Most months several potential investors decide to buy apartments. The task is harder than most of them realize. They expect to win and are often baffled when they don’t prevail … quickly. They don’t understand this area is in a tougher league than most of what they encounter. A great broker can boost their odds of success.
Most potential investors have high income, high net worth and want to own local rentals. Few are stupid or foolish. Yet, most fail to buy. After a generation of serving investors, here are some thoughts about why so few affluent people actually buy local apartments.
Why Do Millionaires Want Used Apartments?
San Diego County rentals have appreciated at a compound rate of 7%. An investor, let’s call him Isaac, who puts 40% down, can buy 2.5 times his equity. So, he puts down $400.000 and borrows $600,000 to buy the million dollar asset. Suppose next year’s appreciation is $70,000. $70k increase/$400k equity is a 17.5% annual increase, about twice the long-term return on the S&P 500 index. That does not include any cash flow and tax benefits. Steadily, the loan pays down. Being a rental owner can be a low-risk escalator to wealth.
Isaac has government policies to thank for this profitable situation. Southern California government policies have limited apartment construction to about half as many condos and apartments as new households need.
Our government fees and development costs are among the highest in the nation. In some southern California cities, a developer might pay $80,000 for development fees per apartment. That is only for permission to build. It excludes land, labor, and material. New construction can exceed $400,000 per apartment. As a result, only apartments renting above $3000 per month get built. Most households can’t afford that rent. In contrast, in many Midwestern cities, $80,000 will buy newer apartments with higher-income tenants in place.
The First Conversation
When Isaac Investor, who wants to build wealth safely, connects with an income property broker, each side attempts to determine if they might be a mutually profitable fit. Isaac wants to know if the broker is competent and knowledgeable.
The broker’s attempt is to learn if Isaac has the financial capacity and emotional intelligence to be a good owner. Brokers don’t like to waste time with people who will compete hard enough to close in our highly desirable and competitive markets. Often the broker declines the assignment because the investor lacks sufficient down payment or has unrealistic expectations.
Potential investors learn about available options. Some brokers provide a systematic market overview. Some investors learn that San Diego is a low-risk escalator to wealth, how to turbocharge their equity growth and why financial leverage builds wealth faster than a property’s zip code.
Ways Things Don’t Work Out
Knowledge is important, but it’s not enough. Most investors who get this far don’t buy despite having knowledge, sufficient assets and a personal history of success.
Then, it’s mostly up to the investor. Most don’t buy. The skills and talents that made them successful are usually not enough for them to become income property owners. Here are several common reasons why. If I’m polite, may I be direct?
- Many investors are uncomfortable dealing with households whose income and education are lower than their own. Rental owners deal with people who earn less, with little savings and limited margin.
- Many investors appreciate the benefits of competition but hate competing. They are used to being the judge and they don’t like being a contestant. Investing in apartments means buying used income property from another millionaire who will never deal with you again and who probably is considering multiple offers. People who won’t write an offer if someone else is also trying to buy, probably won’t buy local income property.
- Many buyers want newer, bigger units in fancier neighborhoods, but won’t pay a big enough premium to buy the preferred assets. Most rental properties are 50 years old. They lack garages and the kitchens and bathrooms have not been upgraded.
- Many investors drop out when they learn the market won’t fulfill their fantasy. They want to believe that wishing would make it so. Brokers can’t create what does not exist.
- Other people expect a Nordstrom personal shopper experience. Their thinking might be, “Do all the research and when you find something that any investor would buy, bring it to me and only me. Ignore your other clients, some with longer and/or stronger relationships, or who have or will generate more commission.” Emotional intelligence matters.
- Many buyers freeze when it’s time to pull the trigger. If Isaac has not bought after seeing options for 90 days, some brokers review what sold that Ivan didn’t even write an offer on. Often buyers assume that if the asset didn’t meet their expectation, that no other investor would find value in that property. Most of us learn from our mistakes rather than from our wins. Not all buyers understand they can decline the asset if it doesn’t meet their expectations.
As I wrote in Building Legacy Wealth, great investors pounce. No broker knows which potential buyer will or won’t close.
Win, Win, Win
A great broker helps economic winners succeed in a low-risk investment arena against scores of unseen competitors. Obviously, the investor wins. And the brokerage team wins. Over the last generation hundreds of investors became millionaires slowly and steadily. And tenants win. In San Diego County 100,000+ people have enjoyed the improvements made to apartments which our clients bought.
Terry Moore, CCIM is an investment real estate broker with a proven history of success in creating value, 1031 (tax deferred) exchanges, and building wealth through apartment investments. He has taught at UCSD, National University’s MBA program, the Appraisal Institute, SD County Tax Assessor, California Association of Realtors and is a National Certified Commercial Investment Member. For more information contact Terry at [email protected], call 619-497-6424 (Direct), 619-889-1031 (Mobile) or visit www.SanDiegoApartmentBroker.com. (License #0091851).