How To Analyze A Multifamily Real Estate Deal Like A Pro [Step-By-Step]
Multifamily investments promise both short and long-term benefits. However, to guarantee optimized ROI, investors must analyze every factor they have on the table for multifamily property investing deal and review their expected returns from each angle. The main criteria- for zeroing-in on a potential multifamily investment deal- is the location. When we invest in a multifamily asset, we expect to rent or resale the units to multiple tenants or buyers.
There is only one common denominator that you will need to pitch to every party in this equation- the property’s location. Thus, the smartest option is to opt for multifamily real estate in a location that has several amenities that attract takers of every demographic. Once you have a suitable asset in your sight with respect to this criterion, you will need to assess the property’s profit potential.
Assessing the Property’s Profit Potential
Once you have picked an ideal location and found yourself a multifamily property worth your investment, it is time to assess the profitability of the asset. There is a step-by-step approach to performing due diligence in this regard.
Step One: Analyzing the purchase price
Analyzing the purchase price begins with an assessment of the property value versus the asking price of the same. Start by comparing the property details with that of other, similar property in the same location.
To get an accurate comparison, it is advisable to do so against a property that offers the same square footage and the same amenities as your chosen property. This should help you arrive draw a realistic inference as to whether the purchase price is fair or not.
Step Two: Analyzing the financial data
What is the cost?
The purchase price is only the tip of the iceberg when it comes to calculating your net costs. You have to consider the cost of repairs (best to call an inspector for a property evaluation) and closing costs such as bank appraisal, taxes, attorney’s fees, loan application fees, etc. Thus,
Net cost= property price + cost of repairs + closing costs
Cash requirements= down payment + cost of repairs + closing costs
What is the projected income the property can generate?
The actual value of any rental property lies in the rental income it can generate monthly. Your property can generate passive income from parking facilities, laundry facilities, vending machine sales, etc.
How to fetch the numbers?
Start by asking for a pro forma of the expected expenses and incomes from the seller so you can form an estimation. Sellers are often known to inflate the occupancy rate or exaggerate the typical market rents.
At the very least, the pro forma should cite historical data, the profit and loss statements, the rent roll, etc. The rent rolls tell you about vacancy and occupancy rates. Excessive turnover and vacancy rates call for more in-depth scrutiny of the root causes if you want to go through with the investment.
Understanding projected expenses
The projected expenses include the cost of management, the taxes, the insurance, the cost of landscaping, utilities, and insurance. Instead of banking solely on the pro forma data, it is prudent to ask for the previous years’ tax returns. Double-check variables such as tax assessments.
Step Three: Analyze the net operating income
Thirdly, as the investor, you should calculate the net operating income of the property, which should not comprise of financing expenses.
Net Operating Income= Income (rent, parking, etc.) – Operating cost (taxes, insurance, management, maintenance, etc.).
Regardless of the financing options available, you should compare the different multifamily investment options on the table.
Step Four: Analyze the cash-flow
Analyzing the cashflow requires us to subtract the Mortgage Payment from the Net Operating Income.
Cash flow= Net Operating Income – Mortgage Payment
Mortgage payments always consist of principal interest. The applicable taxes and mortgage insurances are usually taken into consideration, as well.
Step Five: Analyze the Return on Investment
Once you have deduced that your cash flow is positive, then you are good to proceed to the next stage- calculating the Return On Investment. When it comes to success from any form of real estate investment, it comes down to how well you can leverage your money to generate a manifolds return. The formula for the same goes as follows:
ROI = Cash flow / Investment Cost (downpayment + closing costs + rehab costs)
Thus, it can be easily surmised that to have a better ROI, it is more opportune to pay a low downpayment even if it means your monthly mortgage expenses increase.
How to deduce the applicable ROI for a multifamily asset?
There is no ‘one’ right value for the rate of Return On Investment. It is a subjective value, so the answer varies. As the investor, you may have certain expectations from your investment, while a money manager who knows the ups and down’s of the market considers a return of 8% to be a reasonable ROI from a balanced portfolio of stocks and bonds.
Step Six: Calculate the net ROI
There are several factors to take into consideration to infer the net ROI from your investment. Firstly, you will earn tax benefits from tax deductions. Secondly, your asset continuously builds equity. Lastly, and foremost of all, your property appreciates. For the sake of working with constants rather than with variables, even if we leave the rate of value appreciation out of the equation,
Total ROI = Total Return / Investment Cost
What have we learned?
Thus, we safely conclude that when it comes to investing in a multifamily rental property, the surest way to generate a good ROI is to opt for the best location available; after that, it all comes down to the numbers game. Making a comparative study of the options at hand is essential. So, is gathering data on the pro forma numbers provided by the seller; should they offer some peace of mind, you can go the extra mile and ask for the actual numbers generated by the property in question in the recent past. These accurate projections can solidify your chances of securing financing. Estimating cash flows, ROI, net ROI, etc. requires data backing. Should these figures meet your expectations, then you have a quality multifamily investment deal in your hands.
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