So you want to start investing in multifamily real estate? Before you buy your first apartment building, you will need to get a firm grasp on at least these 14 principles. This article will explain the basics of each element, so read carefully, take notes, and do not be afraid to ask us questions!
The Top 14 Things You NEED to Learn How to Start Investing in Multifamily Real Estate:
Multifamily vs. Single Family Real Estate
Multifamily vs. single family real estate—what’s the big difference? Well, to put it simply, multifamily real estate includes buildings with multiple residential units. In contrast, single family real estate only includes buildings each with only one residential unit. Now, what does "multifamily" mean and what are the different types?
In real estate, "multifamily" refers to buildings or properties where multiple families or residents live in separate units within the same structure. Residential multifamily properties have two to four units. These are commonly known as duplexes, triplexes, and fourplexes. While a great place to start, they do not offer the same benefits as small apartments and large multifamily.
Small apartments typically range from 5-70 units and can be financed through recourse or non-recourse regional bank lending, depending on the price. On-site management staff is typically not economical (until over 50 units).
Large multifamily apartments, generally with 70-300 units or more, often feature professional property management and a wide range of financing options. These properties appeal to individual investors, private investment companies, REITs, and AAA life insurance companies, all of whom seek scalability and stable cash flow.Â
Multifamily properties provide a reliable investment vehicle for diverse entities aiming to balance their portfolios and generate long-term returns. Make sure to check out our article on the different types of multifamily structures for more information.
Underwriting
Underwriting is the process of assessing a property’s financial viability before purchasing. Every property goes through a thorough underwriting process before final acquisition. At EagleCap our deal team analyzes over 200 potential new properties every month. Of those 200, only a handful (maybe 10-20) will make it to the desks of our experienced, in-depth underwriters. Once those have been strictly analyzed, we take the top 2-5 to the offer table. After all is said and done we will likely only proceed with purchasing 1 of those properties.
When conducting the underwriting process, all of the economic, market, financial, and demographic aspects of a potential acquisition must be evaluated. Everything including rent rolls, P&Ls, expenses, CAP rates, NOI, IRR, AAR, and DSCR, must be stringently taken into account. On top of that, you should have already done a market analysis to make sure that the location in which the deal is located is within your target.
CAP Rate
The rate of return on a property based on the income it generates is called the CAP Rate or Capitalization Rate. This rate is generally set by the market and determines the values of multifamily assets depending on their NOI. This is because the CAP Rate is the ratio between the Annual Net Operating Income (NOI) and the capital cost, which is the asset’s current market value.
For example, an apartment building with an NOI of $400,000 that can be sold for $10 million has a cap rate of 4%.Â
$400,000 / $10,000,000 = 4%
Conversely, an asset with NOI of $250,000 being sold at a CAP rate of 5% would be worth $5 million.
$250,000 / 0.05 = $5,000,000
Investors in prime markets may be willing to accept lower CAP rates in return for lower risk. With CAP rates, you should buy HIGH and sell low.
NOI
The total income minus operating expenses, excluding debt service is known as the NOI, which stands for Net Operating Income. Very simple, but here is an example anyways:
Total Income: $500,000
Operating Expenses: $200,000
Net Operating Income: $300,000
IRR
The IRR (Internal Rate of Return) shows us the projected annual return on an investment adjusted with time. IRR is the discount rate at which the net present value (NPV) of all cash flows from an investment is zero, meaning it takes into account the timing of all cash flows. Unlike the AAR, the IRR accounts for the exact timing of each cash flow, which makes it a more accurate measure for investments with irregular cash flows over time. This makes it reflect the impact of both compounding and cash flow timing on investment returns.
AAR
The AAR (Average Annual Return) is slightly different in that it gives us a simple average of the annual returns over the life of an investment. The AAR calculates the total return over the investment period divided by the number of years. AAR includes all cash flow generated by the property (like rental income) and any appreciation in the property’s value over the holding period. It does not account for the timing of cash flows or the effect of compounding. Each year's return is weighted equally. The AAR is best to use for a straightforward, average measure of yearly performance, without considering the exact timing of cash flows.
