Multifamily owners have varying objectives for their multifamily investment property and the decision to renovate is complex but can be primarily boiled down to two points:
- How much will it cost me to renovate?
- How much more rent can I charge?
Fortunately, there are financial formulas that will assist multifamily property owners in making the correct remodel decision for their property. This blog will breakdown the decision-making process into bite sized pieces that will assist multifamily owners in making the correct financial decision on whether or not they should renovate their property.
Step 1 – Identify your competition and market rental rates
Identifying your competitors and the current market rental rates is imperative information to have if you are considering a renovation. You need to know the market data on how your rents compare to similar properties and what rents are for properties with different levels of renovation. Fortunately, this information is relatively easy to come by using an online search. Below are several good informational sites you can assist you in your search:
Step 2 – Choose the Scope of renovation
Once armed with the information in outline in Step 1, you will need to decide the scope of work to be performed. In order to accurately identify a scope of work you need to partner with a qualified contractor, like Wheelhouse Construction, that will work with you to compile a realistic budget and help you choose materials that are cost effective, resilient and will command the highest possible rent in the marketplace.
Below are the areas you need to consider for your renovation project:
- Exterior
- • Landscaping
• Painting
• Flat Work
• New or Improved Amenities
- Common Areas
- • Floor coverings
• Paint
• Light Fixtures
- Units
- • Floor Coverings
• Window Coverings
• Cabinets (New or Paint)
• Light Fixtures
• Plumbing Fixtures
• Paint
• Doors
Step 3 – Financial Analysis
You now have all of the components to help you make an informed decision on renovation. In the examples below let’s use the following information*:
- 10-Unit building
- Pre-renovation rent per unit $900/month
- Post-renovation rent per unit $1200/month
- Projected Renovation Cost $12,000/Unit or $120,000
- Prevailing Cap Rate (R)= 5.5%
*Please note that the example above is for educational purposes only.
Using the information above you can now use the following calculations to analyze your renovation investment:
Return on Investment
Return on Investment (ROI) is calculated by dividing the $ return on the investment by the cost of investment and multiplying that 100%.
- Net Return on Investment = post renovation rent – pre renovation rent X # of units
- Net return on Investment = 1200-900= $300
- $300 rent increase x 10 units = $3000/month increase x 12 months = $36,000
- ROI = $36,000/$120,000 = .30 x 100% = 30%
In this scenario you will get a return of 30% on the renovation investment of $120,000.
Now that you have the ROI, calculating the payback in years of your renovation investment is as simple as flipping the ROI calculation around. Payback is equal to cost of investment divided by net yearly return on investment:
$120,000/$36,000 = 3.33 years to payback the investment
Value Analysis
Value Analysis is used if you are considering either refinancing or selling your asset. In order to calculate the actual value of your renovation you need to contact either an appraiser or apartment broker to determine what the prevailing capitalization rate (cap rate) is for the market you are in. The cap rate is the rate of return that an investor expects to receive.
The calculation to determine value is:
V= Income/Rate
Where
V= Value
I= Net Return on Investment (same number as above)
R = Cap Rate
Using the scenario in step 3 the value of your renovation project is worth:
V= $36,000/5.5% = $654,545
Once you have researched your competition and current market rates, decided on the scope of renovations you want to embark upon, and have done a financial analysis, you will be be equipped with tools to help you decide if renovating is worth while. The two key factors of knowing the renovation costs and how much you can increase rental rates by should enlighten multi-family owners into an educated decision. Wheelhouse Construction is equipped to assist you in any of your multi-family renovation needs. Contact us to discuss your multi-family renovation project today!
