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The number of investors venturing into the real estate market is continually growing because of the potential high returns. Particularly, multifamily real estate has become the target of investors because of increased demand and promise of long-term appreciation.
Statista reported that the number of multifamily houses in the United States reached 56.1 million in 2018. The statistics portal also predicted that this number would increase to 155.25 million this year.
While there are many opportunities for investors in the multifamily real estate sector, it does not mean you will not have to overcome risks and hurdles, especially if you are a newbie in this field. Knowing how to analyze multifamily properties through effective metrics is crucial before investing in any multifamily home.
Analyzing the Market
Market analysis is essential to make your investment strategy more effective. An investor should have a good grasp of the market situation and trends because, through this analysis, he can identify potential opportunities and risks of a particular multifamily real estate asset.
Assessment of key factors, such as population growth, local market competition, and rental rates, is vital in your market analysis. Taking these components into account helps you determine the demand for multifamily properties, potential rental prices, and possible return on investment.
- Population Growth. When the population in a particular area increases, the demand for rent also increases. Population growth tends to affect the rental market, helping rental and occupancy rates to shoot up higher.
- Local Market Competition. Assess the level of competition in a local market by studying the number of similar properties. You can recognize possible risks of investing in a specific multifamily property once you determine the competition level of a particular area.
- Rental Rates. Comparing rental prices of similar homes in a particular market helps you determine the possible income of a property. Having a good grasp of rental rates in a local market will help you identify your options to hike rental prices and boost your investment gains.
Analyzing the Property
It is vital that you assess the physical, financial, and market-related aspects of the property. This process is what experts call property analysis, helping you decide whether the rental home is a profitable and sustainable investment. Check out these two factors when analyzing multifamily homes.
- Location. One of the basics in determining the potential sustainability and profitability of a property is its location. A rental home located in areas with easy access to hospitals, schools, and public transportation is likely to have higher occupancy rates and gain more rental income due to high demand.
- Financing Options. It is vital to determine what is the best financing option or how much a lender is willing to provide for the investment property you want to purchase. You can avail of a government-supported loan, a traditional bank loan, or an online loan nowadays. Consider your investment goals and how to minimize financial stress when choosing a financing option.
Financial Analysis
It is fundamental when investing in a multifamily property to evaluate how the property will perform financially. There are key metrics when doing financial analysis on multifamily properties.
- Net Operating Income. NOI is the earnings the property generates after the deduction of all operating costs. This financial metric is crucial in determining the profitability and capacity for the cash flow of a property.
- Capitalization Rate. The cap rate gives you an approximate potential return on a real estate asset and helps you compare different property investment options. You can get this financial metric by dividing the net operating income of a property by its current market value. The higher the capitalization rate, the greater the potential ROI the property can generate.
- Cash-on-Cash Return. This financial metric calculates the cash earnings generated on cash invested in a real estate asset. Simplifying the matter, it is the annual return of your property investment in relation to the amount of mortgage paid in the same year. You can get the cash-on-cash return by dividing the annual cash flow by the overall cash invested.
- Debt Service Coverage Ratio. DSCR determines whether the real estate asset can generate sufficient revenue to cover its outstanding debt obligations. If the multifamily property gets a 1.2 or higher DSCR, it means you can pay the outstanding debts.
Final Thoughts
Investing in multifamily properties offers opportunities in producing a stable cash flow and a significant potential for long-term appreciation. However, like any investment, it also comes with risks, especially if the property has a high turnover rate and long periods of vacancy. This possibility may result in income losses, which must be avoided at all costs.
Thankfully, there are three ways to prevent income losses from your multifamily property investment. It is vital that you analyze market circumstances and trends, the physical and financial aspects of the property, and how the real estate investment will perform financially.
