Cheat Sheet 3 Formulas to Know When Investing in Multi-Family Homes

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1 Cheat Sheet 3 Formulas to Know When Investing in Multi-Family Homes

2 Overview There are many factors that go into buying a property size, location, finishes the list goes on and on. When searching for a multi-family there are additional considerations, one of them being cash flow. Depending on whether you re looking to buy a pure investment or owner-occupy the property may impact where the cash flow factor stacks up against your other priorities. When investing, there are no hard and fast rules. Everybody has their own investment objectives and a strategy for fitting real estate into their lifestyle. Perhaps your day job offers you flexibility, so you have time for a fixer upper. Another buyer may be tied to a desk during the workweek and is most interested in turnkey. There is no right or wrong answer and cash flow may compete with or compliment other important factors like appreciation, exit strategy, and ease of management. No matter what, it doesn t hurt to have an awareness of some common real estate formulas. Just remember, a house is lot more than a math equation. When buying a small multi-family, be sure to consider the entire picture. The math is just one piece of the puzzle. There are countless formulas that can be used to analyze properties. The ones that I ve included in this guide are the formulas that I have found to be the most useful overtime.

3 1. The 1% Rule My favorite financial measure for calculating ROI on a small multi-family is the 1% rule. I personally seek out properties that generate 1% of the purchase price + rehab costs per month. In simpler terms, gross monthly rent should be equal to or greater than 1% of the value of the property. Here s an example: You purchase a three-family for $550,000 + $50,000 for rehab, so you re into the house for $600,000. If you re following the 1% rule, you should be striving for this property to bring in $2,000 in rent per month. Gross monthly rent = 1% Property value Is the 1% rule attainable? The closer you are to Boston Proper, the more difficult it is to achieve because the barrier to entry is incredibly high. The numbers are more attainable outside of the city, but still tough unless you are willing to buy a fixer upper or a building with at least three units. Remember, there s always a tradeoff. If you re buying your first investment property, don t underestimate the upfront work, money and upkeep it takes to get a larger property to sing at 1%. *In some areas of the country, the 2% rule can be applied for small multi-families, but in the Boston area, it s difficult to find 2% rule properties and even challenging to achieve 1% on anything smaller than a four unit building.

4 2. Cap Rate (Capitalization Rate) Another solid indicator is cap rate. The equation is net operating income/the cost (or value) of the property. In my personal investments, I strive for a 7%+ cap rate. Net Operating Income (NOI) Property Cost (Value) = Cap Rate % Here s how to calculate cap rate on a hypothetical property: You re considering buying a three family house for $480,000. It needs about $50,000 in updates, and you estimate it could bring in $54,000 in gross income. First, calculate the net operating income by subtracting the property s operating costs from the gross income. Property expenses include taxes, trash removal, maintenance, water and sewer, utilities, capital improvements, etc. Then, divide this number by the cost. Don t forget to account for all income streams when calculating gross income, ie rent plus any additional cash from other sources (washer & dryer coin op, on-site parking/storage) When determining property value, make sure to consider purchase price AND rehab costs. $54,000 (total gross income) - $20,000 (operating costs) = $34,000 (NOI) $480,000 (purchase price) + $50,000 (rehab) = $530,000 (Property value) 34,000/530,000 = 10.2% Pros: This calculation takes into account all income and operating expenses Cons: It does not take into account debt service costs

5 3. Loan to Value (LTV) The loan to value equation applies when purchasing or refinancing. Loan to value is simply the percentage a lender is willing to give you based on the appraised value of the property. Typically, lenders are willing to give anywhere from 70 to 80%, and sometimes 90+% loan to value. Purchase Example: Say you want to buy a four unit for $600,000.Your lender is willing to finance up to an 80% LTV, meaning the bank will shell out up to $480,000. Refinance Example: Let s say you purchased the above four family for $600,000.You then spent $100,000 on renovations to improve the property value. After the renovations were complete, the property appraised for $800,000. Depending on your lender, you could refinance to an 80% LTV, which is equal to $640,000. In this situation, you could pull out $160,000 ($640,000-$480,000) from the property through a refinance and apply this money elsewhere.your new loan would be at $640,000 at current interest rates. Why is LTV important? If you re planning on purchasing multiple properties or renovating, you ll need to know this information so that you can map out your finances. Investment properties require more equity and you may want to leverage your funds and be strategic with spreading the cash you have on hand.

6 About Me Your Local Real Estate Expert. Helping First-Time Home Buyers and Investors Make Smart Real Estate Purchases For as long as I can remember, I have been obsessed with real estate. After college, I began buying properties and collected a couple dozen apartments in the Boston area before my 28th birthday. Now, I am dedicated to helping first-time buyers and first time investors make smart real estate purchases. With a commitment to excellence, I will bring you the edge you need in this competitive market. Whether you re looking to purchase your dream condo in the city, or a starter home just outside, I will represent your interests with dedication. + Five Star REALTOR I am licensed real estate agent in Massachusetts and a member of the National Association of REALTORS. As a sales agent, I proudly serve Boston and the surrounding area and hold a five star Zillow rating. My affiliation is with Harborside Sotheby's International Realty. + Local Investor When it comes to buying real estate, I ve walked the talk. Having owned many properties in Boston and on the north shore, I have years of hands on experience. + Real Estate Coach In addition, I provide one-on-one virtual coaching sessions for a fixed fee. My coaching arm allows me to educate a larger audience of firsttime buyers and investors on smart buying principles regardless of geography. + Zillow Group Columnist I m an avid writer and run a column for the Zillow Group on RealEstate.com. My posts provide tips and advice for millennial buyers looking to make their first real estate purchase. As Featured In