Purchasing multifamily real estate can be a highly profitable endeavor for investors. But to be successful, due diligence is necessary on multiple fronts. Investors not only need to understand the marketplace, analyze recent sales comps, and know how to identify and then properly evaluate a property, but they must also be sure it’s a smart investment that aligns with their financial goals.
The Magic Is in the Math
Calculating the value of multifamily real estate is not as complicated as you might think. Begin by familiarizing yourself with a few key terms:
- Annual Total Operating Expenses— These expenses include property taxes, insurance, utilities, building maintenance, landscaping, trash removal, and more.
- Net Operating Income (NOI)—The annual rental income of your multifamily property minus annual operating expenses.
- Capitalization Rate (Cap Rate) —The net operating income as a percentage of the price of the property.
Next, let’s consider this scenario: You’ve fully vetted a property for which you expect to pay $1 million dollars, and have determined that your annual rental Income will likely be $90,000. You’ve also determined that it will cost you $40,000 to operate the property each year.
With that information, you can calculate your net operating income (NOI) by subtracting the annual operating expenses from the annual rental income:
$90,000 - $40,000 = $50,000 (NOI)
With your NOI calculated, you can determine the cap rate by taking the NOI and dividing it by the property price:
$50,000/$1,000,000 = 5% cap Rate
If you’re simply looking at properties with no intention to buy just yet, you can calculate a much less precise cap rate using the property’s class as a guide. Property class is determined by a property’s location and characteristics.
- Class A Properties, which tend to be new or fairly new and attract more affluent tenants, typically have a cap rate of 3 percent to 5 percent, depending upon location.
- Class B Properties are typically those built within the past 20 years. Although they might require some maintenance now or in the near future, they offer potential for appreciation and positive cash flow. The cap rate for a Class B property is typically between 5 percent and 7 percent.
- Class C Properties are generally over 30 years old and have substantial needs and/or issues, but they still have positive cash flow potential. The cap rate for Class C assets is around 8 percent to 10 percent.
- Class D Properties are typically associated with inner cities and have cash flow issues often related to collecting rent or to other tenant issues. The cap rate for Class D properties is usually above 11 percent.
Need Help Valuing Multifamily Real Estate?
Investing in multifamily real estate can be financially rewarding, but it also requires a fair amount of work and investigation. Due diligence and knowing the mistakes to avoid when analyzing multifamily assets is imperative. A real estate investment management firm that specializes in multifamily assets can help you identify and fully vet the investment opportunities that align with your financial abilities and goals.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and multifamily real estate valuation to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also 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.
For more articles like this one, check out our investment strategy blog posts.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
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