Multi-family deals are one of the most popular investments for real estate investors. Unlike single-family homes, multi-family properties have several units and can help diversify your portfolio. However, underwriting a multi-family property is different than underwriting a single-family home.
The first step is to learn how to underwrite a multifamily property. This includes understanding how to calculate the value of the property, what expenses are involved and how to determine if the tenants will pay their rent on time.
Underwrite a Multi-Family Deal in 6 steps
Step 1. Cash Flow
The first step in underwriting a multi-family deal is to evaluate the cash flow. The cash flow is the difference between income and expenses, which is profit or loss. So, if you take all the expenses and subtract them from all the revenues, what do you get? If that number is positive, then you have a profit. If it’s negative, then you have a loss.
The cap rate is a measure of how much the building will earn on an annual basis, expressed as a percentage of its value. For example: Let’s say that your property has 100 units, each with an income of $1,000 per month and expenses of $800 per month. So your total income would be $100,000 per year (100 x $1,000) and your total expenses would be $80,000 per year (100 x $800). Your cash flow would be $20,000 ($100,000 – $80,000).
Step 2. Cap rate?
The cap rate is the most important metric in real estate underwriting. It is the rate of return you expect on your investment, and it is calculated by dividing the net operating income (NOI) by the sale price of your property. This calculation will tell you how much money will be left over after all expenses are paid.
The second step in underwriting a multi-family deal is to determine the cap rate. The cap rate is the ratio of net operating income (NOI) to the value of the property. Cap rates are used by lenders and investors to determine whether a property is worth purchasing.
The formula for calculating the cap rate is:
Cap Rate = Net Operating Income / Property Value
For example, if you have a property that generates $1,000 per month in NOI and it costs $100,000, then your cap rate is 10%. This means that you would need to pay at least $10,000 per year (1% of $100,000) just to cover your mortgage payment and maintain current operations.
Step 3. Net Operating Income Ratio (NOIR)
The third step in underwriting a multi-family deal is to look at the Net Operating Income Ratio (NOIR). This ratio measures how much of your net operating income goes towards paying for your debt service (including principal and interest). You want this ratio to be as high as possible because it means that you are using less of your income just paying off debt instead of investing it back into your property or throwing it away on other expenses related to operating your business.
Net Operating Income Ratio (NOIR) is a measure of the ability of a property to pay its operating expenses. It is calculated by dividing the Net Operating Income by the total value of the property. The formula is as follows:
NOIR = NOI/Property Value
The higher the NOIR, the better the deal. For example, if a property has an NOI of $50,000 and its value is $1 million, then its NOIR would be 5%.
Step 4. Determine occupancy rate
One of the most important factors in underwriting a multi-family deal is understanding occupancy rates. If the building is occupied at 90%, that means there are 10% of the units available for rent. If there are 40 units in the building and 10 of them are vacant, that’s only an occupancy rate of 30%. In this case, it’s unlikely that investors would be interested in purchasing the property because they would have to bring in tenants before they could make any money off it. This can be especially tricky if you’re buying a distressed property where tenants have already moved out or been evicted due to non-payment of rent or other issues.
The occupancy rate gives you a rough idea of how much revenue will be generated by your property. The higher the occupancy rate, the more revenue you can expect to generate from your investment.
The main factors that determine occupancy rate include:
- Location – A desirable location will have higher occupancy rates than an undesirable one. For example, if you own an apartment building in the heart of New York City, then you can expect much higher occupancies than if you owned one in a rural area without many amenities nearby.
- Rent levels – The rent level determines how desirable your property is to potential tenants and therefore influences its occupancies rates. High rents also increase your profit margin because less money has to be spent on marketing efforts and rent concessions (such as free months). However, high rents also mean higher vacancy periods which will reduce your overall income from your property over time
Step 5. Calculate expenses:
When underwriting a multi-family deal, it’s important to understand how expenses are calculated and what they include.
Expenses can be broken down into two categories: operating expenses and debt service. Operating expenses include items such as taxes, insurance and utilities. Debt service includes the mortgage payment, property taxes and any other obligations that must be paid on time by the owner of the property.
Calculating operating expenses can be complicated because there are many factors that go into determining what a fair rent is for a unit. If you don’t calculate these figures carefully, you could end up paying more than your expected return or losing money on the investment all together.
To calculate operating expenses, you must first determine how much income your property will generate each month. This can be done by analyzing similar properties in the area or using an online rent analysis tool like Zillow Rental Manager or Rentometer. Both tools allow users to input their desired location, a number of bedrooms, and square footage to receive estimated monthly rents for comparable units in the area.
Step 6. Estimate maintenance costs
Maintenance costs are one of the most important factors in underwriting a multi-family property. In many cases, the property is not generating enough income to cover these expenses. The following are some of the most common maintenance expenses:
- Repairs and replacements
- Insurance premiums
- Property taxes
You should always start by estimating maintenance costs. This includes everything from property taxes to insurance and utilities. After you have calculated these costs and added them to your annual rent amount, you will see how much money is left over for your bottom line. If there is not enough cash flow to support your loan payment, then you may want to reconsider buying the property or look for ways to increase your income potential
As you can see, underwriting is a long and complicated process. But by breaking the process into its individual steps and consistently applying those steps to your workflow, you can make the underwriting process run smoothly and efficiently. That’ll help you move your deals from underwriting to funding faster, which will ultimately help get more units built.
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