Blog

3 Keys To Analyzing A Multifamily Investment Property Deal

Published on Wednesday - May 24, 2017

There’s no question when getting started with real estate investing, that single-family homes will represent a lion’s share of your focus. Learning to acquire, renovate, sell — even establish a recurring rental property income — is a fantastic way to learn the basics of the real estate investing trade.

But at some point, if you want to add serious boost to your cash flow, you’ll want to explore adding a multifamily investment property or two to your portfolio. The reason is simple: investing in multifamily properties lets you boost your income while reducing vacancy rates.

Another key advantage to adding a multifamily investing strategy to your arsenal is the power of leverage. Those eight single-family homes in your portfolio are not equivalent to that multifamily real estate property with eight units you’ve got your eye on. With added maintenance and expenses, the eight single-family homes have to go a long way before they reach the profit potential of your first multifamily investment property.

The big question new investors have when looking for a masterclass in multifamily investing 101 is how to determine if a deal is right. What’s the best way to know if the many multiple investment properties you examine make sense financially? And what exactly, from numbers-standpoint, does “financial sense” look like when investing in multifamily properties.

Here are three keys to help you analyze that multifamily investment property deal that comes across your desk.

How to Know if a Multifamily Investment Property is Right for You

Multifamily investing

1. Find your 50%

There are few iron-clad rules when it comes to scanning multifamily properties for sale that you might add to your repertoire. But there is one undeniable truth about multifamily investing deals: if the math doesn’t work, the deal doesn’t work.

The best way to ensure this is to crunch the numbers and determine (approximately) how much a specific multifamily property can make you as an owner. You do this by calculating the difference between expected income (rent payments, storage fees, parking fees) and expenses (repairs, maintenance, etc.)

But how do you do this if you haven’t owned multifamily properties before? Or don’t have a clear comp for a given location?

Simple, just use the 50% rule.

It works this way: Take the expected income and HALVE it, this then becomes your estimated expense number. The difference between your estimated monthly income and estimated monthly expense is your net operating income (NOI).

2. Calculate your cash flow

But wait, you might be saying! What about my mortgage? Well, we bring that into the equation in this next step, by calculating your estimated monthly cash flow. To find out how much money you’ll actually be putting into your wallet on an ongoing  basis, you want to subtract the monthly mortgage payment from the NOI of your prospective multifamily property.

For example, say you’re looking at a duplex with three units that bring in $2000 of rental income per month. Divide that number in half and we’ve got a NOI of $1000/month.

Then let’s say your 30-year mortgage to purchase the multifamily property is for $150,000, at 5%. This would translate to a monthly mortgage of $805, with $195 of positive cash flow.

Or better put:

  • $2000 rent income MINUS $1000 estimated expenses MINUS $805 monthly mortgage EQUALS $195 positive cash flow!

Though not enough to retire, on the surface this multfamily property investment, according to our calculations, appears to be a favorable one. Change the amount of the mortgage, such as paying $175,000 instead of $150,000, and that positive monthly cash flow dips significantly to just $61/month. (Making the investment much less palatable.)

3. Figure out your cap rate

Determining your monthly cash flow on a potential multifamily investment is just the first step to judging the relative merits of a property. What you need to ascertain is the capitalization rate, or cap rate, which indicates how quickly you’ll get a return on your investment.

Now, when you first calculate this cap rate number, you may be a bit shocked how low the number is. “Five percent? That’s all the return I’m getting from my multifamily real estate investment?”

It’s important to remember two things: one, the cap rate for a “safe” investment, such as a certificate of deposit (CD), is usually in the low 1-2% range. Two, this cap rate you’re about to calculate doesn’t take into account factors such as increases in property value, boosts in monthly NOI, or the many tax breaks afforded to owners of multifamily properties.

So, how do you figure out your cap rate?

It’s simple, all you do is take your monthly NOI, multiply it by 12 (to get a yearly NOI number), and then divide that number by the total mortgage amount.

Using our earlier example, the numbers would look something like:

  • Take monthly NOI ($1000) and MULTIPLY by 12
  • Take that number ($12,000) and DIVIDE by $150,000
  • This new number is now a healthy 8% cap rate

The key thing to understand about cap rate is that higher is not always better. A higher cap rate generally denotes higher risk and higher return. While a lower cap rate, conversely, indicates a lower risk and lower return.

A good rule-of-thumb is to shoot for a cap rate in the 5%-10% range. Anything lower and the investment may not have enough yield, anything higher and you want to be sure you understand all the risks associated with the investment.

Crunching the numbers

The great part about using math to inform your multifamily investment property decisions is that it takes the emotion out of the process. Instead of being influenced by extraneous factors, such as personal relationships, by crunching the numbers on a possible multifamily property, you’ll quickly get insight into whether this project has enough ROI potential for you, or is something that should be avoided at all costs.

And knowing which deals to walk away from can often be as important as knowing which deals to pull the trigger on.

🔒 Your information is secure and never shared. By subscribing, you agree to receive blog updates and relevant offers by email. You can unsubscribe at any time.