Investing in rental properties isn’t like purchasing a primary residence or a vacation home. While investment buyers find the process to be quite a bit more complex, it’s also infinitely more rewarding. When a buyer is in the market for investment rental properties, the transaction is purely based on minimizing risk while maximizing financial potential. Thus, understanding the ROI guidelines for multifamily rentals is crucial.
You always have to know a property’s potential return on investment before making a purchase. This is particularly true for any larger, multi-unit rental properties. To help you begin to navigate the numbers involved, here’s a primer on ROI guidelines for multifamily rentals.
Savvy investors understand that numerous factors come into play to make multifamily rental properties a better bet for your ROI. For one, it’s easier and less time-consuming to manage one multifamily property than it is to rent and maintain several different single-family properties in various locations. It also makes much more sense to renovate multi-unit properties. This is not only part of being an excellent landlord; it’s also a smart business strategy. Remodeling and updating increase the property value more sharply in a multifamily property than in single-family rentals. Another plus of investing in multi-unit rental housing is the tax incentives that become available to you. In addition to this, established and successful multifamily rental properties are incredibly attractive to investors, meaning that they tend to hold their value for resell in the future.
Making an income off of smaller rental properties depends on keeping them filled at all times. If you purchase a five-unit apartment building and two of the apartments stay vacant for a while, you’re likely going to take a significant hit to your bottom line. One way to avoid this kind of risk is to look for investment properties with a larger number of units. According to successful real estate investor and Business Insider contributor Grant Cardone, “The more doors, the better.” If you have a building with a larger number of units, the financial impact won’t be as great if you can’t find renters for a few of your units.
One of the key ROI guidelines for multifamily rentals is understanding the investment metrics. The first number you’ll need to know is the net operating income (NOI), or how much profit the property will generate during a specific time period. To get your NOI, add together the rental income with any additional income generated by the property (such as vending machine income or any applicable fees) over a year. This will provide a gross income. Next, subtract that year’s operating expenses from the gross income to get the NOI. Once you have the NOI, you’ll be able to calculate your capitalization rate (cap rate). To get this, divide the property’s price into the NOI. The cap rate is important because it allows investors to get a clear view of the relationship between a property’s value and the amount of income it generates.
The old saying goes that when it comes to real estate, the only thing that matters is “location, location, location.” While this is partly true, you’ll also need to do your homework to ensure that you have a combination of good location, the perfect size, and an ideal rental market to suit your needs. By understanding the ROI guidelines for multifamily rentals and crunching all of the numbers before making your final decision, you’ll be able to make a confident investment that reaps huge rewards for your real estate portfolio.