, but oh well…as long as someone benefits from it. This isn’t by any means an offer or solicitation but rather an inquisitive look into a creatively crafted transaction that allows one party to retire from managing their apartment buildings while still keeping their passive income and another party to make a decent amount of profit managing the building with an opportunity to purchase it without a bank loan. Please feel free to point out any flaws or suggest an improvement. I’d love to try this one day.

In markets like ours here in Glendale, CA, long-time apartment owners very rarely decide to sell their buildings and even if they do, they really stick to their price. That’s another indicator of how desirable apartments are in the non-rent control environment of Glendale. From my experience as a broker specializing in this area, a lot of the property owners WOULD list their property but they just don’t think it’s worth the hassle of dealing with a sale, especially because the values aren’t quite as high as they’d like. Apartment investments in Glendale are constantly growing streams of passive income to their investors…who would want to give that up? Especially if it’s paid off!

Well, any commercial real estate broker that’s worked this area long enough will tell you that a lot of these buildings actually are debt-free and owned by elderly investors who have owned the properties for decades. Most of them rely on the income for a living while others simply pass down the benefits to their trust. (Some would call this an impenetrable market because property owners really have very little reason to sell; they’d have to be in some kind of distress or they’d be price motivated, asking unreasonable amounts for their building.)

Either way, there’s one thing a lot of these older owners have in common: they’re all tired of dealing with the things that come along with owning an apartment building. Decades of dealing with “my toilet broke” calls at 2am or having to rent out empty units can get a bit annoying when you’re trying to enjoy retirement. This is why a lot of my sellers end up trading into a NNN investment where they have no management issues whatsoever. In fact, that’s basically what this post is all about; turning an apartment building into a NNN leased investment with a small lease-to-own and seller-carry component.

How does it work?

Let’s assume I’m trying to do this on a 10 unit apartment building in Glendale at 336 Sample Street. The property owner, an 85 year old retired engineer, has had enough of managing the units but relies on the income. He’s too weary of the current market conditions to sell this investment, but he’s already tried getting his desired sales price for it and failed. I step in and underwrite the property, giving him an accurate view of what it’s worth in today’s market and where the opportunities are. While evaluating his building, we learn that he only gets $1,000 per month in rent from each of the 10 units, while the market rate for apartments like his are $1,200 a month. He’s already missing out on $2,000 every month. Also, his expenses are unnecessarily high (30%) because of the lack of upgrades in the units (low-flow toilets, energy-saving technology, etc.) thus bringing his annual Net Operating Income down to only $84,000. In today’s market, his building would be worth somewhere between $1,350,000-$1,500,000 depending on the location and condition.

Now, if the circumstances are right, I’ll suggest our magic transaction to the owner. We sign a Master Lease Agreement where the owner leases the entire property to me for 5 years on a triple-net basis, meaning I now collect the rents and reap the benefits of the property while also paying for the property tax, insurance and maintenance. I agree to pay him $7,000/month in rent for leasing the property to me. Now, this may seem like too little, but if you do the math correctly, it’s actually what he was actually netting after property expenses and property taxes. Also, every time the rents went down in the neighborhood, he probably made less there too. This $7,000 that he’s getting from me is purely passive profit that is unaffected by any market conditions. Whether or not the building is fully occupied, he’s getting his money!

How the hell could this be profitable for me? Well, I step in and take over management of the building now. I make rental adjustments by raising them to market rates, thus creating an extra $2,000-$2,500 of monthly income. Every time a unit turns over to a new tenant, I send my crew in to upgrade it and make it way more energy efficient. I reface/repaint the exterior of the building to bring it up to or above par with the neighborhood. I modify the expenses until it’s running as efficiently as possible. The lil’ old apartment house that the engineer so tirelessly tried to manage for years is now earning him a guaranteed sum of money ($84,000) every year without him even having to think about it. Meanwhile, I’m netting an extra $45,000-$50,000 a year just by managing a 10-unit apartment building and dumping a minimal amount of capital into it.

To make this deal even sweeter, you could try working out a deal with the owner to have your lease amount go towards your down payment, in case he decides to sell it to you later on down the line. Or he can agree to seller financing if you already have enough to pay as a down payment.

Please share your thoughts about this one…I’d love to hear if anyone’s done anything like this.