Top 3 Things You Need To Know When Purchasing Multifamily Property

When considering purchasing a multifamily property, like an apartment building, there are various ways to analyze a deal. Here are my Top 3 tools:

1. Value-Add Potential

One of the first questions I ask: Is the building under performing, and if I improve it, will that increase the Net Operating Income (NOI)?

When it comes to ROI improvements, the low-hanging fruit tends to be exterior tweaks like painting the building(s) and landscaping the property, and perhaps replacing lighting and outdated signage.

Then, it’s all about efficiently turning units with high-quality upgrades as they become vacant. I typically spend between $25,000-$40,000 on an approximately 1,000 square foot unit. To attract “Class-A” tenants in L.A. upgrades may include: washer/dryer install, smooth walls, all new surface materials and fixtures, new plumbing and electrical, air conditioning (could be wall unit/mini splits), gutting bathrooms and kitchens, new or refinished flooring, and maybe new windows. 

2. Cap Rate

The key is not to focus on the current cap rate, but what it can become in two-to-three years.  

Cap Rate = NOI (gross rents - operating expense)  /  All In $ (purchase price + improvements)

Investment properties are valued off of the income they generate. I search for buildings where I can increase income, thereby increasing cash flow, and appreciation. A higher cap rate means higher value of the asset. 

Increasing not just the appearance of the property, but also the actual revenues is the name of the game. Once you have a more desirable rental unit, use your marketing skills to attract a higher-quality (which also means higher-paying) tenant. My records show that very often we have doubled the rental income on units after improvements. 

3. Cash-On-Cash

Cash-on-cash means what my capital will earn in a year.

If you spend $1M on an investment and it earns $100K in annual profits (after operating expenses and debt payments) your cash-on-cash = 10%.

Cash-on-cash is important when using outside capital, as investors want to see a return that is on par with other common and accessible investments. The trick with value-add apartment deals is educating your investors that they shouldn’t be solely concerned with cash-on-cash returns because there is likely a major capital gain coming their way, in the form of building appreciation. In the first couple of years, the returns may be a cash-out refi, and a few years later a possible sale. Both of these scenarios can repay capital investments twofold. 

That said, cash-on-cash for annual returns is a key metric, but I find that investors who are less familiar with value add/repositioning often overlook the pot of gold that will far surpass a 6-10% annual return.

My final tip: whatever method you use to evaluate your multifamily investments, be consistent. Consistency with your evaluation methods will help you to see the bigger picture and make the best future decisions.