Apartments earn money in more ways than just rent and fees. This article breaks down how the business generates revenue. Once I learned how apartments operate, I instantly realized how superior they could be to single-family home investing. Let me share with you exactly how apartment buildings make money so that the next time you drive by an apartment complex, you’ll start to see it for the business that it is. A business is simply a way to make other people’s lives better. – Richard Branson

Rental Income

Perhaps the best-known aspect of the apartment business is rental income. After all, most of us have lived in an apartment before, so we understand the basics: if you want to avoid getting thrown out, you pay your rent every month on the first of the month. Rental income is the primary way that an apartment building makes money. The rents collected become the majority of the gross income for that month. Then, the mortgage and expenses are paid, leaving the net operating income, or NOI. In other words, the NOI is your monthly profit. When you invest in an apartment building with a team, you split the NOI amongst the partners and investors. For example, let’s say you’re an investor in a 250-unit apartment building: rents average $1,000 per door, for a total gross monthly income of $250,000. Let’s say that the mortgage is $75,000 and that expenses (maintenance, repairs, utilities, management fees, and more) come out to $125,000. $250,000 (gross income) – $75,000 (mortgage) – $125,000 (expenses) = $50,000 (NOI) In this case, your NOI is $50,000. If you owned this entire apartment building yourself, you’d be taking home $50,000 per month. Most likely, though, you are probably investing with a group of people, so that $50,000 is split amongst all the partners and investors, either on a monthly or quarterly basis.

Ancillary Income

While the rents are paid for renting and physically occupying the apartments, many apartment buildings also have other ways of making money through ancillary income. These are all the little extras and amenities, like a coin-operated laundromat, vending machines, clubhouse rentals, reserved parking spaces, covered parking spaces, trash valet, shared wifi or cable, pet fees, and more. This is where apartment owners can get really creative, learn about the needs of their residents, and provide services and amenities of value. For example, many people who live in single-family homes take for granted that their Amazon packages can get dropped off right at their door. However, having packages delivered and held for apartment residents can be a predicament, especially if there’s no dedicated space in the building for them. This need presents an opportunity for the apartment owner to provide an amenity that would be very useful to tenants. The apartment owner might install and rent out package lockers, which provide a needed service for the residents and additional income.

Appreciation

When you purchase a single-family home, you know that the value of your home is connected to comparables in the area. If the neighbor’s three-bedroom house just sold for $475,000, your similar home is probably worth around the same amount. Even if you put in a crazy amount of upgrades, you’d probably be hard-pressed to get more than $525,000, depending on the market.

Apartments are different.

Apartment buildings are not valued on comparables but rather on the income they generate. Let’s imagine you just purchased an apartment building that generates $20,000 per month in NOI. You work with the property manager to increase occupancy, bring rents up to market rates, and decrease expenses. Over the course of a year, you’re able to increase the monthly NOI from $20,000 to $30,000. This might not sound like much, but, believe it or not, that extra $10,000 in monthly NOI means your apartment building is now worth $1.2 million more. Yeah, you heard me, $1.2 million.

How does this happen?!

This is because, in the apartment world, every additional dollar of NOI adds about $120 to the value of the property: $1 (additional NOI/month) x 12 months x 10 (apply a 10% cap rate) = $120 added value So that means your $10,000 of monthly income, multiplied by $120, comes out to $1.2 million. Now, you don’t get this extra $1.2 million right away. It’s not like the monthly cashflow payouts you get from the rents. This $1.2 million is in equity, so you only receive that once you sell the property. This is one of the reasons commercial properties change hands fairly often. Each owner comes in, implements their business plan to improve the property, then sells for a profit and moves on to improve another property. The apartment owner and property manager must work together over time to optimize efficiencies to accomplish these value increases. This drives up the NOI, thus maximizing the amount of profit you can get when you sell the property.

Renovations

One more major revenue generator is through renovations (or adding value). The simple act of improving a unit doesn’t make any money by itself. Instead, think about the goal of a renovation. By enhancing a unit, you provide a cleaner, safer, and better place to live. As a result, you will charge more rent, as people are willing to pay more for nice places to live. Increased rent leads to higher gross income, which, in turn, increases the NOI. Increased NOI also leads to appreciation of the property value. In this way, renovations can lead to increased cashflow returns and increased equity. Further, if you also renovate the common spaces (e.g., improve the lighting, install new windows, improve the landscaping, get a fresh sign for the building, etc.), tenants start to take pride in their building and refer their friends. Passersby on the street begin to take notice. And once that happens, you’ll be able to increase rents further and decrease vacancies, thus further nudging up that all-important NOI.

A Note On Making Money

Some people think that making money is a bad thing and that it shouldn’t be talked about. That somehow, because apartment owners are making money off people’s rents, that they’re only in it for the money, or that they’re greedy and are exploiting their tenants. But think about it this way. What would happen if owners didn’t improve the units? The units would fall into disrepair. Appliances would age, floors would become discolored, and tenants wouldn’t feel proud to live in those buildings. For those owners that let their buildings fall into disrepair, I totally agree that those people should NOT be apartment owners. But most apartment owners are not like that. They’re in this business to provide a great place for people to live and to make an impact on the communities they invest in. The fact that apartment owners can make money from apartments is a GOOD thing because it ensures that they are appropriately incentivized in providing good, safe, and clean housing for their tenants. As you can see, apartment buildings are not just places for people to live. Apartments are businesses. And just like restaurants and corner stores, apartment buildings provide a place for people to gather, live life, and make memories. These are the best types of businesses. The ones that make money and provide valuable services to people and communities. If you’re ready to begin replacing your active income with passive income so you can build time freedom AND financial freedom, apply to the Vestus Capital Investor Club today!

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This work by Annie Dickerson is licensed under CC BY-NC-SA 4.0