When you’re looking to scale from single-family homes (SFH) to multifamily (MF) properties, it’s easy to assume that the same rules apply. After all, if you’ve completed a successful transaction or two in the single-family world, you’ve probably relied on some tried-and-true rules of thumb – the 2% rule, the 50% rule, and the 70% rule – to help you quickly assess deals and figure out whether they'll have cash flow. 

But here’s the truth: what worked in SFH doesn’t necessarily work in multifamily. In fact, if you’re trying to apply these same principles to multifamily, you’re likely to get yourself into trouble.

Let me tell you why.

Why Don’t “Rule of Thumb” Principles Work in Real Estate?

You’re probably familiar with these investing rules rules:

• The 2% Rule: The monthly rent of a property should be at least 2% of the purchase price. 

For example, if you’re buying a rental for $100,000, it should generate at least $2,000 per month in rent to be considered a good deal.

• The 50% Rule: You can estimate that half of the gross income from a rental property will go toward operating expenses (not including mortgage payments).

• The 70% Rule: This is often used by flippers to determine the maximum purchase price for a property. 

It says you should pay no more than 70% of the After Repair Value (ARV) minus the estimated repair costs.

But if you try to apply these rules to multifamily, you quickly find that the math doesn’t add up. When I first started analyzing apartments, I approached it with the same mindset I had for single-family homes. I used the same rules of thumb that had served me well in the past, but quickly realized they didn’t translate to the multifamily space. 

I was spending hours on a single deal, feeling stuck and unsure if my numbers were even close to accurate. 

Then, I discovered the right way to analyze multifamily properties. And let me tell you, it was a game-changer.

How to Value Commercial Real Estate

First off, I learned that commercial real estate is valued differently than single-family homes. In SFH, the value is often determined by comparable sales in the area. But in multifamily, the value is based on the property’s income potential. Here’s the formula: 

Let’s break that down:

NOI 

The NOI is pretty straightforward: it’s the income after all expenses but before debt service (i.e. the mortgage payment). This shows you how much income the property is actually bringing in. 

Capitalization Rate 

Cap Rate is a multiplier that is applied to the NOI to determine the value of a building. In other words, commercial real estate is valued at a multiple of its Net Operating Income. 

Let’s use these terms to calculate the value of a building together. 

Get Your Numbers From the Marketing Packages

Suppose the marketing package you get from your broker shows a Net Operating Income of $50,000. Applying a 6% cap rate, the building has a fair market value of $833,333:

Simple right? But how do you make sure you’re using the right numbers in your assumptions so that you’re valuation is accurate? 

You can’t rely on “city averages” or other generic data to underwrite a multifamily deal. The numbers you use must come from credible sources – typically brokers or marketing packages specific to the property you’re evaluating. If you’re pulling data from anywhere else, you’re setting yourself up for failure.

Now, I know what you’re thinking: “This sounds complicated. How do I make sure I’m doing this right?”

You don’t – not if you’re figuring this out for yourself by yourself. Multifamily real estate is a team sport. You need a team of brokers, lenders, and advisors who know the market and can help you navigate the complexities of analyzing these deals. Trying to do everything yourself, especially when you’re new to multifamily, is a recipe for making expensive mistakes.

When I finally got serious about multifamily, I realized that the key wasn’t trying to figure out everything on my own. 

It was about finding the right people to guide me – people who had already walked the path and knew the pitfalls to avoid. With their help, I was able to cut my deal analysis time down to 10 minutes and make offers that brokers took seriously.

So, what’s the takeaway here? 

You can’t use rule-of-thumb principles from single-family homes to analyze multifamily deals. Instead, leverage the expertise of those who’ve been there before. You need someone watching over your shoulder, helping you make sure your numbers are accurate and your offers are solid.

Stay tuned for more insights and tips on real estate investing. Subscribe to my YouTube channel and follow my podcast for the latest updates. Happy investing!