Are you settling for a Class ‘D’ tenant on your rental investment, and only getting Class ‘A’ tenant (or worse) returns? Do you wonder why your actual return on your rental investment is not what was projected? Are you looking at how to increase your profitability without selling and moving to a different building?
As you recall in my previous post, I listed the apartment classifications and explained what the different types of apartment categories and cap rates are for real estate investors.
Top Quality Tenants for Best Rental Investment Profits
Larger apartment complexes spend a lot of money attracting top quality, ‘A’ caliber tenants. They are only looking for a ~6% cap rate. Cap rate is defined as (net operating income / market value or purchase price). Lower expenses, such as vacancy and maintenance, produce higher cap rates. If you have a 4-plex, with each unit renting for ~$1,000, net operating income for this amount is ~$2,200 per month (~55% of revenue).
Do not ever forget, higher cap rates increase building values for yourself, but when the incoming investor wants a higher cap rate than you are actual getting, it lowers them. By knowing what your cap rate is, or is expected to be, you can back into the market value of your property.
With class ‘A’ tenants, a 6% cap rate is all the return investors need. Top quality tenants do minimal damage, are low-maintenance, and the rents are almost as guaranteed as a government payment. Everyone at who has a decent neighborhood should be thinking they are managing in at least a class B or B- apartment complex. And they should be getting tenants and a cap rate to match.
If you have a class ‘A’ 4-plex, the building at a 6% cap rate would be worth $440,000. At an 8% cap rate, which is a typical cap rate for a class ‘B’ apartment, the buildings are worth ~$330,000. If an investor demands a 10% cap rate, which is a class ‘C’ apartment, the buildings are worth only $264,000. Class ‘D’ apartment tenants require a 12%+ cap rate, just to make any sort of reasonable return. Fill your place with class ‘D’ tenants, and your resale value is only $220,000.
Low Grade Tenants Are Difficult
An apartment turnover for a class ‘D’ tenant can cost thousands. A class ‘D’ tenant turnover can have lots of ‘junk’ left over, ruined carpet, holes in doors or walls, broken shelves in refrigerators, appliances so dirty they need to be replaced, complete paint jobs, and need cleaning beyond belief. And if they stiffed you on the last month’s rent, and it takes three months to get it repaired and re-rented, it is even worse. If you had to file an eviction on your tenant, you probably lost money. A successful showing while a class ‘D’ tenant is in place is impossible. Depending on how your skill level is at turning and marketing your apartment, you could be vacant for a several months.
You already have a sunk cost for the building; it makes sense to get a low-maintenance tenant and better profitability. Depending on what you paid, you can get a class ‘D’ return (12%), with a class ‘A’ tenant. It sounds backward, but it is what you want to achieve.
I have had several zero-vacancy turnovers this year. These turnovers required minimal effort spent on my part to get them ready for the next tenant. Remember, I work full-time, and do these rentals ‘on the side’. I do not have time for a Class ‘D’ tenant.
For a super-fast turnover, get the place advertised and rented 6 – 8 weeks before the current tenant moves out. Get a holding fee from the new tenant, do not sign a lease. Check on the current tenant’s progress to make sure they are on track. Have your supplies ready; You should repair any items that need repair before the current tenants move out. Get in as soon as possible, and get it turned. A few hours are all it takes. There are several other ‘tricks’ that I have in place to make the maintenance easier. Those tricks are for another update.
Have you ever wondered why a property seemed like a great rental investment, but yet no one was making offers?