Modeling Multifamily real estate

What is multifamily real estate?

Multifamily real estate or apartments are defined as buildings containing 5 or more rental units. Multifamily units represent approx 25% of the total US RE market. Multifamily is the most familiar with investors as it is generally viewed as the least risky RE investment.

Garden style multti-family

Properties are found in more suburban locations and are typically 2-4 stories tall

Mid high rise style multi-family

Properties are found in more urban locations and are typically 5+ stories tall.

Within asset categories, properties can be graded based on asset quality, ranging from

Assets range from class A to C

• Class A: assets are typically high amenitized, newer buildings in better locations

• Class C: assets are typically the oldest buildings in a market and have a lower-income renter demographic

Multifamily characteristics

• Short-term leases: Most tenant leases are 1-2 years, resulting in 50% turnover per year

• Safety: Despite rollover, it is considered one of the safest asset classes, as landlords can easily drive occupancy

• Rapid Re-pricing: Due to short term leases, cash flows reset quickly, and assets are revaluated.

• Financing: U.S. government participation in multifamily lending results in positive leverage

Turnover (operating expenses)

Turnover costs are any costs associated with preparing an apartment for a new tenant after the current tenant has moved out.

Payroll (operating expenses)

Multifamily properties have two main categories of employees, which is leasing professionals and maintenance professionals (the number of each is dependent upon the size of the property)

Management Fees ( operating expenses)

Institutional owners typically pay a third party property manager to manage day to day task of owning the property, such as leasing maintenance.

Real estate taxes (operating expenses)

The largest operating expense for any real estate property is real estate taxes, and taxes vary by jurisdiction. Investors hire third-party consultants.

( Property sales often trigger tax reassessments)

T-3 Valuations

T-3 takes the latest 3 months and annualizes it by multiplying by 4. In rental environments that are rapidly changing, T-3 provides a more reliable foundation from which we will forecast future rental income and operating expenses.

Valuations fluctuate frequently based on recent performance.

Non-revenue unites

Model units, furnished for viewing or most commonly maintence staff to have a unit a live to be available at all times (these dont generate revenue)

(percentage of effective rent and after subtracting this you get total rental income)

Collection Loss

Uncollected rent,

(percentage of effective rent and after subtracting this you get total rental income)

Management Fees

Management Fees are calculated as a percentage of rental income

Replacement Reserves

It is not an actual cash flow; it is a “modeling tool.” Think about it as money set aside to replace large items when they break. In multifamily, it can also be a buffer for turnover costs when expenses like labor or paint increase.

Floating rate loan index

• Floating rate loans are priced as a spread over an index

• The most common floating rate index is SOFR (secure overnight financing rate

Floating Rate vs Fixed Rate

lower interest rates = fixed rate

High interest rate = floating rate

The decision to borrow fixed or floating-rate debt is dependent upon the interest rate environment. But there are some general guidelines that most institutional investors take into account…

• Unlike fixed-rate loans, floating-rate loans can generally be paid off anytime without a fee. Investors like the flexibility of floating rate loans for shorter term investments ( 5 years or less)

• Fixed-rate loans generally have lower interest rates than floating-rate loans. For this lower rate, the loan terms are less flexible than floating rate loans.

Yield on cost (YoC)

• NOI / Total cost

• YoC is used to compare the difference between the market yield (cap rate) and the actual yield of an investment

• In order to sell an asset for profit, the YoC must be greater than the exit cap rate

• The story of an asset can be told through the movement in its YoC

Cash on Cash Yield (CoC)

• NOI + Loan proceeds - Debt Services) / invested equity

• CoC is used to measure the operational profitability of an investment, but does not tell an investor much about overall profitability

Value Allocation

• The percentage of profits that come from terminal value versus interim cash flow

• Less risky investments (core, core plus) rely more heavily on interim cash flow profit, while more risky investments ( value add, opportunistic) rely on most of the profits coming from the terminal value

Debt Service Coverage Ratio (DSCR)

• NOI / Debt Service

• Measures a property’s ability to cover its debt obligations, primarily used by banks to determine the maximum loan amount

Debt Yield

• NOI / Loan amount

• Lenders yield on cost used in conjunction with DSCR to determine appropriate loan amount