DSCR
Another straightforward calculation you should familiarize yourself with is the DSCR or Debt Service Coverage Ratio. To calculate DSCR you simply divide the NOI of a property by the cost of debt payments. For example:
NOI: $500,000
Annual Debt Payments: $400,000
DSCR: 1.25
Value-Add
There are A property with the potential to increase its value and income potential. Multifamily properties can be categorized into three main types: turnkey, value-add, and distressed. Turnkey properties are fully renovated, tenant-occupied, and require minimal effort, offering stable cash flow for passive investors seeking low-risk, low-upside opportunities. At the other end of the spectrum are distressed properties, which face significant physical, financial, and operational challenges, such as low occupancy or deferred maintenance resulting in a high-upside, high-risk opportunity. In contrast, value-add properties need moderate improvements, such as renovations or better management, to increase their income potential and value. This is because value-add properties typically have under-market rents, outdated units, and poor property management, offering higher potential returns for investors looking for the best of both worlds–high upside, and low risk. Value-add properties are the primary focus of EagleCap’s strategy, aimed at delivering strong investor returns while minimizing risk to their capital.
Property Classes
The types of Property Classes are A, B, C, and D class properties which are a quality ranking, based on age, location, and amenities.
Class A Building
High-quality, often newer buildings with premium amenities. Typically, A-Class buildings are located in prime (A-class) areas, and typically attract high-income tenants. These properties often have the best finishes, latest design standards, and command top rents in the market.
Class B Building
Generally older than Class A but still in good condition. These buildings are often in well-established (B-class) neighborhoods and attract stable, middle-income tenants. They may have fewer amenities than Class A properties but are usually well-maintained and provide reliable cash flow.
Class C Building
Older buildings, often built 20-30+ years ago, may be in need of renovation or updating. Class C properties are usually located in less desirable (C-class) areas. They tend to attract lower-income tenants and offer basic amenities. They can, however, present value-add opportunities for investors looking to make improvements.
Class D Building
Typically the oldest buildings in challenging neighborhoods with minimal amenities. Class D properties often require significant repairs or maintenance and tend to attract lower-income or subsidized housing tenants. They are the riskiest class but can also have high returns if managed well. EagleCap tends to avoid Class D properties.
Syndication
The process of Syndication refers to the pooling of capital from multiple investors to fund a real estate purchase, enabling individuals to collectively invest in larger, more lucrative properties than they could afford independently while taking on lower risk. This investment model is often structured with a general partner (GP) or syndicator managing the deal and a group of limited partners (LPs) providing the capital. Syndication provides access to diversified real estate opportunities, professional management, and the potential for substantial returns, making it an attractive option for investors seeking passive income and long-term growth without the burden of directly managing real estate assets.
Pro Forma
Pro Forma offers financial projections that outline a property's expected income, expenses, and overall performance, serving as a critical tool for evaluating potential returns and guiding investment decisions. The pro forma evaluations and analyzes given by the listing agent or seller should be used only as a baseline and never as the actual property projections. Strict underwriting must be performed and compared with the pro forma to receive an accurate understanding of the property’s financial position.
Rent Roll
The Rent Roll is a report of the rental income and occupancy from all units in a property. It will typically include the unit numbers, room numbers, names of occupants, security deposit amounts, and monthly rental rate. These details offer a snapshot of current cash flow and tenant status which are essential for assessing the property's financial health.
Equity Split
The percentage of profits that are divided between the GP (general partners) and LP (limited–or passive–partners).Â
General Partner (GP)
The GP is responsible for finding the property, securing financing, and overseeing its operation. These partners are responsible for managing the investment and asset side of the deal. They also oversee the property manager or management company.
Limited Partner (LP)
The LPs are typically passive investors who contribute funds in exchange for a share of the profits. They are passive investors providing capital without day-to-day control.
1031 ExchangeÂ
If you really want to grow your real estate portfolio, you will learn how to master the 1031 exchange. In a nutshell, it is a tax-deferral strategy that you can take advantage of by reinvesting the sale proceeds that you receive from one property straight into the investment of another property. Disclaimer: You must consult a licensed tax advisor or attorney to take full advantage of a 1031 exchange. EagleCap cannot give tax advice specific to your situation, however, if you can utilize the 1031 exchange effectively, you will grow your real estate investment capital tax deferred until you realize the gains!
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