3 Ways to Analyze Multifamily Real Estate Deals

How you analyze a real estate deal depends on your goals, where you are in life, and the disposition of the asset. What do you want to achieve with this investment? Although there are many ways, I believe the following three are most prevalent in today’s market: (1) Cash Flow Method; (2) Value-Add/House Flipping Method/BRRR Method; and (3) Speculation. Additionally, I challenge you to speak with three different real estate investors: (a) a new, young person just getting started; (b) a seasoned professional, older, with 10+ years under her belt; and (c) a retired or semi-retired professional with 30+ years of investing experience. You’ll find that each person likely analyzes deals differently with their flavor permeating through the deal. Second, your analysis will likely change depending on the property’s disposition: stabilized, distressed, undeveloped, etc. 

1. 1. Cash Flow Method

One of the most popular is the cash flow method. This method is most appropriate for a stabilized asset. Take the cash flow and divide it by your equity invested to provide the return on investment. A very simplified example, a ten unit with market rents at $1,000/unit: 

ROI = Cash Flow / (Principal Down Payment) + (Closing Cost) 

= $32,782 / ($180,000) + ($10,000)

= 17%

Assuming you buy and hold, using this method with a stabilized asset, one should expect their cash to be deployed for 5-7 years, or until you have amortized enough debt to get your original principal back via cash out refinance.

*The formal, academic cash flow method will calculate capital improvements after NOI and call it “Adjusted NOI”. Adjusted NOI is more accurate to do it this way because it will amortize the capital improvement over its applicable depreciation schedule, but I'm trying to keep this post relatively simple.

1. 2. (BRRR Method) Value Add / House Flipping Method

This method is more appropriate with a distressed asset, or an asset with a lot room to increase the value of the property by increasing rents, amenities, or lowering expenses. It uses the same principles as those flipping single family houses, but applies it to multifamily. The present cash flow is not as important, nor accurate, because you likely have a short-term bridge loan, are taking the property through major capital improvements, and likely experiencing higher than normal vacancy by turning over the property (increases rents) until stabilization. Your projected cash flow drives the deal.  At stabilization, you will refinance out of the bridge loan, get your original principal investment back, and take on long term debt. The Bigger Pockets community calls this the BRRR method.

The first steps are the same, but this analysis requires you to understand your market’s current cap rates. Using the same example as above, but assuming an 8% market cap rate and that the subject property needs $200,000 of capital improvements to obtain market rents. 

The maximum allowable offer is the most you should be willing to pay for the property (obviously this changes if your goals with the property change). The goal here is different than the goal with a stabilized property in the cash flow analysis. The goal is to stabilize the property and have all of your money out within X amount of time (usually 18-24 months). 

1. 3. Speculation

Speculation is the easiest to understand, but perhaps the riskiest and hardest (for me) to implement because, as the name suggest, requires you to speculate. Cash Flow or Refi horizons typically have little or no bearing on this strategy. There’s one question: will the property be worth X more at X time in the future to satisfy your investment criteria. The Cash Flow Method and the House Flipping Method are typically less risky because, by and large, you control the value of the asset by capital improvements and management. However, speculation largely depends on factors that are out of your control, such as the market, and usually have much longer investment horizons.

My mentor’s mentor does all of his deals in New York (mostly within the 5 boroughs). In New York City, they say that the only thing more valuable than a building is a vacant building, and the only thing more valuable than a vacant building is undeveloped land. He’s the only billionaire I’ve ever met, and every time I hear about his deals, I leave feeling like a piker. In the 1980s he started out the same way I did on smaller deals pursuing cash flow mainly to get out of his day job. Recently, he purchased a tract of vacant land in New York City for ninety million dollars ($90,000,000). It’ll never cash flow during his lifetime. His explanation was that land in New York City doubles in value every 10 years. He put the property in a trust for his kids and grandkids. Under that hypothesis, he’ll increase his net worth (or his kids net worth) by 9,000,000 every year…

Your analysis changes depending on your goals and where you are in life.