Multifamily real estate can be a great option for diversifying an investment portfolio, but evaluating properties for their potential is essential. There are many criteria you can use to vet possible investment properties, and we’ll take a closer look at some of the most important ones to help you prepare for becoming a real estate investor.
A risk assessment, or risk analysis, takes different factors into account to help you determine how financially sound a property might be. An assessment might look at market risk, operational risk, and financial risk factors, giving you an indication of the assets potential for loss. High vacancy rates and tenant turnover, the need for extensive repairs, and a history of poor cash flow are all risks that might indicate a property will not perform for you. Individual investors can hire an outside company to perform a risk assessment for a property to take some of the task out of evaluating multifamily investments, but single-asset real estate investment funds for accredited investors and REITs for non-accredited investors take care of risk assessments for each property so you don’t have to.
NOI (Net Operating Income)
The NOI or Net Operating Income lets you analyze a property’s profitability. The equation for this metric is to subtract the operating expenses from the total revenue generated, resulting in the net income. It’s important to remember that this is a pre-tax number that does not take the principle and interest from any loans into account, and it also doesn’t consider capital expenses, amortization, or depreciation. The higher the NOI, the better the potential for a property as an investment. Of course, this isn’t the only metric you’ll be looking at as you decide which multifamily real estate asset to invest in.
Once you’ve determined the NOI for a property, you can then begin to look at cap rates, otherwise known as capitalization rates. The cap rate gives you better insight into a property’s rate of return. Cap rates for property can be determined by dividing the NOI by the asset’s current market value. However, some analysts will divide the NOI by an asset’s purchase price. Current market value may be a better option, as the second option doesn’t take changes in the real estate market into account. You can use the cap rate to help determine how long it will take to recover your initial investment.
Gross Rent Multiplier
Another metric to use when evaluating multifamily real estate investments is the GRM, or Gross Rent Multiplier. The GRM is the ratio of the price of a property to its annual rental income, not including any expenses. Looking at the GRM for a single property might not always provide you with a lot of information, but comparing GRMs for several multifamily properties can help you narrow down your options so you can make a more informed investment decision. There’s no one standard for what constitutes a good GRM, as the ideal number will vary from one market to the next. A higher GRM in an affluent area might be better than a lower GRM in a middle-class community, so it’s important to compare properties that are similar.
The investment horizon is a factor that relies on your investment needs. You’ll want to determine if you’re looking for a long-term cash flow or short-term investment. A realistic timetable for your investment will help you determine which type of property is right for you. Some investors may want to sell, fix, and flip for a short-term strategy, while others may want to hold onto a multifamily asset for its revenue-generating potential. Some properties are better suited to short-term strategies while others are ideal for building long-term wealth. You can use the metrics already discussed in this blog to evaluate each asset to see how it fits with your investment horizon.
Your exit strategy is your plan for selling the property eventually, and it will depend on your investment horizon. Some individual investors may not want an exit strategy at all, and will instead use the property as a source of income for the long-haul. However, if you do want to sell at some point, having a clearly defined strategy can help you maximize your profits. You may want to set certain parameters for market performance so you’re ready to sell when the conditions are right. A timetable for your investment can also help you determine how much money you’re willing to put into the property. A long-term investment means performing renovations and repairs to maintain the property and boost your cash flow as much as possible, while a short-term strategy might rely on improving the asset enough to garner a higher selling price and nothing more.
Evaluating multifamily real estate investments can be a complex undertaking, but there are options available to make it easier. DiversyFund’s REITs and Premier Offerings consist of carefully vetted multifamily assets, and our team of experts do all the research to determine the risks, NOI, cap rates, and GRM for you. They are long-term investment strategies, so you don’t even have to worry about determining your investment horizon or exit strategy.