Choosing a multifamily investment property is a time-consuming and math-intensive process. You can easily spend hours upon hours crunching numbers to identify whether or not a property is worth pursuing. Like most real estate investors, you don’t have the extra time to complete a full statistical evaluation for every property you look at, but you don’t want to miss a solid investment opportunity either. Poor deal analysis can cause you to pay more for a property or become saddled with a property that does not perform to expectations.
Over the years, investors have taken advantage of a few quick checks, such as the 50 percent rule, to save time, energy, and money when initially analyzing a multifamily property. Let’s look at how these rules can guard against imprudence early on.
The 50 Percent Rule Can Save Multifamily Property Investors Time
The 50 percent rule is used to quickly determine if a potential property is worth pursuing further. It uses a simple mathematical formula: The gross monthly income of a property divided in half to roughly determine monthly expenses, such as taxes, insurance, and maintenance. From the remaining 50 percent, subtract the estimated mortgage. The amount remaining is the rough monthly profit.
For example, if you’re considering a multifamily property that generates $5,000 a month in gross income, you can expect to pay $2,500 a month in expenses. If you determine that financing the property would cost $3,000 a month, you would have a hypothetical negative monthly cash flow. This property would not be worth pursuing further.
$5,000 (gross income) /2= $2,500 (expenses) - $3,000 (mortgage)= -$500 (monthly cash flow)
The beauty of this shortcut is the minimal amount of information required to weed out an unfavorable investment. Not every property owner will provide you with line-item expenses early on; however, most will be forthcoming with their gross monthly income. To precisely evaluate a multifamily investment property, you would need a complete, multi-year income and expense history. The 50 percent rule allows you to very quickly and simply generate a ballpark profit.
The 1 Percent Rule as a Sniff Test for Multifamily Property Evaluation
Although traditionally used for single-family investment properties, the 1 percent rule can be used as a quick ‘sniff test’ to evaluate potential multifamily assets. Less conservative than the 50 percent rule, the 1 percent rule dictates that the gross monthly rent for a property should be equal to at least 1 percent of the total purchase price.
For example, let’s say you’re considering a multifamily investment property with an estimated total purchase price of $500,000 and monthly rental income of $8,500. Using the 1 percent rule, you would quickly conclude that the property should deliver $5,000 or more in rental income to render a positive cash flow. Unless you have a strong reason to continue to pursue this property, you will want to move on to the next potential property.
$500,000 (total purchase price) x .01 = $5,000 (prospective monthly rental income)
$8,500 (actual rental income) > $5,000 = good potential
In this case, you should also apply the 50 percent rule to get a wider view of the potential property before choosing to move forward.
Applying these rules early in the process can help you separate promising opportunities from those less favorable. But as you get closer to making the important decision to invest your hard-earned money, consider working with a trusted multifamily real estate investment management company. An experienced firm can provide you with options for investing in properties on which it has performed analysis and due diligence, diversification by providing economies of scale with multifamily apartments in different regions, guidance through your purchase, and a quick and efficient deal close.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We own and manage luxury multifamily investment communities in major markets around the country, and employ a team of experts who can help you hone your investment strategy.
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