Highest and best use is an interesting phrase when it comes to apartment buildings. The idea that you should be maximizing the use of the land and structure makes sense for a lot of things but there’s limited stuff you can do with multi-family structure short of turning it into a condominium, and I’m not a fan of that idea.
So what can you do to increase the income and reduce the expenses through change of use?
There’s lots of properties out there with so-called illegal suites. Often they’re a store room or the caretakers office turned to a bachelor or one bedroom unit. You can usually identify them by checking the building and development permits to see if the number of units they applied for is what you’re seeing today. The cheaters’ way is to count the number of electrical meters – there should be one for every unit and one or two for the house power (common areas and external lights).
While you own the building, income is income. It’s best if you look at making a legal unit, complete to development permits, parking, wiring etc. That’s not feasible for many owners, so you need to make sure you’re renting a safe place to live that does it’s best to comply with fire, building and safe housing standards. If someone dies during a fire in your building you’ll have bigger problems to deal with than just some smoke damage.
They’re a bit of a liability when selling – if you have 14 doors plus one illegal suite, don’t expect to get 15 doors worth of value. The rent for that suite probably won’t be counted against the income by lenders. Just be happy with the extra cash-flow while you own it!
2. Change main floor residential units or 4-plex units to commercial space.
The City of Edmonton is a big fan of mixed residential-commercial developments right now so I get a lot of questions about the idea. There’s benefits to commercial (office or retail) units compared to residential. At $15/sq ft on a net lease you can get $12,000 for an 800 sq ft unit, PLUS operating costs of (for example) $5-10/sq ft which are the actual/budgeted costs for utilities, condo fees, management fees, property tax etc. You end up taking $1000/month and the tenants cover the costs so you end up farer ahead. The down side is you’re potentially looking at rezoning, allowing your tenants to get a business license, more traffic through your property and more demands for parking, cleaning and upkeep.
I’ve seen at least one 4-plex on the market this year that’s been completely turned over to commercial space. Then again, I’ve seen a couple downtown office towers converted to loft space.
3. Add a floor!
The idea of adding floors just makes my head spin. I’ve seen one person do this with a single family home this year and i recently walked through a 3 story apartment building that had a 4th floor added. There’s a lot to consider here – engineering costs are not insignificant, you’ll have to pull the old roof and re-roof, built the floor and then put a new roof on. You might end up going from a flat membrane or tar and gravel roof to a sloped roof with asphalt shingles or metal.
Compared to building new, when adding a floor to an apartment building can save on digging a foundation, concrete, buying land and drafting up full plans. All you’re really doing is copy and paste. It’s also a slightly smaller project (in terms of total construction), you might be able to do the work with tenants in place so you don’t loose cash-flow, and you can make improvements like adding insulation to the roof and walls.
4. Add a Garage!
I’d love to own a piece of land with nothing but garages on it. (I suppose that’d be called a self storage facility…which I should probably look at.) If you’re lucky enough to own a building with a big chunk of land, consider paving or putting down gravel to make some of it parking and rent that out. Or, you could take the next step and build a garage. There might not be much demand for surface parking at your building but there’s always demand for a good garage. I’m a sailor and I know a lot of guys who would be interested in having a place to store their boats in the winter.
Building a double garage costs between $15,000-30,000. Even if we go towards the high end of $25 for a double garage and get $300/month that’ll still pay for itself in 7 years and there are essentially no operating costs to a garage.
5. Demo and build!
And finally, I think it’s high time we get back on the bandwagon of building apartment buildings. The cost of construction has improved and you can make money at this again. The issue is the cost of land can make this a bit tougher. If you already own a building, particularly if you’ve had it for a while, this is right up your alley.
Two reasons I think this can work well for existing owners. First, you don’t have to be a builder – I have several builders who joint venture with owners to take care of the demolition, all of the build and at the end of the day you both own a great looking property with better tenants and resale prospects than before. The second is the seldom understood concept of a terminal loss.
Pretend the value of your property today is $1,500,000 – we’ll allocate $1,000,000 to the land and $500,000 to the building. If you tear down the building today, you’ve just destroyed $500,000 and that’s a tax loss you can carry forward for 5 years. So if you go and build a building, then sell it for a $500,000 profit (or make $500,000 profit by renting it out), then you don’t get taxed on any of that $500k because you have a loss from the old building you tore down.
See, there’s lots of interesting things we can do with apartment buildings!