Everybody wants to force equity, but you don’t have to be a developer to cash in on some great forced equity opportunities here. Investors seeking pre-existing, cash flowing apartment buildings can also force some substantial equity by finding seventies and eighties era buildings that are being poorly managed.
It’s the classic model: find an older building with a few minor problems, including below-market rents. Typically these buildings are self managed or poorly managed, and they will sell for a higher cap rate because of these problems. Make some interior improvements and get the rents up to market rate as the units turn over. Any smart investor will do this; but this equity takes time.
Fortunately, there are nearer-term opportunities out there if you’re willing to buy by an older building and spend a little time and money up front to upgrade all the appliances.
This is especially true for section 8 and HUD enrolled buildings where the owner provides utilities as part of a subsidized lease. But it can also work in non-subsidized older buildings where electricity is not separately metered and the landlord’s only option is to include energy charges in a gross lease. In many of these situations, utility costs are also being poorly managed by the property manager.
If you’ve had a chance to put energy star appliances in your own home, you understand the savings potential and payback period already of replacing outdated systems. Sometimes Puget Sound Energy will completely foot the bill for you on many of these upgrades. And most states provides additional subsidies while the IRS gives tax credits.
I installed a hybrid water heater in my home in Sudden Valley last year along with a ductless heat pump and LED bulbs in all my light fixtures. I saw my power bill drop by two thirds in the winter and one third in the summer, and I used the heat pump’s air conditioning feature all summer long. But here’s the real beauty: that water heater which costs $1,000 only cost me $500 and the heat pump which would have cost $4,000 only cost $$2,800 because Puget Sound Energy provided $1,700 in rebates.
Electrical energy subsidies change over time, so you’ll have to research the current rebates if you’re reading this article a year from now. Right now Puget Sound Energy (PSE) — which is the utility currently providing electric service to the majority of apartment buildings here — will replace (for free) any refrigerator model dated 1992 or earlier (this includes free haul off and delivery of the new appliance). They will also replace washing machine models dated 1997 or earlier that use electric-powered hot water with a new washing machine for free. They also provide a $500 instant rebate for every electric water heater that is replaced with an energy star qualified hybrid water heater, as long as it is installed in a basement, storage room, attic or crawlspace. And in addition to the rebate, electric hybrid water heaters also qualify for a 30% federal tax credit.
PSE will also audit all your buildings, install low flow water devices on all faucets, provide energy star power strips, and put LED bulbs for all the light fixtures. LED bulbs alone typically cost $10-$15 per bulb and last an average of 35,000 hours of KWh usage.
I’m aware of at least 4 apartment buildings currently on the market here that offer this kind of immediate forced equity. These opportunities all fall between $1M to $3M in market value and typically sell for a cap rate of about 7%. With a 25% down payment required for qualified investors, the buy in for these can start as low as $250,000 and go up to $700,000 for US investors. Qualified Canadian investors (generally investors with a net worth at least equal to the loan amount they are seeking) – even those who have not yet acquired income properties on this side of the border – can get into these typically for around 30-35% (down payments are a little higher for non-US citizens seeking US loans) by simply setting up a US business entity here with the help of a local lawyer (I know a few of the best real estate attorneys in town to help you with this, so please email me for a referral if you’re interested).
Some investors think older buildings aren’t a good buy because they’re nearing end of life. Yes, this can be true, mostly for buildings constructed prior to modern electrical and plumbing codes which have not been updated. But seventies and eighties construction usually meets most of today’s codes including electrical and the plumbing.