Have you ever thought about how to value of your investment property returns for a multi-family property? Here is the good news, there is no need to overthink about it because it’s relatively easy to calculate. As long as you have good operating data on your property, that’s all you need. Investing in multi-family properties is such a great opportunity for real estate investors and comes with many benefits which we look into later on. The value of multi-family real estate property is borrowed from an income approach estimation based on a simple formula for valuing real estate:
Current Market Value = Capitalization Rate/Net Operating Income
We will examine each component of this formula in more details in a bit, since understanding this formula will help you calculate your investment property returns easily. But first things first, you must understand what a multi-family property is and how real estate investors benefit from this type of investment?
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What are the benefits of multi-family properties?
Multi-family properties are buildings with more than one unit. A multifamily could be as small as two units, a duplex, or hundreds of units in a large apartment complex. Most real estate investors own multifamily properties only to rent them out to those who can’t or choose not to buy a single-family home. rarely do you see people buying a multifamily to live in. Investors need to understand the many benefits that come with owning a multi-family property so they can decide if it’s the right decision for them or not. So what are the benefits that come with owning a multifamily property?
1. Easier management
Whats better owning 10 single family homes that are distributed across the city to mange and control or 10 units under one roof? With multifamily properties managing is a lot easier and less time consuming and not so tiring like single-family units. With the 12 individual properties, you may need more than one property manager; with the one building you only need one manager.
2. Forcing Appreciation in Multi-Family Properties is a lot Easier
You can’t just depend on time to make a property’s value increase. You have to do certain things to force the value of a property up or improve amenities and benefits to tenants which will increase the property’s appreciation. In multi-family properties, investors are able to see the returns on renovations a lot faster than in single-family properties.
3. You Can Create Even More Cashflow in The Multi-Family Property
This is pretty exciting stuff, because there are ways to create cash flow beyond rent. In multi-family units, you can charge for extra amenities such as a laundry facility. Tenants who don’t have washers or dryers in their unit can use this laundry room and you will benefit by generating more cash flow. The laundry room is just ONE thing you can add. There are many more amenities to add that bring additional cash flow in a variety of ways.
4. There Are Great Tax Breaks that Come with Investing in Multi-Family Properties
Whats better than providing housing for so many people? And with every good deed done comes a reward. At least that’s what the government thinks so. Because you are helping the residents of that city by providing clean, safe and affordable housing to people who might not otherwise find housing, you should be rewarded. As a reward, you can gain all sorts of tax incentives, also known as tax breaks. You can take a whole lot of deductions because this is a business, and many things depreciate in an apartment building.
5. Multi-Family Properties Hold Their Value
Once the property is fixed up and you’ve made it attractive to tenants, it will also attract other investors who will be interested in buying the property later if you ever want to sell. You’ve put in place everything required to attract and retain tenants. That means steady cash flow, which is quite appealing to investors.
With that being said, let us now answer our main question “how to calculate returns for a multi-family property?”
1. Net operating income (NOI)
Net operating income is the operating profit a multifamily home generates during a certain period, such as one year, before accounting for income tax expenses and mortgage payments. NOI equals gross income minus operating expenses and is an important figure that investors and lenders use to make financial decisions and calculate investment property returns. A higher annual NOI generally results in a higher property value. NOI may change each period based on vacancies and changes in rents and expenses.
How to calculate net operating income
Add together the rental income and other income, such as vending machine income, that a multifamily property generated during a year to determine its gross income. Then subtract total operating expenses from gross income to calculate NOI. Examples of operating expenses are property taxes, insurance and management fees. Exclude income taxes and loan payments from operating expenses.
2. How to calculate cap rate
One of the most common investment unit for multifamily properties is the capitalization, or cap rate. To calculate it, you divide its net operating income by the property’s price. The net income is the money that is left from rent payments after the building’s recurring expenses have been paid, excluding its loan payments. Cap rates vary based on the type of property and its location, as well as on the general view of the market.
Capitalization Rate = Net Operating Income / Current Market Value
Cap rates have an indirect relationship with market value. When cap rates decrease, the value increases and vice versa. The Cap Rate is a formula is very helpful for real estate investors since it lets them know the relationship between value and the amount of income a property delivers. the difference between the value of cap rate in single-family homes and multifamily is that that houses are compared with each other to determine value, while multifamily investments, it is the cap rate that is compared. So for example, if a nice apartment complex in Chicago recently sold at a 6.5% cap rate, it is safe to assume that other nice apartment complexes in Chicago will sell around a 6.5% cap rate. Normally ranging between 5% and 12%, the cap rate changes significantly from one location to another. So in short, the higher the cap rate, the higher the cashflow.
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The bottom line
For investors who own or plan on owning a multi-family property, the key elements that help in calculating investment property returns is net operating income and cap rate. It is all about the NOI of the property and the fact that the investor is purchasing the property based on an income stream. Be sure to check out Mashvisor for the latest tips on how to get your investment property returns going.