1.) The first thing any investor should do when presented with an investment opportunity is to “find their 50%”. This easy calculation will roughly estimate a property’s profit potential and help an investor decide whether or not a deal is worth pursuing. Here’s what that means: As an investor, you will receive rent payments from your tenants, but you should always expect to spend 50 percent of that income on maintenance and repairs. The 50 percent that is left, will be your estimated NOI (or net operating income).
2.) Tip number 2 is to use your estimated NOI to calculate your cash flow and further investigate how worthwhile the potential deal could be. To clarify, your cash flow is the actual money that you will be putting into your pocket on a monthly basis. To find this number, simply subtract the property’s monthly mortgage from your NOI.
3.) Once an investor has calculated the NOI and cash flow of a potential deal, they should work to figure out their capitalization rate (or cap rate for short). Calculating this rate will answer the question “how long will it take to see a return on my investment”. There are two things to remember about cap rates. 1: the cap rate for a “safe” investment is usually in the low 1 to 2 percent range; and 2: the cap rate you calculate will not take into account any increases in property value, boosts in monthly NOI, and the many tax breaks that multifamily property owners receive.
To find your cap rate, multiply your NOI by 12 to find your annual NOI, then divide that number by your mortgage. A high cap rate usually indicates a higher return on a riskier investment, and a low cap rate usually indicates a lower return on a safer investment. A “good” cap rate will usually fall between 5 and 10 percent.
Crunching the numbers on a multifamily property will help you make a smart investment, but how do you find potential investments in the first place? Our next tips will tell you what you should be looking for in multifamily properties.
4.) Tip number 4: Pay attention to location. If you have any experience in real estate, you’ve likely heard the phrase “location, location, location”, which is one of the most important factors prospective tenants will consider. A good location will show high-growth potential, high yield, have high demand, and will be well-maintained.
5.) Once you find a multifamily property in a great location, you need to consider the number of units in the property as well as the number of rooms in each unit. Investors should focus on duplex, triplex, and four-plex multifamily properties. These types typically offer the most return with the least amount of risk, and are generally more affordable.
6.) When you find a promising property, tip 6 is to determine its potential income. Sites like rentometer.com and craigslist are helpful resources to look at current rental prices in a given market. Don’t forget the 50% rule here! Remember, 50% of an investment’s income should be spent on expenses - not the mortgage. The 50% check is a good rule of thumb for beginner investors who are looking to remain conservative.
7.) As an investor, it’s always important to remember to calculate all costs associated with financing your investment; and this will vary from deal to deal. For example, if you decide to live in one of the units in your property and rent out the others, a lender will factor that into their qualifying ratio. Your credit score will also influence the qualifying process. A lender will look at four things: credit, debt to income ratio, the size of your down payment, and your deal’s projected monthly cash flow.
8.) Our last tip for multifamily investors is to always identify the seller of the property you are considering. For example, there is potential to save money when you purchase a bank owned or for sale by owner property but these property types will follow different processes. Remember, every property’s purchase price will be affected by the motivation of its seller, and investors will better know what to expect from the deal if they are fully aware of the seller’s circumstances.
