Investors in single-family properties, at some point, wonder about multi-family properties. From a management point of view, after all, you have one to four homes instead of just one on a single piece of ground. First-time investors might have the same questions for the same reasons. The issue becomes, then in regards to real estate investment property: How to evaluate a multi-family home vs. a single family home?
What is Multi-Family Exactly?
Let's clarify the definition of “multi-family” in this context, since the term is also used to describe apartment complexes. Here, it means a duplex, triplex, or fourplex. These properties are eligible for traditional residential mortgage financing. Borrowers can leverage the purchase with a down payment of less than 20 percent and don't have to seek commercial financing.
What Are Your Investing Goals?
Investors should first evaluate their personal goals. Are they in it for income, long-term capital gain, or both? The value of multi-family properties lies in their income potential rather than their resale. It's not to say that a multi-family property can't be sold at some point–it can–but it's valuation at both purchase and sale will be based on its income stream.
The value of a single-family house is based on sales of comparable properties. If they're used as rentals, they have income streams, of course, but the primary valuation process does not derive from its income.
Multi-Family Deal “Lingo”
Investigate multi-family properties, and you're bound to hear such terms as “gross rent multiplier” and “cap rate.” The gross rent multiplier (GRM) is the property's market value divided by the gross annual income. The gross rent multiplier of a $650,000 property with an annual gross income of $86,000 has a GRM of 7.56, which you could use as a comparison with other multi-properties listed for sale. These terms seldom, if ever, are applied to single-family homes.
A cap rate (actually, capitalization rate) is the net operating income divided by the sales price. It's a little more accurate than a GRM and produces a number in wider use than the GRM. Using the above example, the net operating income (as opposed to the gross) might be $69,000, yielding up a cap rate of 10.6 percent.
Whatever use these numbers have, they're only a starting point. What matters to the investor is, first, the financing package, and second, the property's operating expenses. Since financing varies among investors, we'll look at the operating expense factor.
Financing – Operating Expenses Are Important
The actual operating expenses should be carefully analyzed by an expert. Is the property's current owner, for example, performing maintenance duties an investor would outsource? Are any critical tasks being deferred?
Next are the pro-forma income expenses, which are projections going forward. A central factor in pro-forma projections are the underlying assumptions. Can an investor assume rents may be increased, and if so, by how much? Should the property be improved, and can the improvements' cost be justified?
Most reputable Hard Money Lenders should be able to perform these kinds of analysis for investors or know what to look for when an investors presents to them a multi-family deal for review.
How this real estate investing information will help you reach your real estate investment goals!