How to Evaluate a Multi-Family Investment Property
Buying a multi-family property could become the best or worst financial decision you’ll ever make. The right property can generate cash flow with minimal effort, while the wrong one can quickly drain it. Investors face significant pressure to make the right decision, which is only compounded by the significant and growing competition for these properties. You need to know how to evaluate a multi-family investment property to spot a great deal and move in on it before someone else does.
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Type of Multi-Family Property
A multifamily property contains multiple independent, yet connected residential units potentially spread across multiple buildings. Some of the common types of multi-family properties are:
When looking for a property, take into consideration your own goals, budget, and appetite for risk to narrow your search. You’ll also want to take a look at the locations that would best suit your search criteria and how much income you hope to make from the property.
Like any real estate, location is one of the most important factors affecting a residential property’s value. Areas with a high degree of livability, thanks to nearby amenities, such as schools, grocery stores, entertainment venues, churches, or other community features, will be able to draw in a steady stream of tenants at good rent rates. On the other hand, if you don’t mind some risk, you could buy in an up-and-coming area with new redevelopment.
To get a sense of what a building can add to your cash flow, take a look at its net operating income (NOI), which is the sum of all sources of income in the building, minus the operating expenses. As the NOI is difficult to manipulate, it’s also used for the basis of determining a property’s value. The NOI is divided by another value, the building’s cap rate, to determine how much it should be worth. You can use this as a basis for negotiations if the property is overvalued or to spot a good deal if a building is undervalued.
The Cap Rate
A building’s capitalization rate is its rate of return, which is calculated by dividing a property’s net operating income by its market value. Buildings with higher cap rates tend to be riskier than those with lower cap rates, with an average cap rate between 4% to 10% for residential properties. Low-risk areas tend to have lower cap rates, while higher-risk neighborhoods or properties will have cap rates on the higher end of that range. Cap rates that are outside of this range require further investigation and could be a warning that the property is expensive to run or income is being inflated.
Unless a property is truly singular, its price should be broadly in line with similar properties. Conduct a comparable search of similar properties to find out if the price of the one you’re interested in is broadly in line with that of others. If not, narrow down why it could be off, such as due to a different NOI or proximity to a highly desirable amenity. A large price differential could indicate hidden problems with the property that require further investigation or reconsideration of whether it’s the right fit for you.
Running an investment property isn’t free, and you’ll need to have sufficient funds available to pay for operating costs before rents and other sources of income come in. Some common operating costs for multi-family properties include:
- General maintenance
- Major repairs and renovations
- Landscaping services
- Property manager’s fee
- Property tax
As a rule of thumb, a building’s operating expenses are typically around half of the total income a property yields. If expenses are significantly above or below this amount, that may be a caveat that warrants further investigation.
Risks and Red Flags
Investing in any type of property has its risks, but there are some red flags you should look out for before making a multi-family property purchase. For instance, a poorly-run property or one that has significant problems could have higher operating expenses, while one that has too few could indicate the owner is hiding something. However, you might find great value in both circumstances if you don’t discover any major problems during your investigation. If the market is oversupplied, you could end up in a competing rent war with other complexes, diminishing your return.
Without doing due diligence before making a purchase, you could be stuck with a property that is a drain on your finances. An experienced, professional real estate broker can give you the local insight about a property that you’ll need to figure out if it’s a worthwhile investment.
Do You Need Assistance Evaluating a Multi-Family Investment Property?
The right partner can make all the difference in your real estate search, and Graham Team Commercial Real Estate is here to provide you with integrity, service, and results. Our founder, Gidget Graham, has bought and sold over $1.3 billion in real estate assets in her role as a developer. Let her and the Graham Team place their dedication and intimate knowledge of the Las Vegas and Henderson markets at your disposal to make your search a success. Contact us today to schedule an appointment where we can discuss your options and begin your property search.