Multi-Family Property Considerations

Multi-family properties are quite different than single family homes for a few reasons:

Since the unit you buy today will eventually be sold to another investor who will evaluate it based on the return, you need to buy it based on the return as well. Below are the formulas I would use to compare properties. Note that these formulas depend on accurate vacancy rates, existing lease terms and other issues such as deferred maintenance. Since these factors are specific to individual properties I will not include them in the following. It is critical that you do. Capitalization Rate = NOI/Cost.

For example, suppose you are considering a 4 unit complex and the rents are $600, $600, $600, and $700 and the asking price for the property is $190,000. Assuming 100% rental rate (a really bad assumption) you would calculate the Capitalization Rate of the building as follows:

Capitalization Rate = ($600x12+$600X12+$600x12+$700x12)/($190,000) or

Capitalization Rate = $30,000/$190,000 or 16%

Looks great! However, the above cap rate is fantasy (100% occupancy rate is not realistic in the current market). Trying to be realistic, assume 10 months of rent for all units and $5,000/year rehab/repair costs. Note, the following is how I calculate return; not everyone uses the same method but this has worked very well for me on multi-family properties.

Pre-Tax Cash Flow = $25,000 - $1,750 - $5,000 - $12,912 - $1,900 - $700 or $2,738.

So, Cash/Cash = $2,738/(20% x $190,000) = 7.2%

On the surface, this multi-family property looks good but it all depends on deferred maintenance, ongoing maintenance and keeping the units rented. A few other things to consider:

Expect the unexpected! I purchased a 4-plex in Atlanta with all 4 units rented. Things looked good. After I closed, I learned that 2 of the tenants were threatening to leave due to the antics of one of the other tenants. It took months to get this guy out (this was in Georgia, not Nevada) and I had all sorts of problems with the other tenants until he was gone. The lesson here is to talk to all the tenants during the due diligence period so you know the actual situation.