Investing in multi-unit properties can be a powerful path to building wealth, but it’s far from gambling. It requires a strategic approach, meticulous analysis, and a clear understanding of the numbers.
This guide will introduce you to the key performance indicators (KPIs) that savvy investors use to evaluate potential properties and ensure their investments are sound.
While we can’t promise a 100% success rate – no investment comes with such a guarantee – diligently applying these KPIs significantly increases your likelihood of making profitable decisions.
Let’s dive into the core metrics that tell the true story of a multi-unit investment.
Multi-Unit Investment Potential: Essential KPIs for Success
KPIs are the measuring sticks for any endeavor worth doing, and real estate investing is no exception.
They provide objective data to assess whether a property aligns with your financial goals.
We’ll explore the targets and formulas for each, focusing on the Los Angeles County market as a reference.
If you’re investing outside this area, consult with a local specialist to determine the appropriate regional targets.
1. Gross Rent Multiplier (GRM)
The GRM is often the first screening tool for any multi-unit property. It offers a quick way to compare the price of an income-generating property to its gross rental income.
Formula: Property Price / Annual Gross Rents = GRM
Target (LA County): A sweet spot for GRM is typically between 10 to 13. Hitting this range indicates a potentially strong initial investment.
2. Vacancy Factor
The vacancy factor represents the percentage of time a rental unit is expected to be empty. A lower vacancy factor means more consistent rental income.
Target (LA County): Due to high housing demand, LA County generally sees a low vacancy factor of 3% to 5%. In other regions, this number could be higher, potentially ranging from 6% to 10%.
3. Capitalization Rate (Cap Rate)
The cap rate is a fundamental metric that reflects the unleveraged rate of return on an investment property. It helps investors estimate their potential return and compare different properties.
Formula: Net Operating Income (NOI) / Property Price = Cap Rate
Target (LA County): A healthy cap rate in LA County typically falls between 4% to 7%.
4. Debt Service Coverage Ratio (DSCR)
The DSCR is crucial, especially for properties being financed. Lenders use this ratio to assess a property’s ability to cover its mortgage payments from its net operating income.
Formula: Net Operating Income (NOI) / Mortgage Payment = DSCR
Target (Lenders): Lenders generally look for a DSCR between 0.80 and 1.25. A higher DSCR (closer to 1.25) is more favorable for securing financing.
5. Return on Investment (ROI) / Cash-on-Cash Return
ROI, or more specifically, cash-on-cash return, measures the annual pre-tax cash flow generated by the property relative to the amount of cash invested.
Formula: Total Annual Cash Flow / Total Cash Investment = ROI (Cash-on-Cash Return)
Target (LA County): Aiming for an ROI of 6% to 10%, with 7% to 8% being an excellent sweet spot, indicates a strong return on your invested capital. This often outperforms traditional savings accounts or money market options, especially when considering the additional benefits of real estate.
Beyond the Basics: Advanced Considerations
While these core KPIs provide a solid foundation, experienced investors also consider other factors, particularly tax-related benefits like depreciation, write-offs, and their impact on overall tax brackets.
These advanced considerations are highly personalized and best discussed with a qualified tax professional.
Don’t Let Your Equity Underperform
It’s common for property owners to sit on significant equity without realizing its full potential.
Many might be earning a meager 2% to 4% return on their equity, effectively losing money when inflation and other factors are considered.
By analyzing your property’s performance through these KPIs, you can identify opportunities to improve your returns, potentially through a 1031 exchange or other strategic moves.
Investing in multi-unit properties isn’t about guesswork; it’s about making informed decisions based on solid numbers.
By understanding and applying these key performance indicators, you empower yourself to build a robust and profitable real estate portfolio.