How To Analyze Your First Multifamily Investment Deal

Acquisitions as big as a multifamily investment deal coincide with countless considerations. Not only do you need to determine things like whether or not it’s the exit strategy you want to take on, but also the smaller details. When all is said and done, what you need to know about a particular property before you buy it can be overwhelming, but I digress. While you must certainly mind due diligence, not all details are created equal.

As such, there are four determining factors investors need to consider, above all else, before they buy their next multifamily investment deal. And while they are not the only factors to consider, they are, in my professional opinion, the most important.

Multifamily Investment Deal Considerations

Here is a list of what I believe to be the most important factors to consider when analyzing a multifamily investment deal:

1. Income Potential

Not unlike the unit composition, the potential for income is a necessary step in evaluating the validity of a multifamily property. After all, you would never want to invest as much capital as it costs to acquire a multifamily property without having an idea on the return on investment (ROI), or even the rate of return for that matter. No, instead of blindly acquiring multifamily assets, you have to mind due diligence and — above all — conduct some extensive research. Namely, local market “comparables” will serve as your greatest resource. Check out the competition in the area you intend to buy in and get an idea of what similar units are renting for. Be sure to use similar properties within a close proximity of your own, as even a few blocks can constitute a significant price change.

2. Unit Composition

No potential multifamily investment deal should be given a second thought until you are absolutely confident in the amount of units you want to acquire. If for nothing else, a multifamily property’s unit composition will drastically change what can be expected out of a property. For starters, those homes that consist of two to four units are considered residential. Those with five or more, however, fall under the commercial designation.

In the event you choose to acquire the latter (a commercial deal), there’s something you should know: Commercial property owners have a say in how much their property is valued at, albeit a small one. While comparables and market variables will still play a dominant role in determining your property’s value, commercial multifamily properties tend to be valued based on the income they can produce. It’s worth noting, however, that the income produced by a multifamily property is contingent on what the owner deems appropriate. That means the owners of commercial multifamily properties are awarded the ability to raise the value of their own asset by increasing income and decreasing expenses.

The value of residential multifamily properties (those with two to four units), on the other hand, tend to reflect current market conditions. The amount of rent you are able to collect from tenants will be dictated by nearby comparables. And trust me, in today’s landscape, that’s a good thing.

In addition to commercial and residential designations, the number of units will also impact your overhead expenses, but perhaps not in the way you would expect. While it will cost more to maintain a multifamily property with more units, owners should expect to be the beneficiaries of a financial concept know as ‘economies of scale.’ As Investopedia so eloquently puts it, an ‘economy of scale’ is a unique cost advantage “that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs.” Perhaps even more specifically, the overhead tends to be reduced per unit as the number increases.

Take, for example, a six-unit multifamily investment deal; in a perfect world it’s producing six streams of income. It’s worth noting, however, that each unit is likely sharing the same roof, plumbing system, yard, driveway, and a number of other amenities. That means maintenance costs, on a per-unit basis, are considerably cheaper than those properties with less units. The same concept can even be extrapolated to include third-party management costs.

The next time you analyze a multifamily investment deal, don’t move forward without considering the property’s unit composition; as you can see, it will have a huge impact on how things play out.

3. Location

Not unlike your typical single-family investment property, few things are more important to the viability of a multifamily investment deal than the location in which it is situated. In fact, you could very easily argue that the location of a prospective deal is the single most important factor to take into consideration when analyzing whether or not a multifamily investment deal is right for your portfolio. Nothing else, as far as I am aware, will have more of an impact on the performance of each individual unit than the property’s particular location. What’s more, the location is just about the only thing you can’t change once a property is acquired, so it’s that much more important to pay attention to when analyzing a deal.

In contemplating whether or not to move forward with a multifamily investment deal, I highly recommend conducting extensive market research. It’s not enough to have familiarized yourself with national trends; you must collect data on a more intimate level. Mind due diligence and and get some boots on the ground. Talk with other professionals in the industry on a local level and get a feel for the current state of the area, and where you expect it to be years down the road.

What type of demographic can you expect for your particular location? What’s its proximity to necessary amenities, or even those of a more luxurious nature? How have comparables fared in recent years? Are there any groundbreaking developments taking place in the near future? A new school or a shopping mall, for example, could coincide with significant implications for your impending purchase. Remember, the more you know about an area, the better.

There’s no doubt about it: the location will play an integral role to the way things unfold with a multifamily investment deal, and those investors that listen to what the area is telling them could find themselves ahead of the curve. If you know what to expect from the majority of your prospective tenants, you will find reducing vacancies and marketing to be that much easier.

4. Identify The Property Class

Similar to single-family homes, multifamily properties come in a wide variety of conditions. You will have those that are more than thirty years old, and you will find that there are plenty of brand new properties as well. It’s worth noting, however, that the condition of your property will tell you a great deal about what to expect. Namely, the condition of a multifamily investment deal will hint at the cap rate. Let me explain:

• Class A Properties: Those multifamily investment deals that fall under this category are typically new-builds; they are what many investors would consider to be the latest and greatest additions to a community. As such, class A properties tend to cater to the affluent and come complete with many amenities. That said, these properties don’t have huge income potential, as acquisition costs are usually high. As a result, class A properties are a better vehicle for maintaining wealth, not creating it.
• Class B Properties: While not as new and fully accommodating as class A properties, class B multifamily deals were most likely built within the last few decades. While they may show some signs of aging, they are generally in good condition. As such ,their cap rate is slightly better than class A properties. Since they aren’t as expensive, there is more room for cash flow, with the added benefit of room for appreciation as well.
• Class C Properties: Class C properties are somewhere in the neighborhood of 30 years old, and showing more signs of aging than their class B counterparts. Since they cost less to acquire, their cap rates are higher, and they exhibit a larger propensity for cash flow.

Understanding where your multifamily investment deal falls within this spectrum is integral in determining its potential.

The Devil Is In The Details

Analyzing your first multifamily investment deal is no small task; you must be up for it if you hope to come out on the other end better than when you went into the deal. However, there are guidelines that, when followed, will make the process a lot easier. With a little due diligence on your behalf and a firm grasp of these four important indicators, you will find that analyzing a multifamily investment deal doesn’t have to seem like an impossible task.

Key Takeaways

• A number of factors need to be taken into consideration when analyzing a multifamily investment deal, but none may be more important than those I highlighted above.
• The number of units that make up a property will be very telling in what you can expect from a multifamily deal.
• Only those that learn how to evaluate a multifamily property accurately will be able to come out on the other side stronger than when they went into the deal.