Help Analyze Multifamily Deal

8 Replies

Property Info: 30+ years multifamily, fully leased, roof recently replaced, great rental area, HVAC looks very old.

Price: $258,240

Loan Info: 5%, 30 year fixed, 20% down

Cash Invested: $51,648

Monthly Loan Payment: $1,104

Monthly Rent: $2,255

Vacancy: 5%

Taxes: $2,522

Repairs: $1,500

CapEx: $1,800

Insurance: $1,100

Management Fees: 2,057

Total Operating Expenses: $8,779

Net Operating Income: $16,928

Cash Flow: $3,675

Estimated Appreciation Rate: 3%

Estimated Appreciation: 7,747

GRM: 9.5

Cap Rate: 6.6%

ROI w/o appreciation (cash flow before tax + principal reduction + Tax Saved): 13.6%

ROI w/ appreciation: 28.56%

How accurate are your expense estimates? If these are provided by the owner or their real estate agent, throw them out the window. Honestly, your expenses seem very low. As projected, they only represent 32% of the gross income. Typically, investors find that expenses will amount to 50% of the gross income and that does not include property management or the mortgage.

If the property cannot cash flow at 50% expenses, then walk away. If you can make it better - great. But most cannot and a negative cash flow property is worse than not owning one at all.

If we use your mortgage info, the rent and apply 50% expenses, you are looking at a monthly income after all expenses except taxes of - $14 per month. If we throw in another 10% for the property manager, you are looking at paying out $240 per month. This gives you a cap rate of only 4%! and a cash on cash return of - 5.6%. Run away!

Also, do not factor in assumed appreciation. This is (1) not guaranteed and (2) not accessed until refinanced or sold. Look at it solely as an income producing property. 

@Simon Campbell  - Thanks for this. This is pro forma data. I haven't verified the expenses except for the taxes. So the 50% rule also applies for multifamily properties?

@Simon Campbell  - Sorry for this second follow-up. I should have asked this the first time. But you said "Also, do not factor in assumed appreciation. This is (1) not guaranteed and (2) not accessed until refinanced or sold. Look at it solely as an income producing property." 

I have noticed that with Bigger Pockets, it seems the only thing that matters is Cash on Cash and Cap Rate. I mean, I plan to hold on to a property for 20 or so years. And I really don't need it for the extra income. Assuming this thing never appreciates, should I really not count principal reduction in the ROI?

To answer your questions:

The 50% rule definitely applies to MF properties. It applies to any income producing property except for triple net leases of course.

ROI is a hard number figure. It reflects the actual cash in your hand, not cash reflected on paper if you know what I mean. For example, if a 4 unit rental property earns the owner $100 per door/per month ($400) then he will have really earned, cash in hand, $4,800 for the year, before taxes.

Meanwhile, he has paid down his mortgage and technically has a little more equity. But, can he pocket that equity? No. It is only on paper. Additionally, lets say the property appreciated 5%. Can he put that cash in the bank? No. It is only on paper. The only way the owner can claim the additional equity as cash is either through a cash out refinance or by selling the property. 

As an investor, you want cash flow and reversion value (money when you sell). Investors will frequently by cash flow properties that have little reversion value; but investors do not want a property with negative cash flow and then reversion. 

If you have a $250,000 property that appreciates on an average 5% annually but loses $240 per month. After 5 years you will have paid out of pocket $14,400 to gain $69,070. But in gaining that you have had to pay 8% of the $319,000 sales price in closing and listing fees, reducing your gross capital gains to $43,550. When you factor in the annual income loss, you only earned $29,150 or just under 12%.

Though a 12% total return is not bad, wouldn't it make more sense to get a property with a positive cash flow and then add on top appreciation?

Massive over-analysis.   You don't know future capex, or appreciation; you can guess at those and other figures like vacancy... but really you just don't know.  Here is what I believe is known:

1) That is a good rate and term on an investment loan

2) Taxes and Insurance are inline for the area

3) This property does not pass the simple 1% rule (at least 1% of the purchase price should make it back to you in rent per month).   

My advice: Don't assume appreciation. You can easily do better in your local area, other investors in your local REIA certainly are. Before falling into this level of analysis, look for a property that is 1.5 to 2 times better than the 1% rule first. You can then calculate to the n-th degree the rest of what you can only guess at, but start with the known knowns, and the 1% and 50% rules (the latter of which Simon touched on).

The only thing @Joshua Jensen  is that in many markets the 1% rule doesn't apply. Take NYC for example. Purchase prices are extremely high and the rents do not reflect 1%. But, like the 50% rule, the 1% rule can be a quick decider when looking over a slew of available properties. It is just best to first check and see what are the area norms.

Yes @Simon Campbell  you are correct. I happen to know Christopher's local market really well, and 2% is possible there.  My overall point is that the analysis quickly gets into the weeds when it need not have even started ... given the rules of the thumb for the area.

That is true. Paralysis by analysis. When looking at all of the trees, it is easy to forget about the forest. That simply means that we start with the easy analysis (50% and 1% rules) and then and only then do we advance onto more details such as expense and rental rate verification.