Multi family real estate investing is one of the best residential real estate investment strategies. Whether you’re looking at a small duplex or a large apartment complex, all types of multi family properties have one thing in common: the potential for high returns. But, of course, not every multi family property for sale will provide a good return on investment (ROI). That’s why you have to have an understanding of multi family real estate returns. So, how are multi family real estate investing returns measured?
The Metrics You Need to Understand Multi Family Real Estate Investing Returns
There are many ways to analyze returns when investing in multi family real estate. Rental income, for example, is the amount an investor receives in rental payments. This metric is obviously fundamental. Still, it does not paint an accurate picture of the return on investment for a multi family property. Instead, 4 other metrics are more commonly used in a multi family real estate investment analysis. These include net operating income, cash flow, cap rate, and cash on cash return.
1. Net Operating Income
Net operating income is one of the essential multi family real estate investing metrics so we’ve put it at the top of our list. Also known as NOI, it is the annual profit an investment property generates. NOI gives investors an understanding of the financial performance and profitability of a property based on its required costs. Here’s how to calculate NOI:
Computing net operating income would be a piece of cake if it only depended on these two variables. The truth is, however, that each variable breaks down into other variables and figures. Real estate revenue, for starters, is actually the sum of rental income and other income generated from a multi family property. Examples of other income include those from vending machines, parking spaces, or other services.
Then there’s operating expenses. Any costs that are necessary to maintain the rental property fall under this category. The most common operating expenses include:
- Property taxes
- Vacancy costs
- Insurance
- Utilities
- Repairs and Maintenance
- Property Management Fees
- Advertising Costs
Mortgage payments, depreciation, amortization, and income taxes, however, are not included as operating expenses.
2. Cash Flow
Cash flow is arguably the most well-known metric for multi family real estate investing. It is the difference between the rental revenue and rental expenses of a multi family property.
Overall, cash flow informs investors if their properties are profitable and how much money is being made. Owning positive cash flow properties is the goal of any investor. These properties generate more income than they cost in expenses. Negative cash flow properties, on the other hand, are to be avoided.
You might have noticed that the cash flow formula and the NOI formula are very similar. This is because, in effect, cash flow is an extension of net operating income. While both metrics use rental revenue, the expenses used to calculate each metric differ slightly. Operating expenses, as explained, include costs required to operate a rental property. Similarly, rental expenses include the following:
- Property Taxes
- Vacancy Costs
- Insurance
- Utilities
- Repairs and Maintenance
- Property Management Fees
- Advertising Costs
- Income Taxes
- Mortgage Payments
- Depreciation
- Amortization
As you can see, rental expenses also include the 4 underlined expenses that operating expenses ignore. As a result, we can describe rental expenses as the sum of operating expenses and the 4 aforementioned expenses.
Rental Expenses = Operating Expenses + Income Taxes + Mortgage Payments + Depreciation + Amortization
Related: NOI vs. Cash Flow in Real Estate Investment Analysis
Find a positive cash flow multi family property now.
3. Cap Rate
NOI and cash flow are two types of real estate data you need for multi family real estate investing. However, they do not measure profit relative to the value of the multi family property itself. This limits their use for multi family real estate investing. As a result, NOI and cash flow are used to calculate more complicated real estate metrics that take property price or value into account. The first of these metrics is the cap rate.
Cap rate, short for capitalization rate, is a metric that estimates the rate of return on a rental property. In other words, cap rates show how much of the property’s value is earned as profit. Here is how to calculate cap rate:
The cap rate formula uses NOI as its measure of profit. By dividing NOI by a property’s fair market value (FMV), or property price at a given time, you can compute the cap rate.
As previously discussed, net operating income does not include any financing costs. As a result, cap rate for multi family homes measures the return on investment regardless of how the property is financed. This also makes the cap rate perfect for comparing multiple multi family homes for sale.
Related: Understanding Cap Rates for Rental Property
4. Cash on Cash Return
The last ROI metric used in multi family real estate investing is cash on cash return. While the cap rate uses NOI in its numerator, cash on cash return uses cash flow:
Above all, cash on cash return (CoC return) measures a property’s profit to the amount of cash invested into the property. As seen previously, the cap rate does not take an investment property’s financing into account. CoC return, on the other hand, does so in two ways. Firstly, it uses cash flow instead of NOI, taking mortgage payments into consideration. Secondly, it measures total cash invested, not FMV or property price, in its denominator.
Total Cash Invested = Down Payment + Paid Mortgage + Closing Costs + Repairs
By using total cash invested, the CoC return does not assume an investment property is purchased fully through cash, as is the case for the cap rate. Instead, it only considers the money an investor has actually spent on acquiring a property. As a result, CoC return is reliable for determining multi family real estate investing returns of actively occupied rentals or those financed with a mortgage.
Related: Is Cap Rate or Cash on Cash Return the Better Real Estate Metric?
How to Start Calculating Multi Family ROI
These 4 metrics are some of the most important ones you need to measure the profitability of a multi family real estate deal. But, what can you use to estimate these multi family real estate investing returns quickly? The answer is Mashvisor’s multi family investment calculator! Also known as the multi family deal analyzer, the calculator uses predictive analytics and rental comps data to help you find and analyze multi family investment properties for sale. Want to start a FREE trial with the calculator? Well then, CLICK HERE!
