You want to invest in multifamily properties, but with all the apartment buildings in your city, you could spend all your time looking at them, analyzing them and comparing them without ever getting anywhere. You need a simple, effective way to analyze multifamily buildings to save you time and help you make judicious decisions.
The following three guidelines are all you need to rule out unprofitable deals and narrow in on the best:
1. Cap Rate. Cap Rate is an abbreviation for capitalization rate. It’s the return on investment on a percentage basis if you paid all cash. The formula for Cap Rate is NOI (Net Operating Income, which is simply your revenue minus your expenses) divided by the purchase price. Here’s an example: You have a multifamily property with a NOI of $50,000 per year. You paid $500,000 for the property, so the property has a Cap Rate of 10%. It’s wise to look for properties that have a Cap Rate of at least 10%.
2. Price-Per-Door. The price-per-door is simple to calculate. Just divide the price of the property by the number of units. As a general rule, if the price-per-door is less than $25,000, it will probably have an acceptable Cap Rate and cash flow. The price-per-door also tells you the class of property you’re dealing with and whether or not it’s a deal for you. However, it isn’t wise to look only at the price-per-door without analyzing the other two guidelines. You may miss out on some key information that could help you make a good decision about that multifamily property.
3. Unit Mix. The unit mix is the percentage of units that are one-bedroom, two-bedroom and three-bedroom. A property that has more two-bedrooms than one-bedrooms will have higher rent or higher revenue-per-door. Between a property that is 80% one-bedrooms and another that is 80% two-bedrooms, the multifamily property with more two-bedroom units will have higher revenues and, most likely, a higher Cap Rate. Some people say they like to have more two-bedroom units than three-bedroom units because the three-bedrooms attract children. One-bedroom units bring single people or couples. Two-bedrooms are typically for roommates and small families.
Once you have collected the above information, you’ll be able to cut to the heart of the deal and weed out multifamily properties that don’t meet your needs.