Gas: $49.75
Milk: $3.79
Groceries: $226.00
Understanding key metrics in real estate investing: Priceless.
Decoding real estate industry jargon might be easier than you’d expect. Sure, EGI sounds a lot like PGI, and FMV reads like a radio station. However, memorizing these key terms can be simple with enough repetition—knowing how to apply them is potentially more challenging.
The following hypothetical scenario will provide a practical application of key metrics investors use in multifamily real estate and help you determine a high-risk investment from a low-risk investment:
Jordan is seeking a 100-unit apartment building as an investment property. Upon finding an asset in a desirable market, Jordan can evaluate its key metrics. The 100-unit apartment building generates $1,728,000 in revenue annually (90 Units x $1,600 average operating income per unit x 12 months). It has $756,000 in operating expenses (90 Units x $700 average operating expense per unit x 12 months), resulting in an NOI of $972,000 ($1,728,000 – $756,000).
The fair market value (FMV) of the property is $17,500,000. Jordan calculates that the cap rate (($972,000/$17,500,000) x 100) equals 5.55%. The annual debt service for the property is $775,000, making the DSCR ($972,000/$775,000) 1.25. This is because the first mortgage on the property is $11,375,000 on an FMV of $17,500,000, representing a 65% LTV ratio. Jordan learns that out of 100 units, 90 are occupied, bringing the occupancy rate to 90%. Now, let’s assess whether or not this is a high- or low-risk investment for Jordan.
Most experienced investors in multifamily real estate will tell you that no set cap rate percentage is wholly “good” or “bad.” However, they convey that an increased cap rate results in a higher risk-return profile. Jordan’s prospective asset has a cap rate of 5.55%, suggesting an ideal potential return but requiring further analysis based on broader economic/market conditions and risk factors, including interest rates, rent growth, and location. Generally, a cap rate of 5-10% indicates the opportunity for increased returns. A DSCR of 1.25 tells us that the property is comfortably covering its debt obligations; however, there might be a need for more stringent financial buffers during a recession or if operating costs suddenly increase. Finally, a 90% occupancy rate shows that the property performs relatively well in its market and has a high demand for units or a strong resident retention rate.
Based on the metrics above, Jordan’s prospective property appears to be a high-risk, high-reward investment.
RISKS & LIMITATIONS
Metrics play a crucial role in the success of investment real estate. These measurable benchmarks enable investors to make informed decisions and maximize returns.
However, it’s important to remember that a single metric does not suffice for predicting profitability in multifamily real estate. Instead, a combination of calculations is necessary.
Metrics like cap rate and IRR are sensitive to economic disruptors. Therefore, market volatility must always be considered when underwriting. Underwriting in multifamily real estate is a risk assessment process to determine potential returns on an investment. Specifically, underwriting among real estate private equity firms encompasses rigorous explorations of the quality and quantity of a product. Almost all of the terms above are used in underwriting to identify risk-adjusted returns on a property. From property valuation to legal probes and financial analyses, investment real estate underwriters must conduct due diligence for investors before entering a deal. [1]
Underwriting is typically displayed in a document or spreadsheet called a proforma (also spelled pro forma). A proforma is a projection of a property’s income and expenses. It’s a simplified version of a property’s income and cash flow statements, often used for modeling and valuation purposes. IRR and equity multiple targets (EMx) heavily rely on accurate proformas (forecasting), which can be subject to human error, economic downcycles, force majeure events, and other factors outside one’s control.
WORK WITH BAM CAPITAL FOR MULTIFAMILY REAL ESTATE INVESTING
BAM Capital underwrites up to 200 assets to meet its strict performance criteria, giving the firm greater confidence in its ability to execute value-add strategies and drive strong returns. Investors can receive returns through consistent distributions (preferred equity) or by participating in the upside when an asset sells (common equity). All BAM Capital assets are selected through rigorous underwriting, offering investors risk-adjusted returns and diversification.
As the private equity arm of The BAM Companies, BAM Capital has been focusing on buying the most profitable assets and staying disciplined in its investment thesis. BAM Capital’s investment strategy aims to create forced appreciation while mitigating investor risk. To date, the brand has successfully managed over $1.7 billion in assets across ~9,000 apartment units.
Remember that no investment is risk-free. Before making financial decisions, consult your investment advisor and schedule a call with a BAM Capital investment team member.
Disclaimer: All investments carry risk, including potential loss of capital. This content is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell any security. Consult an independent advisor for personalized guidance and contact BAM Capital for details on current offerings. BAM Capital and its representatives are not fiduciaries or investment advisors. The information provided is general and may not reflect individual financial goals. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect Bam Capital’s opinion and are subject to market fluctuations, economic conditions, and investment risks. Past performance does not predict future results. BAM Capital and its affiliates do not guarantee the accuracy or completeness of this information. Bam Capital offers investment opportunities under Rule 506(c) of Regulation D exclusively for accredited investors as defined by the SEC. Verification of accredited investor status is required prior to participating in any investment.
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SOURCES:
[1]: EquityMultiple. (2024). “What is Underwriting in Real Estate?” https://equitymultiple.com/blog/what-is-underwriting-in-real-estate#:~:text=Real%20estate%20underwriting%20is%20the,real%20estate%20private%20equity%20investments.
