Illustrations of Multifamily Housing Economics
Table 1 illustrates how multifamily apartment projects calculate net operating income, and cash-on-cash, principal paydown and value increase returns, and cash that is available to distribute to investors and to project sponsors. Calculations like this illustration are performed for the total planning horizon of the project, typically for a ten-year period. Table 1 is intended to illustrate an average year for a typical Texas project.
Project-specific detailed calculations following formats such as shown in Tables 1, 2 and 3 are summarized in the Private Placement Memorandum that is issued to investors prior to the equity cash raise for the project.
Multifamily assets are typically priced based on a market-determined income multiple, calculated by dividing net operating income by a market-determined capitalization percentage, such as 7%, and by competitive bidding.
The project sponsor evaluates carefully the potential to increase net operating income (and hence value of the project) through market and project specific opportunities to increase gross income and to reduce operating expenses. The syndicator seeks to avoid paying more for the assets than the current actual net operating income of the project justifies.
Project management will use “yield management” data and software to set market-based rents. The goal is to achieve true market pricing, such as by charging more for the units with the most value in a project, including higher rents for apartments with views and bottom-floor units. A project sponsor will develop a capital plan directed at both improving the attractiveness of the project to tenants, and to reduce operating costs. The National Apartment Association lists the following amenities as the top ten value-add community-wide amenities for units upgraded since 2014: fitness center, business center, clubhouse, common socializing areas, pet-friendly improvements, landscaping in common areas, swimming pool, outdoor kitchen, playground or play area, and package holding area. The top ten value-add unit-specific amenities added include: washer/dryer in unit, high-end kitchen appliances, hardwood floors, lighting, plumbing and electrical upgrades, energy-efficient appliances, high-end kitchen countertops, ceiling fans, cable TV, garbage disposals, and patio, balcony, and personal outdoor space.
Table 1: Illustration of Calculation of Annual Cash Distributions and Returns (Illustrative Figures Derived From An Actual Project in Texas)
- Calculated by dividing the annual returns by the equity raise amount.
- The acquisition cost of this hypothetical 100 door project would be about $9.3 million, with a required initial equity raise to close of about $2.6 million.
To achieve these results the project sponsor would plan to spend $18,000 per door in staged capital improvements.
The acquistion cost per unit would be about $93,000. The required number of investors for this deal would be about 48 at $100,000 average investment.
- The acquisition capitalization rate for the project is about 6.7%.
Table 2 shows an illustration of the types of returns that can be achieved within the multifamily housing universe. Project specific projections of returns will be shown over the planning horizon for each specific project in the Private Placement memorandum. The cash distribution and appreciation projections are most importantly based on projected operations and value-add opportunities for the specific project. The principal pay down returns depend on the debt repayment schedule for the project.
Debt can be scheduled to be repaid in a variety of formats, such as amortizing over 20 to 30 years with a ten-year balloon repayment requirement. The financing structure of the project is very important, since it may affect the cash-on-cash returns available for distributions in early years (may be enhanced through an interest only payment requirement in the first few years), or whether the loan may be repaid without pre-payment penalties, and whether the loan may be assumed by a buyer, among other matters.
Table 2: 10-Year Planning for Success Matrix – Illustrative Returns
- The underwriting model for our investments will plan for similar or better results compared to those illustrated above, assuming a value add investment scenario. We will not present projects for investor approval that we believe would provide less than a 5% cash-on-cash annual return and an annualized 12% total return.
- The key underwriting revenue, operating cost and financing assumptions will be disclosed to investors and will be reviewed for appropriateness by the property manager, lenders, and our business mentor.
- The appreciation potential shown above is conservative; it is based on an approximate 3% average annual increase in value (based on a gross property cost of $400,000 per investor and a 25% downpayment).
- Due to uncertainty about future events, Master Multifamily does not guarantee any particular financial result for your investment. However, this illustration is intended to show our minimum investing goals. You could lose a portion or all of your principal invested.
Table 3 Illustrates how the taxable income or loss of the project is calculated. The specific loss or profit allocated to each investor on Schedule K-1 for each year of the project will depend on their own fractional ownership percentage in the project, operational success, capital spending, financing structure and the depreciation deductions that are available. Importantly, this schedule shows how investors can receive a tax-shielding benefit from the application of the tax laws. Usually, this permits all or portions of the cash distributions from the project to be shielded from immediate taxation. This tax shielding effect can enhance the present value of the investor’s investment in the project.
Table 3: Illustration of Calculation of Taxable Income and K-1 Data for Each Investor
The year 4 information is illustrative of the K-1 real estate loss that investors will receive during the first 5 years of operations. The K-1 for that year reflects a tax loss due to the short tax life of equipment.
Not included in this pro forma illustration is the short depreciable lives of some other portions of the facilities that can be identified through a cost segregation depreciation study of the facilities.