Mastering Multifamily Deal Analysis: A Beginner's Guide to Income, Expenses, and Returns

Investing in multifamily properties can be a smart way to build wealth, but understanding the numbers behind a deal is crucial. Without a clear grasp of income, expenses, and returns, even promising investments can turn risky. This guide breaks down the key concepts you need to analyze a multifamily deal confidently, using simple language and practical examples.

Understanding Income in Multifamily Deals

The first step in analyzing any multifamily property is to understand its income. Income mainly comes from rent paid by tenants, but it can also include other sources such as parking fees, laundry machines, or storage rentals.

Gross Potential Income (GPI) is the total rent the property could generate if all units were rented at full market rates. For example, if a 10-unit building rents each apartment for $1,000 per month, the GPI is $10,000 monthly or $120,000 annually.

However, properties rarely achieve 100% occupancy all the time. This leads us to Effective Gross Income (EGI), which accounts for vacancies and credit losses (unpaid rent). If the building has a 5% vacancy rate, the EGI would be 95% of the GPI. Using the example above, that means $114,000 in actual income.

Other income sources add to the EGI. If laundry machines bring in $500 per month, add $6,000 annually to the total income.

Breaking Down Expenses

Expenses reduce the income you actually keep. They include all costs necessary to operate and maintain the property. Common expenses are:

• Property management fees

• Maintenance and repairs

• Property taxes

• Insurance

• Utilities paid by the owner

• Marketing and leasing costs

  
  

For example, if annual expenses total $40,000 on a property with $114,000 EGI, that leaves $74,000 before financing costs.

Keep in mind, expenses vary by property and location. Always review detailed expense reports and compare them to industry averages to spot any unusual costs.

Calculating Net Operating Income (NOI)

Net Operating Income is the income left after subtracting operating expenses from the Effective Gross Income. It shows how much money the property generates from operations alone, before debt payments and taxes.

Using the numbers above:

• Effective Gross Income: $114,000

• Operating Expenses: $40,000

• NOI = $114,000 - $40,000 = $74,000

  
  

NOI is a key figure because it reflects the property's profitability and helps compare different deals.

What Cap Rate Tells You

The Capitalization Rate (Cap Rate) measures the return on an investment based on the NOI and the property's purchase price. It helps investors understand how much income they can expect relative to the price.

Cap Rate formula:

Cap Rate = (NOI / Purchase Price) × 100

If the property costs $1,000,000 and has an NOI of $74,000:

Cap Rate = ($74,000 / $1,000,000) × 100 = 7.4%

A higher cap rate generally means a better return but may come with higher risk. Compare cap rates of similar properties in the area to gauge if the deal is attractive.

Internal Rate of Return (IRR) and Why It Matters

While cap rate looks at current income, Internal Rate of Return (IRR) considers the total return over time, including income, expenses, property appreciation, and eventual sale.

IRR is the annualized rate that makes the net present value of all cash flows (both incoming and outgoing) equal to zero. It accounts for:

• Rental income over the holding period

• Operating expenses

• Financing costs

• Sale proceeds after expenses

  
  

For example, if you buy a property for $1,000,000, receive $74,000 NOI annually, and sell it after 5 years for $1,200,000, the IRR calculation will show your average annual return including both income and appreciation.

IRR is more complex to calculate but provides a fuller picture of investment performance. Many investors use software or financial calculators to estimate IRR.

Putting It All Together: A Simple Example

Imagine you are considering a 20-unit apartment building priced at $2,000,000. Here’s a simplified breakdown:

• Average rent per unit: $1,200/month

• Gross Potential Income: 20 × $1,200 × 12 = $288,000

• Vacancy rate: 7%, so Effective Gross Income = $288,000 × 0.93 = $267,840

• Other income (parking, laundry): $6,000

• Total Effective Gross Income = $273,840

• Operating expenses: $90,000

• Net Operating Income = $273,840 - $90,000 = $183,840

• Cap Rate = $183,840 / $2,000,000 = 9.2%

  
  

If you plan to hold the property for 7 years and expect to sell it for $2,400,000, you can estimate IRR using these cash flows. This helps you decide if the investment meets your return goals.

Final Thoughts on Multifamily Deal Analysis

Understanding income, expenses, NOI, cap rate, and IRR gives you a solid foundation to evaluate multifamily deals. These numbers reveal how much money a property can generate, what it costs to operate, and the potential returns over time.

Start by reviewing real examples and practicing calculations. Use this framework to compare deals and make informed decisions. Remember, no single metric tells the whole story, but together they help you see the full picture.

If you want to take your investing further, consider working with experienced professionals and using tools designed for real estate analysis. The more you practice, the more confident you will become in spotting strong multifamily investments.