A multifamily residential property, which is also referred to as a multi-dwelling unit (MDU), is a type of commercial real estate that comprises several residential units in one building or complex. This housing classification includes apartments and condominiums.
Multifamily properties are known for their resilience during economic downturns, so it’s not a surprise that apartment construction in major cities has increased for nearly two years while single-family homes have declined. The trend is even more obvious on a local level.
In Atlanta and Baltimore metropolitan areas, for example, the number of permits issued for MDUs has tripled in 2022 compared to the year prior, while single-family permits have dropped significantly.
Apartments and condos have always been considered one of the best CRE assets classes because of several reasons:
But how do you choose a profitable multifamily building? In this blog, we provide insights on how to evaluate multifamily CRE, talk about what makes a solid investment in this segment, and share tips from seasoned multifamily investors.
To find the right multifamily property that suits your investment needs and goals, it’s essential to have a clear idea of your financial capacity, including what you can afford, the amount of debt you can take on, and the real profit you expect to earn.
The first step is to understand the housing market's current situation. This means talking to experts or influencers in the market by attending real estate investor meetups, joining investor groups, or using online forums. You can also speak with a local appraiser who can offer insights on what makes an investment property valuable and what detracts from it.
Understanding the neighborhood is critical because it affects the price and value of the investment over time. The location should align with your goals as an investor.
Assess the neighborhood thoroughly to understand factors such as school districts, public transportation, amenities, nearby businesses, safety, and the state of the overall housing market. You should also consider the type of neighborhood and tenant base you want to attract.
Think about affordability and market demand to decide on the tier of the market they want to pursue. It’s also important to evaluate the security of the area and take into account the cost of building necessary precautions (such as building a gate) if the property is in a high-crime neighborhood.
Before investing in a multifamily property, determine whether it needs significant repairs or renovations, as well as the cost and time required for such projects. This will help you calculate if the overall investment is worth the effort. It’s also important to consider the future expenses that may come with the multifamily building.
One of the biggest costs is property taxes, which can vary depending on the location. You also have to take into account foundational, mechanical, and plumbing expenses.
Check the condition of the heating and air conditioning systems, appliances, and other structural aspects (which can be evaluated by a professional inspector).
If the projected long-term expenses exceed your expected profits, then it may be wise to look for other investment opportunities.
To determine a property's value and its income-generating ability, you need to calculate its NOI by deducting the operating expenses from the total income the property generates in one year. Here’s a more detailed look at how to compute the NOI.
Operating expenses include costs for property maintenance, management fees, utilities, insurance, property taxes, and repairs, while total revenue includes all the sources of income such as rent, parking fees, and vending machines, among others.
If the NOI is too low or non-existent, then it's advisable to explore other investment options.
Calculating the cash flow helps you understand interest payments to lenders, gross rent, operational expenses, maintenance costs, utilities, insurance, and property taxes. To calculate the total cash flow, deduct the mortgage payments and reserves for future capital expenses (CapEx) from the NOI.
CapEx reserves are the funds set aside to pay for large expenses such as replacing the roof, which needs to be budgeted for annually. To determine whether the cash flow is sufficient for the investment, you can consult a CRE financing expert.
To evaluate the property's potential return on investment, divide the estimated net operating income by the current market value of the property. This is known as the capitalization rate or cap rate.
A high cap rate implies a lower listing price and a more profitable property. However, it's important to consider that properties with high cap rates are often located in less desirable neighborhoods or require significant renovation. That’s why this metric alone is not enough. It must be evaluated along with other multiple factors.
When investigating the profitability of a multifamily investment, be sure to do due diligence by examining potential risks, violations, lawsuits, and outstanding fees. Collect documentation such as bank statements, rent history, and unit inspections to verify information about the property.
Additionally, be sure to conduct a physical inspection of the property to identify any structural damage that could cause future problems. Consulting professionals like brokers, lawyers, and tax experts for advice before making a decision is always a wise move.
Only after completing all these steps should you start to negotiate a fair purchase price based on the current NOI and cap rate. In broad terms, the purchase price can be calculated using the formula:
Purchase price = NOI / Cap rate.
For instance, if the NOI is $100,000 and the cap rate is 10%, then the purchase price should not exceed $1,000,000. You do not want to overpay for a property nor let the asking price hinder your negotiation.
Once you have calculated a fair purchase price, you can make your offer and start negotiations with the seller. If you are not buying the property with cash, then acquiring financing is the next crucial step in purchasing a multifamily property.
A long-term bank loan is typically necessary to finance a CRE investment, but you don’t have to limit yourself to traditional lenders. Private equity is also a viable option. Some lenders can issue pre-approval letters that you can show sellers to increase their confidence that you can afford the property.
CRE financing consultants can help you obtain optimal loan rates, terms, conditions, and LTV ratios. They have extensive knowledge and experience in the field of commercial real estate financing and can provide valuable insights and guidance to help you navigate the complex process, especially if it’s your first time.
These consultants also have established relationships with a wide range of lenders, including private equity firms and other financial institutions. This network allows them to identify the best financing options for a particular investment.
They understand that each commercial real estate investment is unique, so they can tailor a financing solution that fits your specific needs and goals as an investor.
Financing a commercial real estate investment can be a time-consuming process, involving numerous documents, negotiations, and due diligence. A CRE financing consultant can handle many of these tasks, saving you time and allowing you to focus on other aspects of the investment.
And while there may be a cost associated with hiring a financing consultant, their expertise and access to lenders can help investors secure more favorable financing terms, ultimately saving them money in the long run.
Investing in a multifamily property can provide a reliable source of income for years to come. But it’s crucial to conduct thorough research and secure your CRE financing to ensure that you select the appropriate property.
Following the steps outlined above is a reliable method to ensure that you have carefully considered all aspects before making a decision. If you are seeking financing for a multifamily building, don’t hesitate to get in touch with us here at Capital Investors Direct.
