Key Metrics to Evaluate When Buying Multifamily Real Estate

Dec 30

Investing in multifamily real estate can be a lucrative opportunity, but success hinges on understanding the key metrics that determine a property’s financial viability. Whether you're a seasoned investor or a first-time buyer, evaluating these metrics is essential for making an informed decision and ensuring your investment yields profitable returns. At Birchwood Property, we help investors in Ulster, Dutchess, and Orange counties find and assess the best multifamily properties. Here are the top metrics you should consider when buying multifamily real estate.

1. Net Operating Income (NOI)

Net Operating Income (NOI) is one of the most important financial indicators of a property's performance. It represents the annual income generated by the property after deducting all operating expenses, such as property management fees, maintenance costs, insurance, taxes, and utilities, but before debt service (loan payments) and capital expenditures.

NOI Formula:

NOI = Gross Rental Income – Operating Expenses

NOI provides insight into the property's profitability and is often used to determine its value. The higher the NOI, the more income the property is generating, making it a crucial metric to consider when evaluating multifamily investments.

2. Capitalization Rate (Cap Rate)

The capitalization rate, or cap rate, is used to estimate the potential return on investment for a multifamily property. It is calculated by dividing the property's NOI by its purchase price or current market value.

Cap Rate Formula:

Cap Rate = NOI / Purchase Price

A higher cap rate typically indicates a higher return, but it can also imply a higher level of risk. In contrast, lower cap rates are often found in more stable, desirable markets. Investors should compare cap rates across similar properties in the area to ensure they are making a competitive and smart investment decision.

3. Cash Flow

Cash flow represents the amount of money left over after all operating expenses and debt payments (mortgage) are made. Positive cash flow means the property generates more income than its expenses, while negative cash flow means the opposite. Ensuring a property has a strong cash flow is key to maintaining a healthy investment.

Cash Flow Formula:

Cash Flow = NOI – Debt Service

When assessing cash flow, it’s important to account for unexpected expenses such as vacancies, repairs, and property upgrades. Positive cash flow allows you to reinvest in the property and build equity over time.

4. Cash-on-Cash Return

Cash-on-cash return measures the annual return on your investment based on the actual cash you’ve invested. This metric is especially useful for investors who finance their multifamily property purchase with a mortgage. Cash-on-cash return shows how effectively your invested capital is working for you.

Cash-on-Cash Return Formula:

Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

Investors typically look for a high cash-on-cash return, as it reflects the profitability of their down payment and other upfront costs. Comparing this return to other investment opportunities will help you decide whether a multifamily property is a better investment for your portfolio.

5. Gross Rent Multiplier (GRM)

The Gross Rent Multiplier (GRM) is a quick metric to estimate the value of a property compared to its gross rental income. While it’s a less detailed analysis compared to NOI or cap rate, it can still provide a basic benchmark for determining whether a property is priced fairly.

GRM Formula:

GRM = Purchase Price / Gross Rental Income

A lower GRM may indicate a better investment opportunity, but it’s important to remember that GRM does not take operating expenses into account. It should be used in conjunction with other metrics like NOI and cap rate.

6. Occupancy Rate

The occupancy rate is a critical indicator of a multifamily property’s performance and market demand. It refers to the percentage of units that are currently occupied by tenants.

Occupancy Rate Formula:

Occupancy Rate = (Occupied Units / Total Units) x 100

A high occupancy rate typically indicates strong demand, making the property a potentially profitable investment. However, if the occupancy rate is too high, there may be an opportunity to raise rents. Low occupancy rates, on the other hand, could signal challenges such as poor property management, undesirable location, or high competition in the market.

7. Debt Service Coverage Ratio (DSCR)

The Debt Service Coverage Ratio (DSCR) measures a property's ability to cover its debt obligations. Lenders often use this metric to evaluate the risk of providing financing for a multifamily property purchase.

DSCR Formula:

DSCR = NOI / Total Debt Service

A DSCR above 1.0 indicates that the property generates enough income to cover its mortgage payments, while a ratio below 1.0 suggests that the property may not be generating enough income to meet debt obligations. A higher DSCR is preferable for both lenders and investors as it signals financial stability.

8. Expense Ratio

The expense ratio compares a property’s operating expenses to its gross income. A high expense ratio indicates that the property is costly to operate, which can reduce profitability. Multifamily investors should aim for a lower expense ratio to ensure higher net returns.

Expense Ratio Formula:

Expense Ratio = Operating Expenses / Gross Income

By controlling operating costs and improving management efficiency, investors can lower the expense ratio and increase the overall profitability of the property.

Why Birchwood Property?

At Birchwood Property, we understand the complexities of evaluating multifamily real estate investments. Our expertise in Ulster, Dutchess, and Orange counties helps investors find the right properties and make sound decisions based on key metrics like NOI, cap rate, and cash flow. Whether you're looking to buy your first multifamily property or expand your portfolio, we can guide you through every step of the process.

Scott Boyd