4 Sources of Returns for Multifamily Investors

 Introduction:

Looking to invest in multifamily properties? Understanding the key sources of returns is essential. In our blog, “4 Sources of Returns for Multifamily Investors,” we break down the basics to help you navigate this lucrative market with confidence. From reliable cash flow to tax advantages, property appreciation, and equity building through mortgage payments, we simplify the essentials for your investment journey.

1. Cash Flow Income

This refers to the steady stream of income, often termed “mailbox money,” that investors collect on a regular basis, either monthly or quarterly, from their multifamily properties. The process of determining your cash flow typically involves the following calculation:

Total Revenue (comprising rent payments, fees for storage and amenities)
– Operational Costs (including expenses for repairs, property management, marketing, taxes, insurance, and more)
– Allocations for Capital Reserves
– Mortgage Payments (covering both the principal and the interest)
– Fees for Asset Management

= Net Cash Flow or Disposable Income

For investments in Class B properties with potential for value enhancement, initial cash flow rates often range from 5-8%, with the potential to rise to between 10-12% as improvements are made and value is added.

2. Tax Advantages

Multifamily properties offer a range of tax benefits that enhance their appeal to investors.

One key advantage is depreciation, which permits the building’s value to be depreciated over 27.5 years. This means an owner can deduct a 27.5th fraction of the building’s value from their taxable income annually, often significantly reducing or even neutralizing taxable income in the initial years of ownership.

Moreover, certain property components like cabinets, appliances, and fixtures qualify for accelerated depreciation. This can be determined through a professional cost-segregation study, which pinpoints these items and assigns their value for faster depreciation.

Another significant perk is the treatment of rental income as passive, particularly for those who don’t classify as real estate professionals. This means such income is taxed at passive rates, exempting it from employment taxes.

Furthermore, any profits from property appreciation are subject to capital gains taxes, which are typically lower than regular income taxes.

3. The Power of Appreciation

The transformative potential of appreciation in building lasting wealth is profound. It stands as a pivotal factor, offering two primary forms—market appreciation and forced appreciation.

Market appreciation emerges from demographic shifts, employment growth, and the interplay of demand against the backdrop of housing availability.

On the other hand, forced appreciation presents a more intriguing scenario. It’s driven by proactive measures taken by property owners to enhance the Net Operating Income (NOI) through revenue augmentation, cost reduction, or a blend of both.

Enhancements that lead to higher income or lowered expenses directly contribute to increased property value. The forthcoming example illustrates how minor adjustments can yield significant financial outcomes.

Consider a scenario with a 100-unit building operating at a 6% capitalization rate. Implementing a modest annual rent increase of $25 per unit translates into a remarkable $2 million elevation in property value over four years.

4. Principal Paydown

Rental revenue from occupants is directed towards servicing the multifamily property’s mortgage, effectively diminishing the remaining loan amount. This process of equity building often yields a yearly return of approximately 2-4% through the reduction of the principal debt.

Convinced about the benefits of multifamily investing? Learn more about the opportunities and our proven track record in multifamily apartment ventures at Faris Capital Partners. Click here to arrange a discussion with our Investor Relations team and learn more.

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