Understanding how to value a multifamily property is a crucial factor when deciding to invest. A prospective property can look like a good idea on the surface level, but if an investor pays too much, it can be difficult to achieve a desired return on investment.
Multifamily investments can be financially rewarding, if done right. Luckily, with the right insight, there are ways to avoid making common mistakes that can lead to a bad investment. Here are the key elements to consider when learning how to value a multifamily property.
Determine the Net Operating Income (NOI)
The NOI assesses the initial value of a property by determining the building’s current cash flow. Unlike an owner or investor’s credit history, measuring the property’s profitability can be less vulnerable to manipulation, as it can only be increased by an increase in rent or fees, or decreased operating expenses.
NOI is calculated by subtracting a property’s operating expenses from its gross income. Gross income includes everything from rent to money generated from parking fees, laundry machines, or other services. The cost of running, or operating, the building such as property management fees, utilities, insurance, and so on are what’s considered the operating expenses.
The capitalization rate of a property is one of the most important factors to consider when valuing a multifamily investment. Simply put, the cap rate is the return o
f investment an investor can expect if they purchase the property with cash. The cap rate can be determined by dividing the NOI by the property value, however, this value isn’t always known due to impacting factors in the market, so the cap rate needs to be estimated.
In order to find an accurate estimate, it’s necessary to review the recent sales of comparable properties and calculate the cap rate based on the NOI at the time of sale and the sales price. Current market conditions will also be a factor, all of which are associated with the perceived risk of acquiring the property. If the risk is higher, the cap rate may be higher. Conversely, if there is less risk, the cap rate in turn could be lower.
Make a Proper Assessment
There’s a lot of factors to investing in property, and it’s not something that you should just jump into without making a proper assessment of the property. More often than not, if a deal seems too good to be true, it usually is. Risks, violations, unpaid penalties, and potential pending lawsuits can quickly turn a profit into a loss, especially if you’re unprepared to resolve any of those issues after purchase. It’s important to note that it’s not easy to know every detail about a property until you actually become the owner, no matter how much research you do. But doing your due diligence before making an investment can save you from a potential loss.
We’ve all heard this one: location, location, location. Economic conditions and location play a huge role in determining the value of a property, as well as your rate of return. It’s important to know the market that you’re buying into, so do some research to understand the economy and if your property value has the potential to increase over time. It’s also important to analyze the multifamily supply and demand of your area, and how that will play out for your property. At the end of the day, you want to make sure the property is going to guarantee a good cash flow, and location is a big factor for how profitable your investment will be.
Anyone serious about real-estate investing should definitely consider multifamily investments. With multiple property sizes and investment strategies available, even a beginner investor can start slow and roll their portfolio up into larger properties over time. If you’re interested in the process of securing financing for a multifamily property or have any questions regarding how to value a multifamily property, contact us today!