Close to five years ago, I was an anesthesiology resident in Brooklyn, New York, enamored by the prospects of investing in real estate. My first deal was underway 300 miles away in Norfolk, Virginia. Like they said on TV, it was “time to find another house to flip.”

This round, however, I would go after multifamily properties. I didn't have loose cash lying around, but I had learned to analyze deals. I decided to find a deal that would allow me to raise capital, give my investors a decent return, and generate enough profit to keep me interested.

How I Chose a Real Estate Market

I would like to say I spent hours poring over economic reports of job growth and population metrics, but that would be false. It came down to this: I lived in Brooklyn and it was expensive. I needed to find a market that was more affordable and easy to reach.

I spoke with other investors and made a shortlist of cities that came up in our conversations. For each city, I would connect with an active investor and ask questions like:

• Which are good neighborhoods in your area for investors?
• Who are the major employers?

I didn’t have to go through my entire list of cities. I got a position to do my Pediatric Anesthesiology Fellowship in one of the cities on my list: Rochester, New York.

Related: New Investor Strategy: How to Buy Your First Multifamily Investment Property & Live Rent-Free

How I Found a Property to Invest in

After I learned I would be moving to Rochester for fellowship, on a train ride home after working overnight, I googled something like “multifamily for sale in Rochester.” I found a commercial broker’s website, and after scanning the deals listed, I sent him a message.

He responded with a list of active deals he had, each with its pro forma attached. I found my first multifamily deal from this batch!

Here’s what I was looking for.

Location

I wanted a property in a B neighborhood—not necessarily a “cream-of-the-crop” neighborhood that was overly expensive, but one that would be decent and safe. Using other people’s money on this first rental property meant that I needed as much working in my favor as possible. I used the Crime Heat Map on Trulia to see where each of the properties fell.

The proximity to a major employer was also important to me. I chose to focus on property that was close to Kodak, one of the major employers in Rochester.

Cash Flow

Because I would be working with investors, I needed the cash flow to be high enough that even after the investors got their returns, there would be enough for me to have considered it worth my while. At the time, “worth my while” wasn’t much. Remember, I was a resident!

Doing the Math

If you’re new to this, here’s how to analyze the potential for cash flow for a multifamily property.

1. Calculate the Net Operating Income

The net operating income levels the playing field for all comers, telling you how much income you can expect from the property after you’ve handled the day-to-day financial demands of the property. You can use the numbers provided by the broker for preliminary screening, but you should really ask for and research realistic numbers. Then, calculate using this formula.

Net Operating Income = Total Income – Total Operating Expenses

Related: 4 Buying Criteria for Rental Property (& How I Determine a Good Deal)

Total Income: 

• Total Rent
• Total Fees (pet fees, late fees, coin-op laundry, etc.)

Operating Expenses: 

• Vacancy (5-10% of rent)
• Taxes (city and county)
• Insurance (talk to an insurance broker)
• Maintenance (3-5% for snow removal, lawn mowing, cleaning common areas, etc.)
• Management (ask local property managers for rates)
• Utilities (call the utility companies)
• Repairs (3-5%)
• Professional fees

2. Calculate the Cash Flow

Cash flow, on the other hand, is specific to you, the investor. Take into consideration your mortgage terms, as well as your inclination to plan and save for future capital expenditures (CapEx). This is what you truly “take home” as profit.

Cash Flow = Net Operating Income – (Mortgage Payment + Reserves for Capital Expenditures)

How much you assign to CapEx reserves is a function of your inclination to plan for big expenses. I like to think of what big-ticket items I’m planning for and how soon I may have to replace them.

Say the roof is expected to last another 15 years, and it will cost $15,000 to replace. I would target saving about $1,000 per year. Some suggest using a quick and dirty $250 per unit per year for larger multifamily properties.

How much cash flow is good enough?

I like to see a cash flow that gives me at least double-digit cash-on-cash returns.

Cash-on-Cash Return = Cash Flow / Cash Invested x 100

Related: The Method We Use to Quickly Evaluate Multifamily Deals

3. Find Opportunities to Raise Value

Unlike a single-family home, the value of a multifamily property is based on its financial operations.

Value = Net Operating Income / Capitalization Rate

The capitalization rate is a multiplier that indicates how much the market is willing to pay for certain returns in a given area and for a given property class. Just like “comps” with single-family homes. You can ask your broker for this number.

When you have the going cap rate in the area, you can determine how much a change in the net operating income (NOI) of a property will change the value. Your goal is to raise the NOI.

How do you raise the net operating income? 

1. Increase Income: Raise rents; charge additional fees like late fees, pet fees, etc.; install coin- or card-operated washers and dryers; offer paid storage; add cell towers
2. Decrease Expenses: Fix leaking faucets and pipes; install energy-efficient appliances and windows; chargeback utilities, etc.

While analyzing the deal, try to identify clear ways you can make these changes. I usually have a column for Current Numbers and another for Projected Numbers. Research your competition and determine if you would need to upgrade the units to raise the rents. Factor the rehab cost into your purchase price.

4. Determine Your Purchase Price

Determine your purchase price based on the current net operating income of the property and the going cap rate. Save the projected numbers as the icing on your cake. Don’t overpay today for unrealized potential.

If, for example, you determine that the current net operating income of a property is $40,000, and the going cap rate in the area is 12%, your purchase price should be no more than $333,000.

Purchase Price = NOI / CAP Rate

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Notice there’s no mention of the asking price in this analysis. Go with the numbers. Determine what your maximum offer is. Make your offer. Start negotiations.

How Did This Deal Go?

I posted about this deal in real-time here. A few months ago, right in the middle of the pandemic, we got a full-price offer for $439,000 and sold it for a decent profit after four years of ownership.

Remember, you don’t have to start with single-family homes. Multifamily properties have features that separate them from single-family homes, and as such, can be approached as a first deal. If you can run the numbers and keenly assess for cash flow and value-add opportunities, you can position yourself to help other investors who may not have the time or interest to do the same.

What calculations do you use to assess a multifamily property?

Show your work in the comments.