How to Get Good ROI from Your Multifamily Investment

Nov 08, 2023

Multifamily real estate investments continue to gather much traction among new and established investors. There is increased spending and cash flow in the sector, even amidst challenging economic times, signifying a ripe investment environment.

According to data, the multifamily real estate investment market surpassed the office market in 2021, representing 42% of the total U.S. market.

Therefore, it is no doubt that the ROI in this sector is excellent. But what is it, and how much should you expect from your investment?

Let's look at ROI in multifamily real estate properties, what makes these investments attractive, and how you can estimate how much you should expect back from your investment.

What is ROI in Multifamily Investing?

ROI, also known as return on investment, is the measure of the profitability of an investment vis a vis the invested amount of money. Therefore, ROI measures the money an investment will earn you over time.

In real estate, ROI is typically calculated by dividing the money earned by the money invested in a real estate project.

Therefore, ROI is crucial in evaluating a multifamily investment's profitability. It helps you decide whether investing is worth it or not. Knowing the ROI of a multifamily property also allows you to set realistic investment expectations.

Knowing the potential ROI of a multifamily investment also helps you understand the risks involved. Typically, the higher the ROI, the higher the risk.

Despite sounding counterintuitive, this positive correlation between risk and return exists because, with a higher profit potential, you risk a higher potential of loss from the investment.

But that doesn't mean you should always go for mid to low-ROI investments. There are several factors you need to consider.

How You Can Analyze Multifamily Investment Opportunities

Several factors will affect the risk and ROI of your multifamily investment. These include walkability, location, and local school ranking, among others.

Combining these factors and more can allow you to make a predictive analysis of your investment options and make the right choice.

The most significant considerations are the local real estate market and the building's asset class.

The Local Real Estate Market

The local real estate market determines the ease of finding renters for your multifamily real estate property. Major cities with consistent job growth typically have a better ROI than small cities with limited utilities and job opportunities.

You should also consider cities deemed growth markets. While the city may not have historically had a booming rental market, the steadily growing population, local job growth, and new business districts make it a good investment market.

Asset Class

The asset class of the multifamily building will considerably impact ROI. Typically, there are three major asset classes. These are A, B, and C.

A Class

A-class buildings are typically less than ten years old. They have luxurious finishes and amenities and are usually located in large, desirable rental markets.

Since they're in new or like-new condition, they rarely need renovations. These buildings appeal to high-earning residents, allowing you to charge high rent upfront. However, you have little room for rent appreciation over time.

Generally, A-class multifamily properties are low-risk investments.

B Class

B-class properties are typically 10 to 20 years old. They're located in steady but not great property rental markets and are often in good condition, featuring fully functioning mechanical and HVAC systems that need minor repair.

However, the finishes are often dated, featuring laminate countertops and carpeted rooms. This class of multifamily rentals appeals to medium-income earners with the potential for price appreciation.

They are typically medium-risk.

C Class

C-class properties are typically 20 years or older. They're located in less desirable areas, often far from major highways, town centers, and employment opportunities.

This class of multifamily properties also features dated finishes, almost non-functioning or obsolete. The roofs, mechanical systems, HVAC, and plumbing most likely need renovation or replacement.

Such properties include mobile homes. They are attractive to low-earning and hourly workers. However, with proper renovation and modernization, they can appreciate significantly and attract higher rent.

C-class properties are typically higher-risk investments.

The Typical ROI for Multifamily Investments

The ROI for multifamily properties takes into account the property's net operating income (NOI). This is the difference between rental income and operating expenses divided by the total cost of the investment.

The total investment cost includes closing costs, the purchase price, and any repairs or renovations.

Before choosing a multifamily property to invest in, you should always carefully evaluate and conduct due diligence on the potential risks and returns, factoring in the property condition, location, market conditions, and tenant quality.

The Thee Main Key Performance Indicators (KPIs) for Multifamily Properties

There are three multifamily investing KPIs that you can track to ensure you're making the right investment and getting good ROI from it. They include the following:

Cash-on-Cash Return

Cash-on-cash return is calculated annually by dividing the cash flow of the multifamily investment by the amount you invested initially.

For instance, if you invest $100,000 into a multifamily property and earn back $8,000 in the first year, you have a cash-on-cash return of 8%.

Typically, a cash-on-cash return of about 5% to 10% is standard in most value-added multifamily investments. That's an average of 8%.

Cash-on-cash return doesn't account for the profit you'll make from refinancing or selling the property after the investment period.

Internal Rate of Return

The internal rate of return (IRR) is a discount rate that brings the Net Present Value (NPV) of all cash flows to zero. Therefore, it calculates an investment's anticipated annual growth rate, demonstrating the rate at which your investment is growing annually.

IRR accounts for the time value of money. It compares the worth of an investment right now to the future, including all cash distributions and proceeds from refinancing and sale.

Great multifamily properties have an IRR in the mid to high teens, typically 13% to 20%. Apart from the thorough due diligence you still have to conduct, anything below or above that might need more scrutiny before investing.

Equity Multiple

Equity multiple looks at how much your investment value was multiplied. Let's take this example.

Suppose you invest $100,000 in a multifamily property. Over five years, the property earns you $6,000, $7,000, $8,000, $9,000, and $10,000 in order.

At the end of the five years, you sell the property for $160,000. Over these five years, the total cash flow from the property will be $200,000, $40,000 in cash flow, and $160,000 in sales earnings.

For this investment, the equity multiple will be $200,000 divided by $100,000, which is 2x.

Passive investors typically realize a 1.7x to 2.5x equity multiple on a five-year investment. This gives you a reasonable minimum and maximum to gauge your investment's returns and worthiness.

Make the Right Investment Choices

Investing in multifamily properties is an excellent choice for building wealth in the short term and long term. However, you must conduct enough due diligence to make the right investment choices.

Contact a multifamily expert and learn what you should consider for your case.

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