Investing in multifamily properties is a solid investment plan and an impressive addition to your portfolio.
Some benefits include a higher reliable income and a lower purchase price per unit than a single-family property provides. Advantages aside, when considering multifamily real-estate, you should be careful about where you are investing.
In fact, learning how to calculate the value of multifamily property investments is essential for profitability and long-term success.
Your focus should be on the state of your investment and expected return—items you can pick out from a seller’s financials.
Below is a discussion of several approaches to property valuation calculations for apartment or duplex properties, and steps on how you make these calculations. Continue reading to identify the most appropriate value estimator for your investment niche.
Profitably owning and running a multifamily rental property means accounting for operating costs. Not understanding what is included and not included in operating expenses can trip up many new investors.
The first step to valuing a multifamily property is to understand the operating expenses do not factor in a mortgage.
Items to include in the rental property operating expenses are:
- Marketing and advertising
- Property taxes
- Annual insurance premium
- Utilities such as water and sewer
- The monthly trash collection charge
- Professional property management fees
- Normal maintenance and repairs done to the dwelling
- Pool care and landscaping
- Legal and accounting fees related to the property
- Pest control and snow removal costs
A critical component of how to value an apartment building is capital expenditures (CapEx). These are large purchases you make to extend or improve the useful life of your multifamily property for more than a year.
CapEx examples include money you spend on making significant repairs or replacement of:
- Electrical systems
- Plumbing systems
The money you spend on upgrading a property to make it more valuable is also under CapEx. These upgrades include installing new equipment to an apartment complex to encourage current tenants to extend their lease or to attract new tenants altogether.
Net Operating Income (NOI)
For multifamily investments, NOI is a powerful instrument.
NOI is the operating profit the property generates within a specified period, usually 12 months, before accounting for mortgage payments and income tax expenses.
The figure shows how much you are likely to earn once you acquire the property. NOI is a good way of determining whether a piece of multifamily real estate property is a highly profitable acquisition. Further, it also shows you what future cash flow will look like based on the data available.
Determine the net operating income
To calculate NOI, add together rental income and other income the property had generated within a year for gross income.
Next, subtract the sum of operating expenses from the gross income.
NOI = Gross income minus operating expenses
Use an investment property calculator
Using an investment property calculator is easier than doing these calculations on your own.
The calculator prompts you to enter certain inputs. These include the gross rental income, other income, vacancy loss, and operating expenses. Based on these inputs, the calculator figures out the NOI of the property.
Another critical consideration when seizing up multifamily properties is capitalization (cap rate).
Calculate the property’s cap rate by dividing NOI by the property price.
Cap rate = NOI divided by Property price
Note, the cap rate varies depending on the property type, location, and general market view.
The rate has an indirect relationship with market value. For example, when the cap rates increase, the value decreases, and vice versa.
Another step to learning how to calculate the value of multifamily property is understanding the different classifications. Each class represents a distinct risk and return for the geographical location and physical characteristics of the building.
Other factors used to assign the letter grades are tenant income levels, prospects of growth, property appreciation, rental income, and amenities. These property classes are:
Class A—A new, shiny asset with plenty of amenities and housing white-collar workers
Class B—Properties placed on the market in the last two decades and are home to a mix of blue- and white-collar employees
Class C—Usually over 30 years old with several maintenance issues pending
Class D—Found in inner cities where rent collection is difficult and vacancy rates are high
Matters of real estate investments are subject to some heated debates without a right or wrong answer.
However, all experts agree that location is a critical consideration in any real estate investment decision.
Here, the location includes many factors, such as
- City, town, or village
- Side of the street the property lies on
Purchasing an investment property in the wrong neighborhood in the most profitable city is an enormous risk. Therefore, do your due diligence market analysis to ensure that you have the right geographical location for your goals.
Why is the location of the multifamily property so important?
- It is constant—You have the option to upgrade the property, install new furniture, and even make it smaller or bigger. However, you can never change the location. After signing the final papers, you are bound to that location until you decide to sell.
- Affects supply and demand—The ideal location is one that provides you with a reasonable supply and is highly demanded by potential tenants.
- Determines property desirability—Access and proximity to amenities, public transportation, public services, shops, restaurants, tourist attractions, and others are all determined by the location. All these factors also determine the tenants you attract to your property.
- Governs your rental strategy—Short-term rental landlords are better off choosing locations close to tourist and entertainment options. Traditional rental units are suitable in areas that offer tenants amenities, neighbors, and accessibility to schools.
- Affects property profitability—Location is key in determining how much rental income you can charge for each unit and the amount of running costs you incur.
- Determines property appreciation—Land is a limited resource, and it is a huge component of the property’s price. Aim for locations that are likely to appreciate in the long- and short-term future.
So, how do you calculate the multifamily value using location?
Perform a comparable search
A comparable property search requires comparing the existing multifamily properties in a location based on several factors. The search helps you test the local housing market, the position of the property against other similar properties, and aids you in determining market rents.
The more comparable properties you have, the more reliable conclusions you can draw.
During the comparable search, test the following:
- Properties with similar rents
- Profile of tenants in comparable properties
- Physical characteristics such as number of bedrooms, size of each unit, development size, amenities, general condition, and curb appeal
- In a large city, choose comparable properties within walking distance of each other and multifamily properties that are found further away from one another in small towns
Still interested in learning how to value a multifamily property?
Go see the property for yourself!
The right income property location for you should:
- Have a low supply of income properties
- Be close to public services, amenities, and entertainment and shopping options
- Be safe for tenants
- Provide reasonable real estate prices
- Have a high and positive cash flow
- Have a high demand for long-term rental units
- Require relatively low running costs for owning and managing
- Offer good appreciation
Making Your Investment More Profitable
Sometimes, it is hard to compete with new, high-end multifamily properties, but that does not mean that older properties are poor investments. With the right value-adds, your property can provide a sizable return on investment.
Foremost, you must find the right mix of add-ons that do not present extreme overhead costs but still improve your property substantially. Some upgrades that can reposition Class C units to Class B properties include:
- Making interior improvements—Consider upgrading appliance options such as in-unit dryers, washers, and dishwashers. Other worthy must-have features renters will love include high-speed internet access and consistent phone reception.
- Embrace technology—Noticeable upgrades include app-controlled HVAC systems and voice-enabled personal assistants. Enhance security using FOB and keyless entry options.
- Provide quality amenities—Introduce amenities such as dry-cleaning lockers, clubhouse, or a fitness center, so that tenants feel like they are getting a rental price deal compared to high-end units with the same.
- Upgrade common areas—Millennial tenants are more adept at taking up residency in properties that provide functional areas for work and social activities. Additionally, renovate with durable flooring and furniture to handle increased use.
- Pass expenses to tenants—Electricity, water, and gas are consumable resources variable by tenant, so it would be appropriate to have them pay. This also helps reduce your expenses, and in turn, maximize your income.
- Tap into additional income sources—Provide premium paid parking, introduce late fees, or even have pet owners pay a fee. All these ideas develop secondary sources of income coming from your multifamily investment.
The Bottom Line
Now that you know how to calculate the value of multifamily property, you are ready to make your investment! The information above can help you weed out deals that do not work for you. You can also use the information to put together an effective business plan and strategy on how to create value once you get an ideal property.
At Avery Carl, we can help you every step of the way! From information on real estate investment to assistance with buying your first property, we got you covered to succeed on your real estate ownership journey.