$1M Net Worth: Appreciation, Passive Income Equal Apartment Riches

Posted on Mar 2 2015 - 12:14pm by Lance Edwards
Lance Edwards Real Estate

Lance Edwards

Want to know how you can buy more assets in small apartments and multifamily? Passive income and appreciation are the one-two punch you need to expand your real estate empire and make the money you deserve.

After you have moved beyond that critical first deal, your next question might be how to leverage upon leverage. How exactly are we going to get the fly wheel going?

Well, I can lay a couple of points of fact here.  When it comes to commercial income producing property like apartments, rental demand translates into hundreds of thousands of dollars.

Income properties are valued based upon the net operating income, otherwise known as the NOI. Net operating income is simply the difference between revenue coming in minus the expenses we paid out.  And in the case of apartments, revenue is primarily rent and expenses are everything associated with operating the property.

Now, if you do the math, there’s a very simple formula. The way it works out is you raise the rent $10 per month, per apartment unit and you raise the value of that apartment complex $1200 per unit or per door.  A $10 rent increase raises the value $1200. Raising the rent raises the net operating income.  I’ve got more money coming in.

Another way to raise the net operating income is to raise the occupancy.  And a 2% occupancy increase equates to $1200 equity per door.

Now, that is something called forced appreciation, otherwise known as the cha-ching factor, because forced appreciation is how you create wealth through apartments.  And this is the ability to go in and acquire either underperforming properties or properties who could be run better and make operational improvements, perhaps make some rehab improvements, put in place a management company but raise the rent and raise the occupancy in creating six and seven-figure returns on equity.

Let me give you an example of forced appreciation.  Remember, a $10 rent increase equates to $1200 equity increase per door.  Well, just do the math.  If you’ve got five units and you raise the rent $10, you’re going to raise the equity $6000.  If you’ve got 100 units, it’s $120,000.  If you have 200 units, it’s $240,000.  That’s just from a $10 rent increase.  Nobody moves out for a $10 rent increase.

If you raise it $15, you add 50% to all those numbers.  If you raise it $20, you double all those numbers.  That’s just for rent increase.

Now, you raise the occupancies 2% and you double those results.  So you raise the rent $10, you raise the occupancy 2% measly on a 50 unit building, you create $120,000 equity.  That means you can have the property reappraised at a value of $120,000 higher than it was previously.

You can sell the property at a higher price.  You can refinance the property at that higher value and pull cash out tax free, by the way, and use that to buy other properties.  I’m getting ahead of myself.  So this is forced appreciation, all right, the power of those zeros.

So let’s take that forced appreciation, let’s raise the rent, let’s raise the occupancy and I could then sell my small apartment to larger apartment and do it on a 1031 exchange tax free, right?  I cranked that extra value, I could sell my property, get a profit on that equity I created, take that cash and if I do it through a 1031 exchange I can reinvest that cash into another larger apartment deal and do it tax free.

There’s no capital gains tax if I do it on a 1031 exchange.  And literally you start doing this over a span of just a few years you can unmask $1 million net worth starting with nothing as long as you do it through forced appreciation.  Keep trading up, keep trading up, keep trading up and doing it through 1031 exchanges so that the IRS is taking no bite of your profit.

Another way you can do the forced appreciation is you can refinance those smaller apartments.  You raise the value through forced appreciation, you get it reappraised, you put a new loan, refinance, you pull out that new equity as cash, tax free, and then take the cash and go buy more apartments.  So you’re still holding on to the original apartment but you’re pulling the equity out as cash to go buy more apartments.  That’s another way to use passive income and forced appreciation to buy more assets.  You’re getting leverage upon your leverage.

And the thing about forced appreciation is it only exists in commercial, not residential.  In houses – in the residential, appreciation comes from market appreciation.  We need to have the market conditions change in order to drive up comps.  In commercial, we don’t – we can take market appreciation if it comes.  That’s great.  But we are not dependent upon it.  We can create forced appreciation.

Another reason I got involved with apartments is because that predictability of being able to predict how much a property would be worth before and after purchase or before and after improvements, that predictability was very attractive to me and the idea that I could be in control of what I was doing with my real estate business.