Improving Your Life Through Multifamily Real Estate

Let’s face it, we want to be financially secure. We may want a larger home. We may want to send our children to the best colleges. Many of us have dreams of comfortable retirement years spent traveling around the world. Reaching such goals will take money. Yet, we probably don’t relish the idea of giving up more of our precious time to reach those goals.

So how can you build your financial wealth to meet your life goals? How can you secure a better lifestyle without being forced to work even harder? Answer: Invest passively in multifamily real estate

Over the years passive investments in apartments have proven themselves to be wealth building engines. The wealth comes from:

  1. The “value add” strategy,
  2. Increasing the velocity of your money, and
  3. Tax efficient gain harvesting

What is the “Value Add” Strategy?

A Value-add Strategyi increases multifamily real estate values by raising rents, reducing vacancy, and reducing expenses to increase net operating income (NOI). To capture value, apartment complexes are rehabbed in a process sometimes called “flipping” apartment buildings.

How can I increase the velocity of my money?

The value add strategy’s wealth building power can be magnified if you increase the velocity of the movement of your money (i.e. reduce the time it takes to compound your investment returns). We call this the velocity principle.

Understanding the Velocity Principle: The Rule of 72

Background: The Rule of 72 is a commonly understood financial formula that quantifies how long it takes to double your money at a given a rate of return. For example, if you divide 72 by 6 percent, the rule states that it will take 12 years to double your money at a constant 6 percent rate of return.

Cascading Your Wealth Upward: The velocity of your money, or the speed at which value doubles, is critical to rapid wealth creation. We call reducing this time as “cascading your wealth upward.”

At Master Multifamily LLC we seek to double your money over five to six years. In other words, we seek to harvest annual investment returns of between 12 and 15 percent . At the same time, we seek to distribute annual cash returns of between 5 and 7 percent to you. These are our goals, not guarantees.

A wealth building example: Let’s look at an example of the application of the Rule of 72. Say a person has $1 million to invest in apartment buildings. After careful consideration, they decide to do so. Let’s assume they receive a cash-on-cash rate of return of 5 percent. This means that they would receive a (tax shielded) cash distribution return of about $50,000 per year. Let’s also assume that the investment principle amount doubles within five years, and the funds are reinvested in apartment buildings at the end of year 5.

In this scenario, the annual cash distribution return would increase to $100,000 after 5 years, while the principal amount invested would increase to $2 million. Assuming this process is repeated after another 5 years (10 years total), the principal invested grows to $4 million, and the cash distributions would increase to $200,000.

While an investor may not be able to live on $50,000 of tax shielded income at the beginning of the investment process, receiving $200,000 per year after 10 years could provide financial independence. Note: True wealth is best measured by the amount of your reliable spendable income.

How can I ensure wealth building continues?

To continue growing value, harvesting gains in a tax efficient manner is critical. Once the “value add strategy” has worked its magic, your investment should be moved to a different asset so value compounding can continue.

Tax Efficient Gain Harvesting – Three Strategies

  1. Debt Refinance – This strategy may return all, or a large portion of, the amount invested by you while at the same time preserving cash distributions from the property. No taxes are due because of a refinancing transaction.
    The refinancing proceeds can be placed in a new investment, thereby providing a new opportunity to capture value compounding.
  2. Section 1031 Exchange – Once the expected growth in the value of an apartment complex has been realized, the sponsor can sell the property and redeploy the proceeds into a larger asset or multiple assets via a Section 1031 Exchange.The Section 1031 Exchange feature of the tax law is only available for real estate assets. It permits you to defer payment of capital gains taxes. An exchange would not return principal immediately to you; however, the exchange would provide you with higher cash distributions and an opportunity to accelerate principal appreciation.
  3. Sale Only – A project sponsor may decide to sell an apartment complex when market conditions present an opportunity to harvest gains. A sale will usually result in payment of capital gains taxes by you when the increase in value is distributed. As such, a sale could partly interrupt the compounding of your investment value due to the tax obligation that must be satisfied. An individual investor, however, may seek to redeploy their investment by completing their own Section 1031 exchange.

You can work with the sponsor of your multifamily investment partnership to encourage an exit strategy that best reflects your goals. By applying these strategies and principles, each dollar invested will be put to hard work in accomplishing your goals and thereby improving your life.

i A “value-add” strategy is similar to “flipping” a single home, though the value add terminology applies to apartment buildings. Adding value to an apartment building is accomplished by any action, such as raising rents or reducing expenses, that will increase the property’s net operating income. These “value add” strategies, such as upgrading the interiors of apartments while increasing rents, typically take at least two years to fully implement. Apartment building investments are sold at values determined by dividing net operating income by a market determined capitalization rate. For example, dividing a $100,000 annual improvement in net operating income by an assumed 6% capitalization rate, amounts to a $1.67 million increase in investment value. We call this the multifamily value gain formula. See Multifamily Value Gain Formula